Look­ing at shares: Tele­scope or mi­cro­scope?

Finweek English Edition - - MONEY - Mar ’98 Mar ’05 BY SCHALK LOUW

Ioften wish t hat t he world of eq­ui­ties could be as f lat as the Ka­roo, so that we could look into the fu­ture and see at what lev­els shares would be t rad­ing by t hen. Wouldn’t that have made in­vest­ment man­age­ment so much eas­ier? Since we don’t know what share prices will be in the fu­ture, we have to rely on other aids.

In­vestors of­ten dis­agree about how to buy and sell shares. Some pre­fer to look through a tele­scope at the ‘ f lat Ka­roo’, well into the fu­ture. They are more than will­ing to buy shares and to wait pa­tiently for good re­turns. Their rea­sons for buy­ing shares are never spec­u­la­tive and they are not wor­ried about short-term f luc­tu­a­tions in the mar­ket. Oth­ers take a look at t he mar­ket t hrough a mi­cro­scope, be­liev­ing t hat ac­tive man­age­ment holds the key to good re­turns.

Shares are bought with the in­ten­tion of gen­er­at­ing quick re­turns, as th­ese in­vestors be­lieve that they will be able to beat the mar­ket over the long term. This week, I will be tak­ing a look at the mar­ket through both a tele­scope and a mi­cro­scope.

1. Tele­scope

This in­vestor buys shares and sees them as a good long-term in­vest­ment. They aren’t both­ered by short-term f l uct ua­tions as t hey si mply don’t eval­u­ate the mar­ket on a day-to-day ba­sis. They se­lect shares that evolve over a longer pe­riod, usu­ally about five to 10 years, and that should out­per­form r i sk-f ree i nvest­ments, such as t he money mar­ket.

Poor mar­ket con­di­tions there­fore of­fer th­ese in­vestors the op­por­tu­nity to in­crease their mar­ket ex­po­sure at more rea­son­able prices.

Con­sider share per­for­mance over the

-20% -40%

Mar ’92 10Yr (Ave 17.4%) 2Yr (Ave 15.5%)

SOURCE: PSG Wealth Old Oak & I NET BFA past 24 years (since March 1991), bro­ken down into one-, two-, five- and 10-year in­vest­ment pe­ri­ods above. You will see that although your re­turns might have been much higher over a par­tic­u­lar oneor two-year pe­riod, you could also have ex­pe­ri­enced more neg­a­tive years.

When look­ing at shares over a five- to 10-year pe­riod, to­tal re­turns were more sta­ble, in the re­gion of 17% a year.

Even more in­ter­est­ing is the fact that if you had mon­i­tored your shares over a five-year pe­riod or longer, you never would have ex­pe­ri­enced a neg­a­tive re­turn over the en­tire 24-year pe­riod. (This in­cludes at least three big cor­rec­tions in the mar­ket.)

2. Mi­cro­scope

5Yr (Ave 15.3%) 1Yr (Ave 17.6%) The mi­cro­scope strat­egy isn’t en­tirely use­less as it can be ap­plied quite ef­fec­tively. Firstly, you can prac­tice the im­por­tance of good tim­ing and se­condly, you can use this strat­egy to iden­tify over­re­ac­tions in the mar­ket.

When look­ing at the mar­ket’s priceto-earn­ings (P/E) ra­tio (which gives an in­di­ca­tion of how much in­vestors are will­ing to pay for mar­ket ex­po­sure) over

Port­fo­lio Manager at PSG Wealth the past 24 years, it would seem as though we are cur­rently trad­ing at lev­els that were ac­cepted as fully priced (ex­pen­sive) in the past.

The con­sen­sus growth rate ex­pected by the mar­ket (now at neg­a­tive lev­els) is -0.51%. This will al­low the P/E ra­tio to trade around 18.5 times if the mar­ket re­mains at cur­rent lev­els. If we com­pare this to the long-term av­er­age of 14.8 times, this makes the mar­ket ex­pen­sive.

The mi­cro­scope in­vestor prob­a­bly won’t be too wor­ried about wait­ing for the mar­ket to be­come cheaper again be­fore in­vest­ing. A re­cent dan­ger arose, how­ever, with in­ter­est rates sit­ting at ex­tremely low lev­els world­wide and con­tin­u­ing to sur­prise on the pos­i­tive side. This is an­other fac­tor that should be mon­i­tored with a mi­cro­scope in the fol­low­ing months.

I be­lieve that an in­vestor look­ing for a bar­gain in this mar­ket will need a very good mi­cro­scope in­deed. When in­vest­ing in shares, I rec­om­mend a longer-term ap­proach in which you for­get about short­term f luc­tu­a­tions – rather look into the mar­ket’s fu­ture through a tele­scope.

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