Looking at shares: Telescope or microscope?
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.
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
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.)
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.