With the market heading back to record highs, it leads me to ponder my next move.
Is the market so buoyant and frothy that I need to be concerned about a bubble?
There is some evidence in the tech and AI space in the US, where many of the big names have doubled in price in the last 12 to 18 months. Companies like Amazon, Apple, Google, Meta (Facebook), Microsoft and NVIDIA, all have trillion-dollar (+) valuations. True, they have changed the way we communicate, connect and do business. However, have short-term expectations outpaced what can realistically be achieved in the near-term?
Even here in Australia, the big banks, retailers and technology companies are enjoying valuations rarely seen. So, what should investors be doing?
At times like this I ask myself three question(s): What’s my strategy? What am I trying to achieve? And does it matter if a share price, and or even the market, falls 30% tomorrow? Sure, it wouldn’t be nice, but does the risk of such a possibility change my strategy?
To answer these questions, I apply the following framework.
- Do I have enough cash and cash flow to be a patient long-term investor?
You don’t want to be a forced seller, but if you are, better to face up to that fact while the market is buoyant, as opposed to waiting for a correction to bring home the reality of your position.
- Do I own quality businesses?
Good management, sound balance sheet, innovative and productive culture, able to compete and grow. If so, they’re not for sale, but unfortunately not every business that I buy will retain its ‘quality’ status, and a buoyant market is often the best time to weed out businesses with operational issues.
- Do I have a diversified portfolio?
As a rule of thumb each holding should be between 3% and 7% of the portfolio. Too many small holdings are hard to follow, and large holdings can have too much influence over a portfolio’s returns and strategy. A buoyant market can be the opportunity I need to trim large holdings in mature businesses, although I will be more patient with businesses delivering strong growth.
- Is the portfolio capable of achieving my return objective?
Typically, this means the portfolio will be generating income of around 5%, plus 5% EPS growth (Earnings Per Share), and be trading close to fair value, at least based on the Morgans analyst’s valuation. A portfolio will typically include quality stalwarts that produce reliable income + higher growth companies to deliver the EPS growth that the portfolio will need to grow over time.
- Should I be investing some of the surplus cash that I might have?
Price always matters. Cash is a valuable asset, and it gives you the capacity to buy things when the price is right. I’m not talking about waiting for a crash, they do happen, but there is no guarantee that I will have the understanding or conviction to act when they do. Plenty of wealth has been created by simply buying quality businesses at a fair price and compounding reasonable returns over time. A fair price is not about ‘knowing’ the future share price, it’s about considering historical valuations metrics, current conditions and opportunities and making a judgement call as to whether the current price is fair and reasonable?
I also like to review past performance, after all, that’s all we have to go on. It is true, no-one knows the future, including me, and arbitrary things can and do happen, and for better or worse mistakes will be made, but statistically the optimists have won. Despite the uncertainty and the inevitable crisis or two, the market has continued its relentless climb.
If an investor had bought the ASX 200 on the 1/7/1994 and held the ASX 200 for 30 years, until 30/6/2024, they would have received the income stream illustrated in the chart below. To be clear the investor takes and spends the income each year (the dividends haven’t been re-invested). Some years their income is cut, as it was during the GFC and during Covid. Some years it’s flat. But overtime the income stream has grown at 5% compound and that initial investment of $400,000 has grown to be worth more than $1.7million.
True investment returns do not come from trading securities, in some zero-sum game, but from owning businesses that produce the goods and services society needs and will pay for. Investors are savers and their savings have come from their work and it is because they have worked, saved and invested that we have the goods and services we need today for our lifestyle and living standard.
I am cautious about the level of the market, but more because I am used to volatility, as opposed to there being a specific issue; it could be inflation and interest rates, it could be the politics in multiple jurisdictions, or it could nothing at all. Just staying vigilant and asking the question, do you have enough cash and cash flow to be a patient investor?
More Information
Ken Howard is a Private Client Adviser at Morgans. Ken's passion is in supporting and educating clients so they can attain and sustain financial independence.
If you have any questions about your financial plan or your share portfolio, your strategy, investments or would just like to catch up, please do not hesitate to give Ken a call on 07 3334 4856.
General Advice warning: This article is made without consideration of any specific client’s investment objectives, financial situation or needs. It is recommended that any persons who wish to act upon this report consult with their investment adviser before doing so. Morgans does not accept any liability for the results of any actions taken or not taken on the basis of information in this report, or for any negligent misstatements, errors or omissions.
.jpg)
