Covid-19 and the stock market crash have made life extraordinarily uncertain. That makes our task as investors particularly hard. Normally, we can value a company’s shares based on future cash flows or profits. Even before the onset of the virus, estimating future earnings was difficult. It has now become virtually impossible. How can we value shares if we have no idea what earnings will look like in six months’ or year’s time?
How would I invest now?
First of all, I would stick to ‘value’ stocks that are trading below what they’re really worth. They generally have a lower risk profile than growth stocks and usually have earnings that are predictable and steady. They tend to be stable companies that will perform well under a range of different economic conditions. They’re the companies that even today, are often able to operate at somewhere near normality, like Sainsbury’s or Mondi.
They may not double your money in one year, but they’re the kind of investments that should deliver steady returns year after year. In today’s circumstances, this is exactly the kind of investment that I’m looking for.
Growth stocks can be great. But they’re also riskier. Investors usually end up paying a much higher price for the hope of future growth. And this growth may not come to fruition, especially in the current climate. Stocks that continuously fail to miss growth expectations are likely to sooner or later suffer the effects of gravity, as the stock market crash showed only too well. As a general rule, when the economic backdrop becomes more uncertain, I want to invest in stocks that are more certain.
Stable returns in the stock market crash
Value stocks aren’t boring either. They often come with high dividends of 4%+ and generate solid returns on capital. Once earnings and dividends have been compounded over years, they’re likely to produce impressive returns for investors. Even better, they generally do this with less volatility than their riskier counterparts. After the stock market crash, there’s no shortage of stocks that fall into this category.
I would also avoid investing in companies that look like they could blow up at any time. In the current climate, companies need to have strong balance sheets, to be able to weather the storm. Right now, a strong balance sheet is more attractive to me than growth. After all, what use is future earnings growth if a company goes bust beforehand?
Having said that, I could be tempted to take on riskier stocks, if the price was low enough and I had many years of investing ahead of me. The low price would compensate for taking on the extra risk, with outsized gains being the potential reward.
Following the stock market crash, there are some interesting opportunities out there, for those prepared to take on extra risk. For a start, insurers and banks look too cheap to me, especially given their strong balance sheets and solid business models. For those feeling even more adventurous, it may be worth looking at airline stocks, given their price levels. Just be aware that in a pessimistic scenario, they won’t look so cheap. I’d always balance any riky plays on future fast growth with more reliable stocks in a portfolio. And the closer I get to retirement, the less risk I’d want to take.
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Thomas has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020