The last two months have seen a level of volatility in the FTSE 100 which has not been present for many years.
Firstly, it collapsed from around 6800 points to as low as 5850 points within the month of August as concerns surrounding Chinese growth potential caused fear among investors to soar. Then, it recovered to 6,200 points in the following days before shifting violently between loss and profit so that it yo-yoed up and down day-by-day (and sometimes hour-by-hour).
The last ten days have seen it rise from around 5,900 points to over 6,400 points and, at the present time, investors seem to be relatively upbeat about the index’s future. This, though, can change very quickly and could understandably lead to many investors thinking that the UK’s main index is little more than a roulette wheel in a posh frock.
In the short run, this appears to be true. Buying the FTSE 100 now with a one day, one week or one month timeframe is little more than a punt. Within that space of time, it really is anyone’s guess as to which way it will move and by how much, thereby making it a gamble rather than an investment.
However, over a longer period of time, say three to ten years, the FTSE 100 is a whole lot less like playing roulette. In fact, it could be argued that luck or chance play only very small parts in the long term performance of the UK’s main index.
That’s because it is a reflection of the financial success of some of the largest companies in the world. Therefore, by investing in businesses which have attributes such as a wide economic moat, a competitive advantage, an appealing valuation or a product which offers strong growth potential, it is possible to benefit directly from their success. And, while not all companies will see their profitability rise over the long run, for the savvy investor there are opportunities to identify unique business models and strong management teams which can deliver bottom line growth over a sustained period of time.
In fact, it is the growth in profitability which has the main impact on a company’s share price performance in the long run. Although investors may reward increasing dividends and a bright future outlook with higher valuations, realistically it is the delivery of consistently high profit growth which causes share prices to rise at a rapid rate.
This contrasts sharply with the short term gyrations of the stock market, which are based on emotion rather fact. For example, in the last two months very little has changed in terms of the financial performance of the FTSE 100’s constituents, but investors have been fearful, greedy and now they are somewhere in between.
So, while over the next two months the FTSE 100 may climb back to 7,000 points or drop back to 5,850 points, nobody really knows. However, in three, five or ten years’ time, buying shares in high quality companies now is likely to prove to be a shrewd move.