Following the coronavirus crash, we’ve been seeing an impressive stock market recovery. And the speed with which some shares have been shooting back up has surprised many people.
The big fear is the recession in the real economy could be long and hard. And it can be tough to square that possibility in your head with buoyant stocks. But the stock market is a leading indicator. And all the investors participating in the market are looking ahead to where the economy may be going.
In sport, for example, it’s a good idea to run to where the ball is going rather than to run to where it is now! I reckon something similar has been happening in the stock market over recent weeks.
Meanwhile, some of the best investments we can make are when the outlook remains a little murky. If you want certainty, expect high stock prices as well – the two go hand in hand. And the opposite can be true – with uncertainty, shares can be priced lower by the market.
Cheap shares in the stock market recovery
One of the three ways I reckon you could boost your chance to make a million in the market is by buying cheap shares. But what is a cheap share? One way of looking at it is that cheap can be defined by low earnings multiples, and low share prices compared to assets. As well as other traditional value indicators.
However, that’s not the whole story when it comes to ‘cheap’. Take the stocks with cyclical underlying businesses, for example. In many cases, they’ve seen the complete loss of revenue and profits during the lockdowns. So valuing those shares against non-existent earnings would be meaningless.
Think about names in the FTSE 100 such as cruise operator Carnival, hotel and restaurant company Whitbread, and retailers Next and Burberry. Earnings have collapsed and their P/Es look high. But the share prices are much lower than they were before the crisis. And there’s huge potential for recovery in the underlying businesses.
So I’d describe those fallen cyclical stocks as cheap. To me, they look attractive right now.
New opportunities
The crisis has thrown up new opportunities for some companies, such as in the healthcare sector.
And one of the other dramatic changes has been the high uptake of working from home. Indeed, some of those changes could end up being permanent.
Sectors benefiting from the switch include IT and technology. Providers of cloud services and video conferencing are obvious examples, but many London-listed companies have been doing well lately. I’d look for opportunities in some of the lesser-known names, such as Sage in the FTSE 100, and smaller companies like EMIS and Oxford Metrics.
Solid businesses
A third group of businesses has seen little change to trading patterns because of the coronavirus. These tend to be the well-established, defensive and cash-generating companies that are resilient to the ups and downs of the general economy.
They can be great vehicles for compounding your investment by ploughing the dividends back in. I’m thinking of FTSE 100 names such as British American Tobacco, Diageo, GlaxoSmithKline and National Grid.