Valuations matter

A relatively short blog post this one. It's really for those who are relatively inexperienced in 'stock picking' and those fretting about the current situation.

This is the third bear market/huge correction I've encountered since starting my 'stock picking' passion.

I suspect it's more of a bear market than correction because it feels very much like 2007/2008. Just when you think a company's share price can't get any lower, it does.

In truth, the huge sell off has been a long time coming. I thought last year would be the year, but of course there were no triggers. However, along comes Covid-19, mass hysteria, mass panic and stock markets around the world plummet as potential worldwide recession casts it gloom across the globe. It's the end of the world!! Again.

In future, some of the signs to look for before a mass sell off are stock pickers relatively new to investing believing they're demi-gods after a couple of years or so of positive returns, a rise in the 'investment gurus' on social media and elsewhere where their mere mention of a company moves it's share price up regardless of it's valuation (I'll come to this in a minute), a significant number of companies on p/e ratios of 30+ which can all be justified of course because earnings will eventually reach infinity and beyond, companies with market caps that are a significant multiple of it's revenues. These are just some signs, but I could go on.

Largely, I learnt my lesson (and it was an invaluable lesson) in the dot-com boom and bust (look it up if you're new to stock picking or a youngster). I wanted a piece of the 'stock market' action, but knew sod all about balance sheets, p/e ratios, balance sheets etc. I got lucky at first, every one's a winner!! Big percentage rises, easy money! Of course, along came the non too friendly bear and oh dear!

Here's the thing though. At that stage of my 'stock picking' excursion I thought I was being sensible and conservative. Two of the companies in my portfolio were GlaxoSmithKline and British Telecom.

I bought GSK for about £20 and BT for around £8 per share. During the bear market, their share prices plummeted. These are quality companies (certainly in GSK's case) but in nearly 20 years the share prices of these companies has never returned to these levels. I should add however that at least you'd have received a nice income stream, but capital appreciation would have been less than zero. Quality companies but not great investments at those prices.

The bear market was the best thing that happened to me however. I couldn't understand why the share prices of these two stalwarts of the market had fallen so dramatically?

That's when I started to read extensively. I'm not talking about the shite website tipsters, the bloggers, the twitter gurus or bulletin board heroes. Ignore all these. Get some books and information about the proven great investors with track records e.g. Buffett, Graham, Lynch, et al and learn about dividends, p/e ratios, net asset values etc.

When I did this in the early 2000s it was transformational. I quickly ditched GSK and BT and took the losses on the chin. The stock market made sense and was no longer a scary place. Knowing how to value companies sensibly is the key to successful investing. Bear markets create huge opportunities. Life changing opportunities.

Of course, I still make mistakes and pick some howlers, but being able to pick companies on a cheap valuation gives you an edge. Where's the evidence then? Well here's one example. The majority of the shares were bought around the 25p mark. The company eventually got bought out for £6.50, not to mention all those dividends and special dividends along the way:-

https://uk.advfn.com/cmn/fbb/thread.php3?id=20681152&from=1

If you read no further than post 2 on this thread it'll give you an idea of why the valuation of this little known company was fantastically appealing. It'll also give you an idea of how low valuations can sink in times of irrational panic.

In conclusion, valuations matter!