By Simon Angelo
October saw most markets down heavily. It wasn't a crash - which generally constitutes a double digit fall over several days, but it was a decidedly bearish correction with the Nasdaq down 12.3% (from month start to end) and our benchmark - the MSCI World Index down almost 9%.
Some over-diversified products such as ETFs and KiwiSaver Growth accounts for example saw balances drop more than 10%.
For the value investor, with convictions on a much smaller number of businesses and sectors you have been following for years, this should present a buying opportunity. You back your research, back your preferred businesses, take the risk (of further correction) and top up.
The reality in this market is good businesses are holding their value which reinforces our belief in following a global but concentrated strategy. Against wider falls of 10%+, our composite portfolio strategy was down only 3.07% from October start to end.
Dividends play a role
By definition, a good business produces excess cash flow, enough to both distribute as profit and reinvest for future growth. When the market falls and hard times come, these sort of businesses weather the storm better than others. Even when price declines, you can still enjoy a running yield over 5%. This allows you to continue to hold these businesses until growth in the economy and market resumes.
A more risky type of investing is to focus on stocks that are purely growth oriented. These are often tech or small cap businesses that reinvest all profits (if any) and don't pay a dividend. Some investors have made big returns from these businesses - I'm thinking of one local cloud based software business for example. These investors deserve their returns. They've taken on a lot of risk, since such businesses can also be worth nothing, quite quickly.
The problem for a value investor hunting for value, is that these hot, growth businesses look pretty speculative when you start reviewing the assets they own and the cash burn needed to build them. And then you enter a territory where you're investing into something you don't fully understand or can reasonably predict the outcome of. In other words - taking a punt, or gambling.
When you're seeking to increase income and deliver stable return from capital, there's no place for gambling. Moreover in the public markets, short sellers can more easily spot problems with business models based on slender assets than you can spot untapped potential.
Speaking of potential and value...
Market sogginess weighed heavily on one of our UK positions through October - the home builder Crest Nicholson. Brexit concerns, a tough London property market, an earnings downgrade and the bearish sentiment pulled it down to a 5 year low of 274 pence. It had been trading as high as 622 last year.
Around 280 pence, PE (Price to Earnings) was as low as 4, asset value was well supported by land holdings in Southern England and the company had a clear plan to slow down building and maximize cash flow while waiting for the market to improve - which the market could likely do once Brexit pans out next year. The more than healthy dividend of around 10% is also well supported.
Looking at market depth and announcements it is now clear that smart investors bought large positions, internal directors increased their holdings and in just two weeks it went from 274 back up to nearly 350. Those investors have enjoyed a 27% return in 2 weeks while they await their next dividend payment in March - on track to yield 10% p.a. on top of the growth.
It is these sort of value spots in a bearish market that present golden opportunities for the value investor and that's why now is such a good time to enter the market to take advantage.