Yesterday it was ‘all quiet again’ on the Western markets’ front.
After the slump at the start of the week, and the madcap rises of Wednesday, the FTSE 100 traded in a narrow range. It ended up just five points. And Europe was much the same.
As John Stepek has been saying of late, it’s all a bit confusing. One moment, most people seem worried that economic meltdown is nigh. Next minute, everything looks all right again.
But current stock market volatility is still serving up ways of making good money. For example, this looks like a good time to lock in decent profits on some of our previous tips. And on the same basis, there could be some buying opportunities, too…
Snap up cheap stocks while they’re out of favour
If you’re a genuine long–run investor, you probably shouldn’t spend too much effort in trying to ‘time’ the market. Even the legends of the investment world, like Warren Buffett, don’t really attempt it.
Ben Graham, the ‘father’ of value investing, bought stocks when he believed they were cheap, not because of where the index stood.
And Peter Lynch, who once ran Fidelity’s Magellan fund, bought many stakes in small cap stocks he reckoned were undervalued. He then held these until the market realized their true worth. Although that often took time, Lynch notched up a 29% annual compound return from 1977 to 1990, around twice that achieved by the S&P 500 index.
Clearly stock markets overall are very volatile right now. Yet one of the best ways of beating them is to unload expansive shares while the going’s good, and be ready to snap up cheap stocks while they’re out of favour.
At MoneyWeek we’ve been banging the ‘high-yield cheap defensives’ drum for months now. In other words, we’ve been tipping a raft of companies that don’t depend on economic growth to make money. Also, they’re cheap. And they pay above-average dividend yields.
We’re talking about the likes of food retailers, ‘big pharma’ firms, non-life insurers, electricity/water utilities and telecom service companies. In last year’s ‘dash for trash’ rally, they were all unloved sectors. But broadly speaking, they’ve been the right place for your money while the overall market has trended sideways-to-lower in 2010.
At some stage, though, we reckon the market will recognise the true value that these stocks contain. That will mean their share prices – and valuations – rising someway higher. So their yields must drop.
It’s time to take profits in water utilities
Indeed in one of these areas, that process is already well underway. So much so, in fact, that it could well be time to take your profits.
Last October we reckoned the market was providing a handy buying opportunity in Britain’s water utilities. Or to be more precise, some tough talking from the water regulator Ofwat was driving down the sector’s share prices into nicely cheap territory.
But to cut a long story short, Ofwat has since softened its tone. And over recent months, investors have steadily latched onto the value appeal of the UK’s water stocks.
Sewage and waste management operator Pennon (LSE: PNN) has since served up an overall return, including dividends, of more than a third since October 2009. International water utility Severn Trent (LSE: SVT) has returned some 46% in total during that time.
Further, UK water and sewerage firm Northumbrian Water (LSE: NWG) has made 21% including dividends for its shareholders since we tipped it less than three months ago.
At the same time, as you’d expect, the valuations of these stocks have risen while the yields have dropped. Pennon is now on a current year p/e of 16 and a 4.1% prospective yield. Severn Trent is slightly cheaper. But it’s still on a multiple of over 15 times, while the prospective yield has fallen below 5%.
OK, neither valuation has reached crazy levels. But you could no longer describe either stock as cheap. So taking your profits looks like common sense. Northumbrian, meanwhile, is on a current year p/e of 13.4 with a 4.2% prospective yield. Sure, its valuation is clearly lower than the other two. But if you want to lock in that 20%-plus short-term profit, I wouldn’t blame you.
It’s a good time to buy energy suppliers
Yet while water stocks are flying high, their peers in the utilities sector aren’t doing as well. For example, electricity supplier Scottish & Southern Energy (LSE: SSE), has provided a total return in line with the overall market since we tipped it a year ago.
And yesterday saw news that it’s under the microscope of Ofgem. The energy regulator has just said that it’s investigating four major UK energy suppliers “amid concerns of mis-selling to customers”, says the BBC.
That could cast a short–term cloud over SSE’s share prices. But as with the water suppliers last year, this could provide a good buying opportunity. The UK’s leading energy firms are under pressure to invest huge sums to ensure the country’s future energy supplies. Ofgem won’t want to endanger this. So it’s unlikely to do anything more substantial than showboat over these mis-selling claims.
On a current year p/e of 10.8, and prospective yield of 6.4%, SSE is already very good value. And it’s right out of favour. It should be well worth taking advantage of any further investor dislike to pick up this stock on the cheap. And then, wait for it to come back into fashion.
Category: Investing in Technology