For the past nine months, we’ve been in the midst of a stock market rally based upon yield.
Before the Reserve Bank began slashing interest rates in November 2011, it was a no brainer about how to get a decent return on your money.
The stock market was going nowhere and there were very attractive rates on offer from the banks for term deposits. With a government guarantee on deposits, that was an equation that read: no risk, handsome returns.
That is a pretty rare combination and not surprisingly, investors homed in on those attractive rates like a swarm of bees.
So when rates began to fall, investors started looking elsewhere for a decent yield. And they found it on the stock market. There were some big, safe companies out there, such as the banks, delivering spectacular dividends that were even better than the peak of the term deposit rates.
Mind you, it is worth remembering that stocks are much riskier than term deposits, so there is a trade-off there. But as the central bank continued to slash rates, the hunt for yield accelerated. That’s what has driven the rally so far.
It now is becoming increasingly difficult to find a good yield in a relatively safe company because the easy pickings have been had. And this is where the concept of value investing comes to the fore.
It’s no good investing in a share to get a good dividend yield only to discover that you’ve lost a lot of your capital when the share price in the company in which you’ve invested gets hammered.
Value investors look for companies that are, well, undervalued. If you can find one of them that pays a good dividend, then you are on the way towards a sensible investment decision.
There are a number of ways to figure out the value of a company. The easiest way is to look at the value of the company’s assets, minus its liabilities. And then you divide that number by the number of shares the company has out there. Don’t worry, there are plenty of brokers and analysts that do this all day every day so check the newspapers or the internet for this information.
If a company’s shares have an intrinsic value of say $1, but its share price is 90 cents, then there is good value here. If it is trading at 2 cents, that is incredible value. But it’s highly likely there are other problems here that have everyone running scared.
If a company is a little overvalued, that often is because it is considered to have good prospects. But if the numbers are way out of the ballpark, then you are taking a big punt.