The recent collapse in stockmarkets merely seems to have whetted the bulls’ appetites. “The crash has thrown up some great bargains,” says Jennifer Hill in The Sunday Times. She’s not the only one. Fidelity’s Anthony Bolton declared last week that he had been buying shares with his own money. So is now the time to stuff your portfolio with cheap shares? Not at all – here’s why.
Every silver lining has a cloud
The outlook for equities is horrible. The BBC’s Robert Peston suggests looking no further than tumbling commodity prices. At first this looks like good news if it helps to bring inflation down. But such rapid falls are a warning sign that the credit crunch is morphing into a global slump, as reduced demand for consumer goods from holidays to cars results in falling raw material prices. In short, there’s plenty more bad news to come for share prices.
Stockpickers also face another problem. Assuming we are heading into what the FT’s Lex describes as “a near-unstoppable deflationary bust”, then earnings forecasts and therefore share valuations “are not worth the paper they are written on”. That in turn means that many investment theories simply “go out of the window”, as Mark Dampier at Hargreaves Lansdowne puts it. So while shares may look cheap on “normal” valuation measures such as p/e ratios, as the Motley Fool’s Bruce Anderson says, “these are not normal times”. So what should investors be looking out for just now – and which apparently dead-cert share tips should be avoided?
Not all ‘safe havens’ are safe – National Grid
Utilities, such as UK and US gas and electricity network manager National Grid (LON:NG), are often seen as ultra-safe bets; energy demand tends to hold up no matter what the economic climate. Better still, 95% of the group’s business generates income at a stable, regulated price. The Share Centre’s Nick Raynor also points to a “strong history of increasing dividends”, which he believes should reassure investors who have seen the share price drop sharply since the start of the year.
However, as the FT’s Ed Crooks points out, there is plenty to worry about, despite chief executive Steve Holliday’s claims that his company is “very, very low risk”. For starters, National Grid may become yet another British company that has failed to navigate the treacherous US market. National Grid’s entry to the US was achieved by buying KeySpan in 2007 for $11.8bn and it now faces “much tougher regulators and trade unions”. What’s more it may have expanded at just the wrong time. Net debt (long and short-term debt less cash balances) jumped around 50% to £17.6bn in 2007 and the company still has “quite a lot to raise”, says Martin Brough of Dresdner Kleinwort. Not only is raising capital becoming harder, but the rising cost could quickly put pressure on what the company claims is “comfortable” interest cover (profits before interest and tax as a multiple of the interest charge) of 3.2.
High dividend yields can’t be trusted – BT Group
Despite a share price fall of around 50% in the past year to 155p, Raynor also believes the telecoms sector “remains stable” and that income seekers should be “encouraged by a near-10% dividend yield” at BT (LON:BT.A). But that 10% is no free lunch. Société Générale points to a “hidden nasty” – its huge pension deficit. The need to fund an estimated pension liability of £37.6bn will have “significant repercussions” for cash generation and dividend payments. Also, net income from BT’s global services unit has fallen by around 35% to £397m, while regulator Ofcom recently confirmed its market share of fixed-line calls and network access revenue has gone below 60% for the first time. In fact, SocGen suggests you forget the dividend and bank some option premium income by selling BT December calls instead.
Recent earnings trends are unreliable – JD Sports
This sports retailer is tipped as a buy by James Hall in The Sunday Telegraph on the strength of its latest results, described by one analyst as “nothing short of excellent”. Pre-tax profits rose by 54% over the six months to 2 August, while like-for-like sales rose by 6% at a time when others have seen declines. But how long can it last?
Sure, JD Sports (LON:JD) currently tops its peer group and should weather a downturn better than many but that can’t disguise one key fact – the worst is yet to come for all retailers. Rising unemployment, falling house prices, rising household bills and record low levels of business confidence suggest this Christmas will be total turkey. Insolvency specialist Begbies Traynor has placed 323 UK retailers on “critical watch” with a 70% or greater chance of failing in the New Year. And as households look to economise, snazzy new trainers seem destined for the chop. This makes earnings forecasting a lottery. As such the low forward p/e of five is an unreliable buy signal.