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6. Strategies for Investment (I)

Introduction

Over the past decade, global capital markets have experienced one of the most volatile periods in their entire history. For example, since the millennium, the index of Britain's highest valued companies, the FT-SE 100 (Footsie) has often moved up and down by more than 100 points in a single day, driven by the extreme price fluctuation of risky internet or technology shares, the changing value of blue-chip companies, a global banking and Euro financial crisis, rising oil and commodity prices, all underpinned by increasing geo-political instability.

Leading up to the millennium during the dot.com boom, many I.T. firms never turned a profit, let alone a dividend. Yet, even without yield, cover, or P/E ratios to compare one company with another and its peer group, their share prices soared, fuelled by speculation. Many traditional companies suffered from this tyranny of fashion. Despite creditable financial performance, their values plummeted as investors moved sectors. In March 2000 a radical shakeout of the FT-SE 100 occurred.

FT-SE 100 Adjustments: March 2000

Out of the Index

Into the Index

Allied Domecq

Baltimore Technology

Associated British Foods

Cable and Wireless Communications

Hanson

Capita

Imperial Tobacco

Celltech

Powergen

Emap

Scottish and Newcastle

Freeserve

Thames Water

Nycomed Amersham

Whitbread

Psion

Wolseley

Thus

As the table reveals, out went many UK household names that still provided essential goods, services and utilities to millions of consumers at home and abroad. In came little known firms, valued on hope rather than rational expectation. In terms of trading fundamentals, the nine new entrants only made a total profit of £500 million compared with the £3.73 billion earned by the companies they replaced. The new entrants also employed far fewer people. For example, Baltimore's staffing was only 500, compared with Whitbread's 98,000.

However, by 2001 the techno-bubble burst. Five years into the new millennium, Britain's blue-chip companies were also back in favour, as evidenced below by a reversal of fortune for the majority of companies who still survived from the previous table.

The FT-SE 100 Position: August 2005

Out of the Index

Into the Index

Baltimore Technology

Associated British Foods

Celltech

Hanson

Emap

Imperial Tobacco

Freeserve

Scottish and Newcastle

Nycomed Amersham

Whitbread

Psion

Wolseley

Thus

Throughout 2006, UK plc like other economies appeared to be in good shape, with companies reporting increased sales, profits and dividends (a continuation of the strong results delivered in 2004 and 2005). The Footsie (like the American Dow Jones) was also extremely buoyant, well above the new psychologically important 6,000 barrier, up more than 80 per cent since its low of 3,287 in March 2003.

Yet, history tells us that "bull" markets (like "bear" markets) do not go on forever and sure enough, equity prices were rising for a fall. In 2007 the American sub-prime mortgage scandal fuelled by cheap money and credit facilities became public knowledge and quickly reverberated throughout global stock markets.

You will recall from Chapter One that the classic text by Charles P. Kindleberger on behavioral theory, now in its sixth edition (2011) offers a plausible explanation for what happened next.

At some stage after insiders sold their mortgage books to move into cash, markets generally began to panic and sell, resulting in what Kindleberger terms "revulsion". A period of several months ensued where disillusioned investors refused to participate in the market until prices were low enough to tempt them back.

Since then, governments, banking and financial institutions have all sought to put their house in order with tighter regulation. Many companies world-wide have also undergone a period of introspection. Management has sought to prune unnecessary costs and provide an increasing share of corporate efficiency gains in dividends. Thus, investors, technical, fundamental, or speculative, have received more money to reinvest, which has revived stock markets and particularly, takeover activity. However, with increasing political tension and the Greek Euro crisis, it remains to be seen whether markets can maintain their momentum. Much of the cost cutting is now implemented and future gains will be limited if consumer demand tails off and rising inflation, interest rates, oil and commodity prices squeeze profit margins.

So, without access to insider information what does this mean for investors?

The purpose of this Chapter is to suggest various strategies for buying, selling, or holding shares, when markets are buoyant, even in a climate of geo-political, economic, business and financial uncertainty. To keep the analysis simple, we shall focus on the data contained in share price listings, price, yield, cover and the P/E ratio. In Chapter Six we shall then move on to other sources of information from the press, media, internet and analyst reports to support these trading decisions.

 
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