Yes, buy, but slowly

Value investing or buying stocks trading at cheap valuations is a guaranteed way of generating above-average returns.

Warren Buffet, one of the most successful investors and third wealthiest person in the world, generated his wealth by practicing value investing.

However, the act of buying cheap stocks is easier said than done. Stocks of companies usually become cheap when there are problems—the economy is weak, or the industry where the company belongs to has challenges, or the company itself has issues.

Usually, there is poor visibility on when these problems will be resolved. This is why it is difficult to buy cheap stocks.

The whole stock market could also be suffering from contagion, similar to what is happening to the Philippine stock market today.

The outlook of the Philippine economy is improving. Inflation continues to fall, while the Bangko Sentral ng Pilipinas continues to ease monetary policy by cutting rates and reducing banks’ reserve requirement ratio.

Just last Friday, the government announced September inflation slowed to 0.9 percent.

There are also indicators that gross domestic product (GDP) growth would rebound in the second half of the year from only 5.5 percent during the first half.

Government spending is already higher for the months of July and August after falling by 0.9 percent in the first half of the year.

Consumer confidence and business confidence have also recovered, and should result in higher spending and more investments going forward.

However, global economic conditions continue to deteriorate. International businesses continue to hold back on investment spending due to numerous uncertainties, which include the worsening US-China trade war and the increasing possibility of a hard Brexit.

As a result, foreign investors have no risk appetite and are indiscriminately selling emerging market stocks globally, including those in the Philippines. Instead, they are buying safe-haven assets such as US sovereign bonds and gold.

Since foreign investors account for more than half of the Philippine Stock Exchange’s (PSE) value turnover, continuous foreign selling is largely responsible for local stocks’ steep drop in the past few months.

Nevertheless, values are emerging, creating an attractive opportunity to buy stocks.

At 7,700, the Philippine Stock Exchange Index (PSEi) is trading at a 15.4X price-to-earnings (P/E) ration for 2020. In the past five years, the PSEi traded above the said valuation multiple more than 80 percent of the time. Moreover, 22 out of the 30 PSEi index members are trading at a discount to their 10-year historical average P/Es.

Once sentiment improves and risk appetite returns, there is much room for stocks to go up given the Philippine economy’s attractive outlook and stocks’ depressed valuations.

There are some caveats.

Just because stocks are cheap, doesn’t mean they can’t become cheaper. This is another reason why it is very difficult to buy cheap stocks.

In our study of the past 10 steep market corrections in the Philippines, the PSEi fell by a range of 12-25 percent from their peaks.

At the current level, the PSEi is down by only 8 percent.

Moreover, the S&P 500 in the US is down by only 4 percent from the peak and could continue to go down further in the next few weeks, creating volatility in global stock markets.

Finally, nobody knows when prices will bottom and start to recover.

In our study of the past 10 steep market corrections, the time it took for the PSEi to bottom ranged from as short as two weeks to as long as nine and a half months.

Coupled with the possibility that prices could still go down, an investor who decides to buy right now might be stuck with a losing position for a very long time.

Despite the risks, we still think that value investors should not avoid buying stocks. However, exercising some risk management strategies such as buying slowly and managing size is crucial for success.

Remember that it’s currently a buyers’ market. Therefore, take time accumulating stocks so that you can take advantage of lower prices.

Also, given weak market conditions, the amount of stocks you buy today should just be enough to let you sleep soundly at night. Also make sure that you can hold on to your stocks for a long period of time because, as we have said, nobody knows when and where prices will bottom.

Prepare for the possibility that you might have to hold on to your stocks for more than a year.

You don’t want to be forced to sell at the bottom just because you need to raise cash to pay for short-term needs.