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Intelligent Investing

Don’t be too pessimistic despite all the bad news

/ 04:03 AM August 03, 2020

The next few weeks will be filled with negative news flows such as the steep contraction in the Philippines’ GDP and weaker than expected second quarter earnings results for most listed firms. Although the market will likely go down as a result, investors should guard against the temptation of becoming too pessimistic.

One of the reasons why we should not be too pessimistic is that everybody already expects second quarter numbers to be bad. That said, analysts like me are more focused on listed companies’ guidance on how they are doing under GCQ and what they plan to do under the new normal. For most companies, the second quarter was probably the worst and after going through that difficult period, most of them already know what they need to do to survive the crisis. With improving earnings visibility, analysts’ ability to analyze stocks and determine whether they are cheap enough to buy increases significantly.

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Another reason why we should not be too pessimistic is the favorable financial condition prevailing today despite the ongoing crisis. In the past, economic crises in the Philippines were always accompanied by a weaker peso and significantly higher interest rates, making it even more difficult for companies already suffering from weaker demand to stay afloat. However, the opposite is true today. The peso is stronger, helping companies’ import costs to go down and margins go up. Interest rates are also significantly lower, allowing companies to refinance their debts at a much lower cost and at longer maturities, helping them stay liquid during these difficult times.

Significantly lower rates also make stocks more attractive relative to bonds because potential returns on stocks are now higher compared to bonds. In fact, there are some listed companies whose profits are barely affected by the COVID-19 crisis but are trading below historical average valuations. Some also provide dividend yields that are higher than bond yields. In my opinion, stocks with these qualities are compelling buys for long-term investors.

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Although the Philippine market seems expensive based on the PSEi’s current valuation as measured by the P/E ratio, the said multiple is largely pulled up by the expensive valuation of a few highly capitalized holding companies. Excluding the said companies, most stocks are trading below their historical average P/Es, with some even trading below their prices five years ago despite having much higher earnings today.

For the said reasons, we should avoid the temptation of being too pessimistic and prepare ourselves to start accumulating stocks when the market goes down because of negative news.

There are risks, however. Just because a stock is cheap does not mean it cannot become cheaper. After all, corporate earnings are expected to stay depressed the next few quarters. Although the worst is over, it will still take a while for most companies’ earnings to return to pre-COVID-19 level.

Moreover, the COVID-19 crisis is still far from over. With the number of infections still trending higher, consumer confidence is expected to remain poor. Moreover, the government might reimpose measures such as lockdowns to contain the spread of the virus. While lockdowns are effective in flattening the curve, they are bad for the economy.

Because of this, investors who buy stocks today should be mentally prepared for the possibility of losing money in the short-term before making money eventually.

Despite the said risk, we should not be worried. As Benjamin Graham,the father of value investing ,once said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” As long as we know the value of what we are buying, we will eventually reap the reward of buying good stocks at cheap valuations. INQ

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