Don´t Try to Time the Markets
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
What should I do now with my positions? Buy more? Sell? Has the market reached a bottom or are we still in the first stages of a violent bear market? Every investor goes through this kind of dilemma many times in his investing career, especially in volatile times like the ones we have been experiencing in the markets lately. But believing we should try to actively time the markets, or even individual stocks, can be an unnecessary, stressing and energy consuming task. Even worse, it can most likely be detrimental for your long term returns.
Most opinions about the future evolution of markets are generally wrong, even when coming from seasoned investors, and particularly more when coming from the so called experts or media personalities. Back in September or October of last year most pundits were recommending selling everything because the world was a mess and Europe could explode in any second. It turns out that was a great time to be buying high quality companies at convenient prices.
In March or April of 2012 most commentators were bullish, and the big investment banks were claiming that the worse had passed in Europe, while at the same time the US economy was gaining traction. In hindsight, that moment was far from an ideal one to increase positions. Innumerable studies have demonstrated through history that the masses are usually wrong when trying to time the markets, and the same goes for the most renowned experts.
The best thing an investor can do over the long term is buying good companies when they are cheap, or when there is information about that business which merits a change of idea. Trying to time the markets or the evolution of economic variables is obviously very tempting, but most usually not worth the effort.
Each case is different of course, and smaller companies in more dynamic businesses are usually more often exposed to changes that can be relevant enough to merit a trading decision. But in big and stable high quality companies, the best moment to buy is when valuations are cheap, because the fundamentals don’t usually change that much.
The following graph shows the evolution of price and P/E ratio for Procter & Gamble (NYSE: PG) during the last five years. This titan of the consumer staples industry is one of the most resilient companies in the world, Procter & Gamble is able to sustain its profits under the most complicated economic conditions, since it owns many of the most recognizable brands in an industry which doesn´t fluctuate much with the economic cycle.
However, investors were quite depressed during the last recession, and the company´s valuation fell from a P/E ratio of nearly 20 to around 11 in 2009. When you find a tremendously solid business trading at almost half its historical valuation, you have most likely met a buying opportunity. In hindsight, the first quarter of 2009 was a great time to buy shares of Procter & Gamble.
On the other hand, smaller companies can be more exposed to important news which modify their merits as an investment. Shares of Westport Innovations (NASDAQ: WPRT) for example jumped by a 20% on Tuesday when it was announced that Westport is working with Caterpillar (NYSE: CAT) in developing natural gas engines for the Caterpillar´s vehicles. This may not be a determinant change for Caterpillar, although it certainly helps to know that the leader in the global machinery business is trying to capitalize the benefits of low natural gas prices.
For Westport, however, the news is much more important. Being a smaller company, the financial impact of the agreement is obviously more relevant for Westport than for Caterpillar and besides that, it says a lot about the industry´s prospects and the company´s traction among big customers. The fact that Westport has convinced a giant like Caterpillar to trust its technology and the advantages of moving to natural gas means something important about Westport and its long term prospects.
Timing the markets is a loser’s game, at least for the vast majority of investors. Depending of the company, its size and development stage, relevant information on the kind which merits a trading decision may be more or less frequent. But trading decisions are usually much more efficient when based on fundamental news or valuation considerations instead of opinion about the short term prospects for the indexes.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Westport Innovations. Motley Fool newsletter services recommend The Procter & Gamble Company and Westport Innovations. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.