Interactive Investor

Taking tips from Warren Buffett on market volatility

10th February 2016 14:15

Ben Hobson from Stockopedia

UK stockmarkets have slumped to one of their worst starts to a year in decades. The FTSE All-Share has fallen by around 9% since the turn of 2016, and it's down by 18% from a 12-month high last April. For investors, these volatile conditions present some tricky questions. One of the most common is whether to sell out of sliding stocks or sit tight and even take the opportunity to buy shares at cheaper prices.

The answers to these questions depend on a host of factors. Those with long time horizons, robust strategies and widely diversified portfolios may be content to sit on their hands. But those exposed to stocks on overstretched valuations or less certain prospects may be tempted to act.

Taking any kind of action means straying into the perilous territory of gambling on where markets will go next. Selling down portfolio positions with a plan to buy them back later will certainly free up cash and make it easier to sleep at night. But deciding when to buy them back may end up being just as stressful. In addition, the round-trip trading costs will quickly mount up and dividend payments might be missed, which begs the question: is it worth it?

By comparison, buying shares at cheaper prices can lead investors into catching falling knives. After all, prices may fall a lot further and apparent bargains might not be what they seem. Just look at the recent performance of American professional networking site, LinkedIn. Its shares collapsed by 43% on news that it would generate lower-than-expected sales and profits in 2016. But, despite nearly $10 billion (£7 billion) being wiped from its valuation, LinkedIn shares are still priced at close to 30 times its forecast annual earnings.

So those shares may now be cheaper that they were, but that doesn't necessarily mean that they're attractively priced. It's a reminder of how valuations in glamorous shares can become very inflated in bull markets, and why "buying the dip" is a strategy that needs a great deal of care.

The importance of being idle

The doyen of dealing with market swings is Warren Buffett, the American investing legend. Buffett is famous for being one of the world's wealthiest individuals. He also has a knack for summarising his common sense approach with some very memorable one-liners.

Among them, he famously said that, when his Berkshire Hathaway conglomerate owns stakes in outstanding businesses with outstanding managements, "our favorite holding period is forever."

He also uttered the oft-repeated rule: "Be fearful when others are greedy, and be greedy when others are fearful."

The sentiment in these statements is that most individual investors can - and should - invest with a multi-decade horizon. With good-quality stocks, they can worry less about periodic declines in price. Buffett's view is that, when investors start associating price volatility with risk, they can, ironically, end up doing some pretty risky things.

In particular, he sees the biggest dangers as being over-trading, trying to time the market, inadequate diversification, paying unnecessary fees and using borrowed money.

Screening the market

The lesson from Buffett is that market direction is less important than a sound, long-term investment plan. With that in mind, it's worth reiterating that the top 10 lists created by Stockopedia for Interactive Investor are never recommendations. Rather, we look for patterns and sources of potential interest and further research. Decisions on buying or selling shares during periods of volatility needs careful thought.

This week we screened the market for shares that have enjoyed robust price momentum over the past year but have been hit by the recent volatility and appear on several measures to be reasonably priced. The momentum and value ranks are calculated by scoring each stock using a range of key financial and technical measures - from zero (poor) to 100 (excellent).

NameMomentum RankValue Rank% Price Chg 1mYield %Dividend Cover
Pendragon7992-31.23.72.9
Go-Ahead7476-15.94.51.7
Wincanton8992-13.3--
McKay Securities7379-12.93.81.4
Man7878-124.92.1
Trinity Mirror8791-113.36.4
Norcros7680-10.43.53.6
Novae9784-10.35.31.8
Wizz Air Holdings9780-3.72--
Hogg Robinson8579-3.623.72.8

The sharpest faller here is Pendragon, the auto retail group. Like other companies in this sector, shares in Pendragon have had a strong run in recent years, although many have dipped in 2016. Yet earnings have been rising and analysts expect that to continue. The sharp fall since the start of the year has also pushed the yield up from 2.7% in 2014 to an expected 3.7% this financial year.

Among the other double digit fallers over the past month are transport group Go-Ahead, logistics firm Wincanton and commercial property investor, McKay Securities.

Man, the hedge fund giant, is the largest company to make the list, with a with a price fall of around 12% over the past month. Among the smaller companies are construction products group, Norcros, and corporate services specialist, Hogg Robinson.

Sticking to the plan

Periods of volatility can cause panic in the minds of some investors, and it's here that Buffett's long-term approach makes great sense. The stockmarket should really only be used as a long-term compounding capital growth vehicle - which is where it trumps other asset classes.

Having a plan in place to manage periodic declines may well mean that the best thing to do is nothing: switch off, trade less and wait for value opportunities to arise when everyone else is rushing for the exit.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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