On the second trading day of the month of October the ASX reversed course and began to move upward.  The headlines out of Europe were moderately positive.  Do you have any doubt about what will happen after the next negative headline?

Share markets everywhere are in a period of extreme volatility where fundamentals matter little.  More and more retail investors are “going to cash” and sitting on the sidelines, waiting.  Some are so shell-shocked they are adamant in insisting they will never put another dime into the share market.  

If you are one of those who has gone to cash or thinking about it, you need to remember why you got into the share market in the first place.  Investors everywhere have one goal in share market investing – making money.

Yet world-class investors like Peter Lynch and Warren Buffet and others maintain the reason so few retail investors make money is they buy high and sell low.  How can such a counter-intuitive investment approach happen?

Some retail investors recognise they are not professional investors like Lynch and Buffet, so they look to the professionals for detailed road maps to wealth.  Only there aren’t any.  If share market investing were easy, everyone would do it and everyone would get wealthy.

As a result, some investors blindly follow the crowd when analyst after analyst heaps praise on a particular share, inevitably driving up the price.  But they buy at the higher price and bail out when times get tough.  If you want precise details on expected returns, stay away from shares and get into fixed income investments.  

There are three other key differences between retail and professional investors we sometimes forget – expertise, time, and money.

First, professional investors not only have the expertise to evaluate market conditions and share fundamentals, they have the time to do it.  They have the time to keep track of changes in markets and in the fundamentals of the companies in which they invest.  Although much expertise can be learned, not that many retail investors have the time to do it.  Far too few retail investors take the time to stay abreast of their investments on a daily basis.

Finally, professionals manage more money, enabling them to better withstand losses.  It is wonderful for a value investor to advise going all in on a share you are convinced is the greatest opportunity of all time.  They have the cash to do it and can take a hit if things go the wrong way.  Retail investors can’t.  Averaging into a share you have identified as a target is a better strategy for retail investors, even if it goes against some investing strategies.

Regardless of whether you are on the sidelines or not, if you follow the market, you know the recent downturn has turned the ASX into something like the bargain bin section at your local discount retailer.  One of the tips you often find when it comes to saving money is to shop sales.  You make a list of things you need or want and then wait to buy them until they hit the bargain bin or sale counter at a price you find attractive.

The same principle applies to share market investing and now is a good time to build a list.  Rather than search the Internet for some one else’s list, why not build your own?  We have a list to share, developed based on the following principles:

•    Look for companies that have survived previous downturns

•    Buy what you know or what interests you.

•    Shop companies, not sectors

•    Stay with dividend paying shares

•    Watch out for debt

•    Search for ideas and advice, but make your own decisions

Shop the Survivors

Given the daily dose of doom to which investors are exposed, it seems common sense would suggest looking for shares that are proven survivors.  Common sense also tells us big companies generally should be more likely to survive than smaller companies.  We started with a list of Australia’s top ten companies and then ran a 5 year share price movement chart on each company.  The BHP chart shows what we were looking for:

BHP was trading at $50 a few months before the GFC and then went south with everyone else once the selling panic set in.  Some investors who bought in to cash in on the mining boom in late 2007 sold out as the crash picked up steam, with the intent of converting what was left of their cash into safer assets.  Had they held, they would have lost nothing as BHP survived and returned to the $50 price in early 2011.

Not every one of Australia’s top companies has come back so far, but the recovery of the following survivors was substantial enough to warrant a place on our potential shopping list.  Here is the full list of survivor companies:

1.    BHP (BHP Billiton)

2.    RIO (Rio Tinto)

3.    WOW (Woolworths)

4.    WES (Wesfarmers)

5.    CBA (Commonwealth Bank of Australia)

6.    WBC (Westpac Banking)

Buying What You Know or Have Interest In

The investing maxim “Buy What You Know” is everywhere, but we think that sells intelligent investors short.  If you have an interest in what a company does, you are more willing to invest the time it takes to learn what you need to know.  Banking shares are a good example.  Financial statements in sectors like banking and REITS are different from those of other companies and they can be very challenging to interpret.  If you have an interest in numbers and love to see how things add up, you can learn what you need to know.

Shop Companies, not Sectors

Conventional wisdom says some sectors do more poorly in downturns than others.  Right now the retail sector in Australia is suffering.  However, this does not mean there are not quality companies in that sector you might want to consider.  Wesfarmers and Woolworths are two examples.  Their share price may not have fallen enough to match your investing philosophy, but neither company is going out of business.

Dividends and Debt

In tough times, dividends are a safety net and debt can lead to an abyss from which you need to stay away.  All of the shares on our list pay dividends and have manageable debt loads.  The latest bout of thrilling financial news concerns another credit freeze.  Should that happen, companies would find it difficult to refinance existing debt facilities.

Make Your Own Decisions

The advice and information you find on investing websites are good starting points, but ultimately intelligent investors need to get over looking for someone to hold their hands with detailed instructions and think for themselves.  Sometimes this involves ignoring the crowd.

For example, conventional wisdom might advise you to stay away a company like Cochlear (COH) due to a recent product recall; or JBH (JB HiFi) since it has been on the top shorted list for months.  Using our survivor principle, let’s first look at COH.

Cochlear was trading at around $75 at the onset of the GFC and was recently trading $10 above that price -- $85 dollar a share.  This alone is not a reason to buy, but it is a reason to put it on a potential shopping list.  What about the hated JBH?  Here is their chart:

Despite its recent fall from grace, JBH is still trading near its pre-GVC levels.  Again, this is not a reason to buy, but it is a reason to investigate further.

To make a decision on which of these 8 target shares merit a place on the shopping list, here are some key performance indicators for each company:

Here you can see the problem with analysing bank shares.  They do not report debt nor gearing in the same way other companies do.  We substituted bad debts and operation income to assets ratio numbers.  

Even though their dividend yield is smaller, the P/E for both RIO and BHP earn them a place at the top of the shopping list.  The next step is to carefully examine share price movements and pick your entry point.  Risk averse investors would opt for lower entry points.  Then you have to determine how much cash you want to allocate and the size of your purchases.  If your total goal is 200 shares of BHP, do you want to buy 50 shares in four spaced buys on dips or 2 buys of 100 shares.

The WBC and CBA earn a place on the list with their high dividend yield, although we would want to look into the bad debt issues further.

Both retailers WOW and WES are worthy of the list, due to their dividend yield and penetration in the Australian market.  However, we would definitely want a better price point than the current P/E suggests.

Cochlear has a good combination of low debt and high dividend.  JBH has an attractive P/E.  Despite what the short sellers think, do your homework and you will learn JBH is augmenting its brick and mortar locations with a vastly expanded and improved online buying option.

If you think shopping lists in tough times are not worth the effort, look back at the BHP chart and consider how much money you could have made buying shares during the lows of 2008 and 2009.

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