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Are We There Yet?

April 10th 2020 – Written by Andrew Chorley

Are We There Yet?

Most of us will have heard, or know of, this question from children that is usually asked about ten minutes into a journey that we know will take at least an hour!

When it comes to investing and whether now is an opportunity many of us are asking the same question; particularly after declines in equity markets touching 30% in the year to date. Our view is that for the UK investing conditions have improved, but we are still some way off it being a sure thing!

Below is an indicator that we use to provide a guideline as to what we can expect from the UK Stock Market over the next 10 years; the top graph shows the estimated returns in blue and the actual returns in red. We also draw a line at 7.5% annualised, which is the level of return you would hope to receive from equities.

The bottom graph provides a breakdown of how we calculate this estimate from three key components:

  1. The PE Ratio reverting to it average over the next 10 years.
  2. Profit Margins reverting to their average over the next 10 years.
  3. Dividend yield.

Adding these together gives us the current estimate of 6.6% (1% + 0.9% + 4.6%) which looks very attractive; however, we must consider what may come and the risks to this estimate.

  1. Dividends can and already have been cut by UK Firms.
  2. Profit Margins and earnings will in the coming months suffer as the effects of businesses effectively shutting down are felt

By 2003 after the Technology Bubble and in 2009 this estimate was well over 10%; we are not at the 7.5% threshold yet and given the potential impact of this Global Pandemic waiting until the return estimate is higher seems a sensible option that would provide a large margin of safety.

EST. 1999