As a value investor, my investment strategy is quite simple - buy undervalued businesses, then sell overvalued businesses. Thus, knowing the stock investment cycle may help me do a better decision. In this post, I would like to summarise what I have learnt about investment cycles - from extremely undervalued to extremely overvalued.
During the bottom of Bear Market, trading volume is extremely low. Only few investors (who are well prepared) are interested in stock market investment. Most employee may struggle to find good jobs; and most employers may struggle to restructure their business after some sort of financial crisis.
During this moment, most of businesses are extremely undervalued with PE < 5 for small cap; and PE < 10 for blue chip.
Most people are having jobs, and most businesses have been restructured successfully. Nonetheless, most of the businesses have been priced with some discount. This is because people are still having negative impression on stock market.
During this moment, most of businesses are undervalued with PE < 8 for small cap; and PE < 15 for blue chip.
More and more people (or 'investors') have realised some attractive profits from their stock market investment. The confidences of new investors are increased when more and more successful stories exist in the market. Interest rate is still low, many people have been "forced" to shift their hard earned money from bank to other assets such as stock for better return.
During this moment, most of businesses are valued with PE between 10~12 for small cap; and PE between 20~25 for blue chip.
Future prospect of economy is good. More and more people are optimistic about the future of businesses and willing to over-pay (with high PE) for the "good dream". Interest rate is raised (or going to be raised soon).
During this moment, most of businesses are valued with PE > 12 for small cap; and PE > 25 for blue chip.
When the "dream" has been perceived as a realistic with abundant "evidences" or "news" that provided by "experts" or "insiders", the price of "good dream" is increased.
In the market, most people are discussing about future prospect instead of intrinsic value of businesses. Attractive stories are created to spiritually support the "last batch" of "investors".
Nonetheless, these attractive stories are normally lack of evidences. For example, company XXX earned 100billion; and the industry is expected to be growed with two digits annually in the future. This kind of story is normally independent of the market price of the businesses. Thus, investors need to do their homework to avoid this kind of potential trap.
So, how high the price will soar? It depends on how good the story is.
Written by: Xaivier Chia