Bargain hunters’ stock-buying guide

This may seem like a treacherous time to expand your share portfolio given there is little doubt that the market faces a highly volatile future.

But high volatility and wide investor uncertainty can create some of the best buying opportunities for cashed-up investors who refuse to run with the investment herd.

Indeed, this could be an excellent opening for investors who switched to call-cash portfolios during the GFC and failed to renter the market with its rebound since March last year. Such investors could consider progressively buying back into shares from this point.

On their fundamentals, quality shares are now cheap.

Caution, nevertheless, should be a guiding word for investors looking to take advantage of the reality that many emotion-driven investors are either getting out of the market altogether or rapidly diving in and out as their mood changes.

Here are six straightforward strategies for would-be bargain hunters:

1. Recognise that share prices are cheap

This is the fundamental first step for would-be bargain hunters.

Consider what a selection of investment specialists told SmartCompany late last week:

• David Cassidy, chief equity strategist for UBS: “Valuations look cheap. In my opinion, it’s a pretty good time to be buying. The market is trying to make bottom; it’s early days. But there are promising signs.” Cassidy is sticking with his forecast of 5400-5500 for the S&P/ASX200 by December – this could be lowered depending on developments with the resource super profits tax which has been “spooking investors”. Another factor is Europe’s sovereign debt crisis. (The index closed last week at 4505).
• Michael Heffernan, private client adviser and strategist for Austock Securities: Shares are “definitely” cheap. “The sharp decline in the market has been overdone. This is the time to take a serious look at buying stocks with sound fundamentals but you will need the strength of character not to worry about volatility.” Heffernan had initially forecast 5600 for the S&P/ASX200 by December but has reduced this to 5000 because of the resource super profits tax.
• Shane Oliver, head of investment strategy and chief economist for AMP Capital Investors: “Share prices are more than 10% cheaper than their previous high; prices are quite cheap. It is not a bad time for cashed-up investors who missed the rally from March last year to bite the bullet and get in. You are effectively buying cheap.” Oliver believes there is “still a lot of potential” for S&P/ASX200 to reach his earlier forecast of 5300-5600 by December.

Significantly, Oliver says that the resource super profits tax has already been built into the prices of mining stock, which are down 12-13% on their previous high. And he says that several of the concerns hanging over the market – European debt, Korean tensions, the Gulf of Mexico oil spill and the resource super profits tax (“all signs point to some comprise in the making” on the tax) may “defuse”.

Further, Oliver points out that the market’s average price-earnings multiple is now 11.5 times – down from its long-time average of 14.5 times. Only two months ago, the market’s P/E was 15 times. And he emphasises that Australia is more exposed to the fast-growing emerging markets than to Europe and the US.

Nevertheless, would-be share buyers should be realistic: “In a broad sense, there is good reason for concern about Europe’s debt worries.”

2. Buy progressively into the market – not all at once.

A simple dollar-cost-averaging strategy is well worth considering. It involves investing a set amount into the market at regular intervals – perhaps once a month or every few months – over at least a year or much longer.

In this way, you reduce the risk of buying just before the market suffers a sharp downturn. And you buy more stock when prices are low and less when prices are high.

A strategy of averaging your way into the market is particularly smart when share prices are highly volatile or the market has already risen by a large amount. Both factors now apply.

3. Begin to buy back into the market on lows when others are selling hard.

“As Warren Buffett says,” comments Shane Oliver, “the time to get greedy is when everyone else is panicking.”

A variation on a conventional dollar-cost-averaging approach is to cautiously and systematically add to your portfolio whenever the market turns down. Again, this should be progressive buying – not plunging all of your capital into the market at once.

“I think the trick is for investors to buy in dips,” Oliver says. “This market is more choppy [these days] and investors have to be much more careful abut when they buy. A lot of people [unwisely] buy near the top because they feel more comfortable.”

4. Don’t plunge a huge amount on a single stock – even if it appears an unbeatable buy.

Your share portfolio should be widely diversified between companies and market sectors.

In this way, your portfolio is cushioned from the collapse in the share price of a few individual companies. And your portfolio is exposed to market sectors that may be flourishing while other sectors are faltering.

Think about using a widely diversified, low-cost index fund – tracking a wide market index such as the S&P/ASX200 – as the core of your equity portfolio.

5. Don’t believe that a heavily sold-off stock is necessarily a bargain – it could be a real stinker.

A stock could have lost much more of its price than the overall market for good reason.

When buying individual stocks – as opposed to investing in, say, widely equity funds – a smart move is to stick with quality companies for at least the foundation or core of your portfolio. Broadly, this means companies with clear market advantages, consistent growth in earnings, strong financial positions and excellent management.

6. Concentrate on minimising your investment costs.

When the market is highly volatile and returns are down, the impact of high investment costs become most apparent to investors.

If you are reentering the market at this point, a low-fee, tax-efficient index fund and/or exchange trade fund is well worth looking at. These funds gain their tax-efficiency because the level of trading within the funds is relatively low – thus reducing capital gains tax.

And index funds and exchange traded funds have much lower cost structures than actively managed funds.

Think as well about taking more advantage of a concessionally-taxed superannuation fund, perhaps a self-managed fund, as a means to hold your share portfolio and other retirement savings. The tax savings from super may substantially cut your overall investment costs.

Finally, buyers should consider following a buy-and-hold investment strategy, if appropriate for the stock and for their circumstances – thus reducing capital gains tax generally being incurred when an investment is sold for a profit.