Sharemarkets are down, but now is not the time to be afraid, writes The Motley Fool.

A recent front page feature in The Australian Financial Review said ‘Now it’s getting scary’. With the S&P/ASX 200 down 20% in six months many Australians might agree.

Hopefully you are not one of them!

Fear not fundamentals

I hope you’re excited by the current sharemarket sale, as this sell-off is based on fear not fundamentals.

Here are some statistics that few people are talking about. In the last six months the book value of S&P/ASX 200 shares is up 19%. Normalised earnings are also up 19% and cash flow is up 40 to 80% – depending on what free cash flow multiple is used.

 

S&P/ASX 200

P/B

P/E

TEV/UFCF

MC/LFCF

08-Apr-11

4971

2.18

20.84

32.48

36.78

30-Sep-11

4010

1.48

14.15

19.24

16.1

Change

-19%

-32%

-32%

-41%

-56%

Source: Capital IQ. P/B Price to Book, P/E price to normalised earnings, TEV/UFCF and MC/LFCF are two free cash flow multiples.

With fundamentals up, why is the sharemarket down? The answer is fear and fear alone. The market has fallen as investors have become fearful of the near term future.

That would make sense if investors had a track record of accurately predicting the future, but alas they don’t. The economy and sharemarkets are too complex for even the best economists to accurately predict.

So what hope do individual investors have?

The good news is there is no need to predict the future to succeed in investing. In fact the more time you waste predicting the future the less time you have to focus on what’s right in front of you.

What is in front of us now is a sharemarket on sale. Yes the market could get cheaper, but so what? That merely means even better bargains. Falling markets are only a concern to those unfortunates who are leveraged or need the money in the next couple of years.

Hopefully that is not you. (If not, you might want to check out our 4 step action plan if you’re fully invested.)

Start spreading

We’re not talking about spread betting or punting on risky CFDs.  Spread your investments over the months and years ahead. Spreading your investments reduces the psychological pressure of investing. Doing so during market sales increases your likely returns and reduces your real risk.

Buying during market sales is the holy grail of investing. Higher potential returns for less risk. This grail is only protected by the thin veil of volatility.

Modern finance suggests the high potential returns available during market sales are only available due to the increased risk. Which you may be surprised is exactly what I’m saying. Modern finance defines risk as volatility. So modern finance actually states higher returns are available to those willing to accept volatility.

Volatility is not risk

As Fool contributor Scott Phillips said ‘volatility does not equal risk’.

I am willing to accept volatility and I hope you are too. It is one key to higher returns. A short-term rocky road is a small cost to pay for long term outperformance.

Volatility increases during market sales, as the following chart highlights. If you can look past the veil of volatility and out past the near term concerns of the market you will see the bargains on offer.

During a sideways market, like we are in, going long shares when volatility is high and selling when volatility is low, is a simple strategy that both increases your returns and reduces emotional pressures.

Foolish Bottom Line

As my crystal ball is as cloudy as everyone’s I can’t tell you when this market will bottom. But I am confident that we’re in a value phase of the market. Buying during this part of sharemarket cycle is an excellent path to market outperformance.

With markets down, now might be a great time to consider this one large company we think has some serious long-term potential. Get this free special report from the Motley Fool –The Best Stock For $100 OilClick here to sign up for free, now.

More reading:

The ultimate high yield dividend portfolio

Dean Morel is The Motley Fool’s Investment Analyst. Dean is long the Australian and U.S. sharemarkets, with cash ready to buy bargains as they appear. The Motley Fool’s disclosure policy has low volatility.

 

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