How investors should respond to Hurricane Sandy

Here’s a hint: Don’t…

a woman

Hurricane Sandy is currently bearing down on the major population centres of the US east coast.

There have been scores of lives lost in the Caribbean, and we hope any further loss of life is limited or preferably avoided entirely as the storm crosses the American coast.

Our thoughts are with those in its path and in its wake.

The US markets might have been closed last night and tonight, but the rest of the global markets, including the ASX, obviously remain open.

And while we have one eye on the natural disaster, investors are wondering how it will impact on companies in their portfolio.

Investors react

In the first line of consideration are the insurance companies – in particular QBE Insurance (ASX: QBE). QBE has significant US business, and will likely be hit by claims from the storm, which have the potential to reduce earnings in the current financial year.

On the flipside, construction businesses will be busy in the next year or two if Sandy does have a significant impact. Companies like James Hardie (ASX: JHX) will also tend to benefit if that’s the case.

Perhaps unsurprisingly, QBE shares opened down this morning, while James Hardie shares opening in the green.

Before investors get too despondent or excited, it’s time for a few deep breaths.

Understanding the impact

Insurance company shareholders are notoriously – and surprisingly – fickle. They should know better.

Insurance is a terribly ‘lumpy’ business. It’s a game of probabilities. These operations are run to make money over the medium and long term, while recognising that Mother Nature refuses to adhere to financial year schedules.

In some years, insurance companies will be enormously profitable, when there are few or no significant disasters. In other years, profits are hard to come by as disasters strike. The bean counters make sure the companies make money over the medium term – by pricing policies according to probability – but no-one expects them to be able to forecast where and when disasters will happen.

When you know that, it’s amazing to watch insurance company share prices fluctuate in line with the latest disaster, as if investors have only just realised that they happen. The savvy investor uses the pessimism to buy cheap.

Construction companies, on the other hand, will have the opposite impact. If there is significant reconstruction required (and we hope it isn’t), there will be a 12-18 month boost in revenues and profits as order books fill up. Just as the insurance claims are one-offs, so a construction boom will be relatively short lived. As always, it’s the sustainable, underlying business that investors should be focussed on.

Silver lining

While we’d all prefer natural disasters didn’t happen, there is at least a silver lining.

The reconstruction effort will actually stimulate economic activity, creating demand for businesses and jobs for workers. It won’t add to the US national wealth – it will simply be replacing infrastructure that was destroyed – but the extra economic activity should give America at least a little momentum.

Foolish takeaway

Successful investing requires the ability of investors to discern the difference between underlying and one-off impacts on a business – and using that information wisely. In the case of insurance companies, using a long-term average profit is wise.

It’s also a good time to remember that investing is important, but not everything.

If you only invest in one company this year, make it our “Top Stock for 2012-13”. Operating in two hot markets — one set to double by 2012, the other predicted to grow 5x over the next five years — this stock is a solid growth play that also boasts strong recurring revenue, zero debt, and lots of cash. Get its name and full research case in this brand-new FREE report.

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Scott Phillips is an investment analyst with The Motley Fool. He owns shares in QBE Insurance. You can follow Scott on Twitter @TMFGilla. Take Stock is The Motley Fool Australia’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691).

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