Why Roger Montgomery thinks the time is right to jump in
It’s time to start buying quality stocks that have fallen sharply over the last six months. This is the view held by Roger Montgomery, founder of Montgomery Investment Management. Given that valuations have come off, Montgomery believes investors have a far better chance of making attractive returns buying now; with one big caveat – that these businesses grow their earnings.
Year-to-date, the S&P/ASX 200 year-to-date is down 3.4 per cent, but that headline fall is hiding some of the biggest laggards, of even the highest quality. Roughly 112 of the biggest 200 companies listed on the ASX are below their price at the beginning of the year.
Montgomery lists the following stocks as examples:
- Zip is down 76 per cent year-to-date
- Pointsbet is off 60 per cent
- Kogan is 47 per cent lower
- Boral is 43 per cent below its price at the beginning of the year
- Reece is 38 per cent weaker.
- Other high-quality companies such as REA Group, Wesfarmers, ARB Corporation, Credit Corp and Super Retail Group are down between 15 and 25 per cent in less than 16 weeks.
The cause of these large share price falls is rising inflation in response to the massive stimulus released by central banks around the world. The US Federal Reserve is now on an interest rate tightening path, looking to reduce its balance sheet.
This leads Montgomery to conclude that we are in the midst of a correction. He says, “P/E ratios have compressed materially over the course of the last six months. Now that they are lower, investors have a better chance of making attractive returns, provided they buy businesses that can grow earnings. Let me explain with a few simple tables.”
Considering that P/Es have compressed, the game is to find businesses with the potential to grow earnings.
To safeguard from a further compression in P/Es, Montgomery advises buying companies that grow at a rate that meets or exceeds market expectations. He says, “If growth is expected to be 20 per cent and comes in at 18 per cent, the P/E may contract further, offsetting the benefits accrued to investors from the earnings growth.”
There is light at the end of the tunnel. Once the war in Ukraine dissipates and inflation/interest rates begin to taper off, P/E ratios may start to expand again and those that invested after the PE compression will benefit. Montgomery concludes by saying, “P’E compression and stock market falls may just be the rational price for which investors in equities and managed funds have been waiting.”