It’s always the way. A company is unloved and unwanted. It’s share price has been trashed. Who on earth would buy shares in this company? Not me, that’s for sure…
What happens? Well, of course, the share price rockets.
Then, of course, people realise that the share price is rising. Well, perhaps this company is performing better than we thought. Let’s check the fundamentals. Well, actually this company is quite cheap.
Other people are buying into this company; maybe we’re on to something here. Comforted by the fact that the crowd is buying, you buy in.
What happens? Well, of course, the share price falls.
Look forward, not back
Growth guru Peter Lynch called it penultimate thinking: people tend to place too much emphasis on what has just happened, rather than what will happen.
People do this all the time. The economy has been through the mill, and is in terrible shape. So people assume that it will always be performing poorly, with talk of a ‘new normal’. But it’s just when the pessimism peaks, that the economy recovers.
If a share price is rising, you think that it will always rise. If a share price is falling, you think that will always fall. But if you are a contrarian, you try to think the opposite of what has just happened. That’s why contrarian thinking can make you feel more than a little uncomfortable, but often it ends up being right.
I initially bought into Barclays (LSE: BARC) (NYSE: BCS.US) in 2012 at 150p, at the height of the Eurozone crisis, when the banks were in bargepole territory. I should have bought more, but I was put off by the awful mood music. The share price promptly doubled.
Strong long-term prospects
Suddenly banks were fashionable investments again. The economy was improving, and people were realising how cheap the banks were. But, after reaching these highs, their share prices fell. The banks have had a dose of reality.
Now the pendulum is falling again, with people being more sceptical about investing in the banks. This is just the time where I am starting to be interested in investing in banks again.
Let’s have some perspective — at the end of the day these are short-term fluctuations. I am still a firm believer in the strong long-term prospects of the banks, which will benefit as the economy surges ahead, interest rates rise and the housing market booms.
The consensus forecasts show that these businesses are cheap, yet are growing profits. Barclays is on a 2014 P/E ratio of 9.5, falling to 7.0 in 2015, with a prospective dividend yield of 3.9%. Lloyds (LSE: LLOY) (NYSE: LYG.US) is on a P/E ratio of 10.4, falling to 8.7, with a prospective dividend yield of 2.0%.
Both companies now are strong value investments, with P/E ratios way below the FTSE 100 average. I have added both these businesses to my watchlist, and am seriously considering buying more shares.
This is not the time to lose faith in the banks — of course not. On the contrary, these share price falls have provided a buying opportunity. The banks have had a healthy dose of reality, but I still think they are buys.
