COMPANY COLLAPSES EXCEPTION IN STRONG ECONOMY
Mark Lister, 1 November 2016
Two high-profile collapses from NZX-listed companies lately won’t do wonders for the way many bystanders already perceive share investing.
I could just about hear them cursing as I read those headlines. “The sharemarket is a casino”, “just stick with property” and “get out now before you lose the rest”.
NZ shares have returned 11.7 per cent per annum since 1980, outpacing house prices which have gained 8.6 per cent over the period and inflation which has averaged 4.6 per cent.
Those returns don’t come for free, though. The price you’ll pay for such attractive long-term growth is higher levels of volatility over shorter periods.
That’s why shares are great for your 10-years-plus money, but no good for your short-term funds.
Still, it’s extremely rare that a share price goes to zero, even during recessions, let alone at the moment.
Wynyard Group and Pumpkin Patch are very much the exception to what is happening in corporate New Zealand, rather than the rule.
Economic growth is the best it’s been in two years, population growth is strong, unemployment is falling and business confidence is high.
That’s all happening without the help of the dairy sector, so things look pretty good heading into next year if dairy prices hold up.
Unsurprisingly, against that backdrop most companies are earning healthy profits, paying good dividends and have delivered excellent returns. Read just about any recent annual meeting speeches, such as those from Port of Tauranga, Auckland Airport or Fletcher Building, and you will hear a plethora of positive comments about how these businesses are doing.
Last week we had an upbeat trading statement from economic bellwether Freightways, and a profit upgrade from Summerset.
Investors can avoid getting caught up in collapses by making sure they have a well-diversified portfolio with lots of different companies, in different sectors. That won’t completely remove the risk of one of them going pear-shaped, but it will certainly reduce the impact of it.
If you don’t have the money to spread your investments over at least 15 companies, I would say you belong in a diversified fund of some sort.
Note that smaller companies come with higher risk (but potentially higher returns) than big ones, so if you want to reduce risk further then stick to larger companies.
They usually have bigger, more established businesses that generate consistent profits, and pay dividends out of those profits.
Companies that are unprofitable are inherently higher risk as well, as was the case with Wynyard Group, and Pumpkin Patch in recent years.
Some early-stage, growing businesses have provided stunning returns, but when a company doesn’t have any profits or cash flow to fall back on, things can quickly go wrong if they run into trouble or start to face balance sheet problems.
Conservative investors can avoid these issues by simply drawing a line at companies that don’t make a profit or pay a dividend. If you want to add some spice to your portfolio, then do so in a limited manner.
For example, ring-fence 5 per cent of your money for these sorts of companies, and keep the rest invested at the safer end of the spectrum.
This article was published in The New Zealand Herald on 1st November 2016.