The disappointment caused by Kier and Thomas Cook’s share price declines may have left many investors wondering whether the stock market is worth avoiding in future. After all, the two stocks have fallen by over 85% in the last year. Holders of one or both of the companies are therefore likely to have experienced substantial declines in their portfolios.
While this is likely to be a challenging period for such investors, I think it is worth persisting with the stock market. Even though it can cause huge disappointment in the short run, over the long term it has the potential to deliver high returns that may lead to an improved financial outlook for investors.
Return prospects Although the main UK index, the FTSE 100, may be trading less than 10% higher than it did almost 20 years ago, its long-term growth potential remains high. At the present time, for example, it appears to be undervalued versus its past price levels. It currently has a dividend yield of around 4.5%, with its income return having been at or above this level only for short periods in the past. Often those periods have coincided with a highly uncertain outlook for the world economy, which could mean that the index offers a wide margin of safety for new investors.
Moreover, the index was grossly overvalued two decades ago. In fact, it had risen at an annualised rate of around 13% in its first 16 years of existence (between the start of 1984 and the end of 1999). This led to high valuations across a wide range of companies at a time when the tech bubble was growing rapidly. Due to its overvaluation two decades ago, it is perhaps unsurprising that it has recorded more modest returns in subsequent years.
Growth potential Looking ahead, the stock market could experience heightened volatility. With the global trade war continuing to grow in terms of its potential threat to GDP growth and other challenges such as Brexit being ahead, investors in the stock market may not generate significant returns in the short run.
Furthermore, there will always be stocks within the FTSE All-Share that produce disappointing financial performance. Kier and Thomas Cook are two recent examples of FTSE All-Share stocks that have delivered significant declines in their valuations, but they will not be the last companies to disappoint investors.
However, from a long-term perspective, shares continue to offer appealing returns. Emerging markets such as China and India are expected to grow rapidly, with them having the potential to catalyse the wider global growth outlook. And with the UK’s main index, the FTSE 100, appearing to offer a wide margin of safety, building a diverse range of stocks could lead to an improving financial outlook for investors.
As such, I think that now is not the time to give up on the stock market following the disappointment with Kier and Thomas Cook. In fact, it could be a good time to invest in high-quality companies that trade on low valuations.
Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019