The best New Year's resolution that any investor can make is to become an optimist

  • In Business
  • 2022-12-30 06:00:00Z
  • By The Telegraph
new year
new year  

This year has been the most significant one for investors since the global financial crisis. It drew to a close a long period in which ultra-loose monetary policy became the norm and rampant inflation was viewed in some quarters as a problem of yesteryear.

Now investors face a new era in which interest rates are likely to settle roughly in line with their long-term average and above-target inflation seems likely to be looked upon with a degree of forbearance.

This situation poses difficulties for investors. The old days of overlooking high valuations among companies with no competitive advantage and weak balance sheets are over. Instead, investors must be more thorough and less forgiving.

It is logical for all investors to modify their strategy where necessary in light of ongoing economic change. With that in mind, here are five New Year's resolutions that could enhance your returns over the coming years.

Avoid heavily indebted companies

Companies with large debts will ultimately find it more difficult to service and repay them in a new era of tighter monetary policy.

Some companies that operate in relatively stable industries, such as utilities and tobacco, can cope with greater leverage than cyclical businesses with more volatile financial performance, such as retailers and media stocks. However, investors should become less amenable to any business that has loaded up on debt.

One means to calculate leverage is to deduct cash balances from total debt and then divide the figure by net assets. Any figure above 100pc is a red flag unless the business is very stable. A further consideration is net interest cover, which is calculated by dividing operating profit by net finance costs. Any figure of less than three is a cause for concern unless the company operates in a very defensive sector.

Insist on a competitive advantage

Margin growth is likely to become harder to find thanks to rising costs and a weaker economic environment. Only companies with a clear and sustainable competitive advantage will be able to deliver a significant rise in profitability. This contrasts with the past decade, when a buoyant economy allowed even low-quality companies to deliver a growing bottom line.

Identifying competitive advantage is not an exact science. Double-digit returns on equity over multiple years, when combined with modest debt levels, are an encouraging sign. So too are pricing power, brand strength and customer loyalty.

Demand fair prices

Higher interest rates mean valuations are unlikely to return to the levels investors became accustomed to in recent years. Higher interest rates mean higher "discount rates" are used to calculate the "net present value" of a company's future cash flows.

A variety of valuation methods can be used. In Questor's view, consistency within the same sector and demanding a margin of safety are crucial.

Be prepared to act quickly

The stock market's short-term performance is inherently unpredictable and can quickly change. This year, for example, various indices traded close to all-time highs in January before falling heavily.

Such events present excellent buying opportunities for long-term investors. Therefore, it is worth keeping part of a portfolio in cash to capitalise on temporary price movements. Equally, identifying stocks that are currently overvalued but would be attractive in a market downturn is a worthwhile use of time.

Adopt a bullish long-term view

Optimism is somewhat scarce among investors after a challenging year for shares. However, the stock market is cyclical in nature. Just as its upturns always come crashing down, its downturns are always pushed aside by surging prices.

Investors who can look beyond short-term challenges to the potential long-term rewards from holding stocks are likely to be handsomely rewarded. Therefore, despite all the doom and gloom, the best New Year's resolution any investor can make is to be an optimist.

Read the latest Questor column on every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

Read Questor's rules of investment before you follow our tips


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