Is the Correction Over?

Even though the markets recovered somewhat on Friday, at the end it was another bad week with losses for the leading US market indexes. The S&P 500 shed 7.23% this month and was down more than 10% at some point. Does Friday’s recovery mean the correction is over? We don’t think that anybody actually knows for sure.

We always prefer a longer term view. The volatility within a few days or even weeks is not important. One of the two main benchmarks we use is the S&P 500. It has an average return over the last 10 years of 10.41% and a CAGR of 8.49%. Our US portfolio has outperformed this benchmark since we started this portfolio in January 2017. December 2017 and January 2018 produced excess returns of about 4% on a year-to-year basis. The number of data points is still too small. Perhaps we just got lucky and in future we won’t be able to produce an excess return. Only time will tell if the excess returns are sustainable.

Let’s have a look at how the setbacks in the last two weeks influence valuations. 

For example Apple (AAPL) is now available at a price/earnings (P/E) ratio of 15.94. Forward looking P/E ratio is 12.5. When we look at the average annualized total return for AAPL, its value is 19.72% over the last 5 years. They just announced their biggest quarterly profit of all times. Apple now has an installed base of 1.3 billion mobile devices and they add more each month. While a large portion of their revenue is generated by the iPhone, their service business is growing faster than the iPhone revenue. As a result the share of services is now 9% compared to 6% of revenues. There are indications that Apple Music may overtake Spotify in the US market as the largest music streaming provider. Since Apple started to pay a dividend they have increased their dividend each year. They are sitting on a large pile of cash. Now that they can repatriate that cash into the US at a much lower tax rate, more of it could be appropriated to buying back shares and increasing the dividend. This is not to say that they will actually do that. But there is definitely more wiggle room for it. All taken together, in our view this means that the “For Sale” sign went up on Apple stock. This might be a good buying opportunities either now or until the current correction has bottomed out.

Looking at dividend aristocrats, another group of shares that we really like, the picture in terms of valuations is improving as well. Before the recent market declines most of them had P/E ratios of over 20 or even 30. Some still do. But some now some have become available at P/E’s of less than 10. For example AT&T (Ticker symbol 'T') has a P/E ratio of just 7.74 as of writing. Yes, there are reasons to be cautious in their case. AT&T’s liabilities are at 71.85% of their total liabilities and equity in the latest quarter. Long-term debt is at 34.86%, so any increase of interest rates could impact their bottom line. On the other hand large mobile phone providers like T Mobile USA and Sprint have indicated that they will scale back their discounts throughout this year removing some price pressure. This should help AT&T as well. The pending acquisition of Time Warner is not approved yet and the settlement talks with the Department of Justice (DOJ) fell through in December 2017. The lawsuit continues and the outcome is far from clear. One option that AT&T could consider is a (partial) float of their DirectTV business to generate some cash. The upside for AT&T’s stock is that their dividend yield is a generous 5.33% and they being a dividend aristocrat they have increased their dividend for at least the last 25 years. While some of their decisions are risky, the sheer fact they are willing to make significant changes demonstrates that they are taking concrete steps to secure their future.

So, perhaps, it’s best to take comfort in the knowledge that in general buy-and-hold is a long-term strategy that has worked out for other long-term investors like Warren Buffett, provided you selected quality stock in the first place. Setbacks in the stock markets could be buying opportunities!

Happy investing!

Disclosure: We own shares of Apple and AT&T. We don't have a position in any of the other companies mentioned in this article. We have no plans to change our positions within the first 48 hours after publishing this post.