Most of us have had our fill of bad news this year. But things may be looking up come the turn of the year.
There are good reasons to feel optimistic about 2021.
Battered businesses are adapting and evolving their business models to cope with the crisis. More of them have digitalised and are relying on online sales to replace a portion of their lost revenue.
With the announcement of vaccines with strong efficacy rates of around 95% by both Pfizer (NYSE: PFE) and Moderna (NASDAQ: MRNA), there’s now justifiable optimism in seeing an end to this pandemic.
While share prices have collapsed in the wake of a fall in profits and cash flows, I believe businesses should see better days ahead.
A turnaround in profits
Many companies have now announced that they are seeing a nascent, albeit slow, recovery in business prospects.
Some have even commented during the third-quarter results that the worst may have passed.
What this implies is that earnings may have seen a trough as widespread lockdowns that occurred in the earlier part of this year flowed through to lower profits in the last quarter.
While the virus is still running rampant in countries such as the US, it’s unlikely that we will see a repeat of the lockdowns as governments also want to keep their economies afloat.
2021 may see more companies reporting a rebound in revenue and profit.
An increase in dividends
Over the last six months, many businesses focused on survival and hoarded cash.
Some even tapped on credit lines to increase their access to liquidity to avoid a potential cash crunch.
All these measures meant that dividends had to be drastically reduced to prioritise the survival of the business.
With better days ahead, companies should enjoy healthier cash flow and some may even start to pay out more dividends.
Though the level of dividends may not match what was paid out before the pandemic, this increase should nevertheless be significant in percentage terms as it is coming off a lower base.
Valuation uplift
Investors should not forget that valuations also tend to rise once optimism seeps into the stock market.
This rise has a double bonus effect on share prices.
Imagine if a business reported that earnings per share fell from S$0.05 to S$0.02 due to the pandemic.
As growth prospects have grown more muted, investors also assigned a lower valuation for its shares.
Perhaps the price-earnings multiple has now been reduced to just ten times, from 20 times before the pandemic.
The shares of this hypothetical company will trade at just S$0.20 (S$0.02 x 10) instead of S$1.00 (S$0.05 x 20), implying a plunge of 80%.
The converse is true when earnings show a swift recovery.
If we assume earnings per share recovers to S$0.03, and investors assign a price-earnings multiple of 15 times as they are feeling more optimistic, the shares would have more than doubled to S$0.45 (S$0.03 x 15).
An increase in dividends could act as an additional cherry on top of the cake as the investor’s total return will be boosted by the higher payouts.
Get Smart: Opportunities galore
Now, imagine if this scenario was played out across a wide swath of companies that were badly hit by the pandemic.
A strong recovery in profits, cash flows and dividends may occur as early as the first quarter of 2021, assuming the vaccines can be deployed to a large portion of the global population.
People have been desensitised when it comes to further bad news, and this will not have any more negative impact on share prices.
However, when news of earnings recovery and dividend increases starts circulating, it could trigger a relief rally and a valuation uplift as described above.
As investors, we should stand ready to scoop up all these juicy opportunities.
And we should be ready to invest in them before the good news breaks out.
Fortune favours the bold.
And we believe now is the perfect time to be bold and be ready to invest in great companies that will ride the upswing.
Want to stay abreast of the latest investing news, analyses, and stories for FREE? Subscribe to our weekly email, Smart Reads, now to receive a curated list of our top articles weekly. CLICK HERE to subscribe now!
Follow us on Facebook and Telegram for the latest investing news and analyses!
Disclaimer: Royston Yang does not own shares in any of the companies mentioned.
