Amid all the wild moves in financial markets, stocks have especially borne the brunt. Even financial markets that are typically very stable, such as US government bonds, have seen large moves of the likes we have not seen since the global financial crisis.
Investors have rushed for safety and sold riskier assets like shares and found there are few buyers around, exacerbating the situation. Volatility begets volatility.
Eventually markets will find their balance. But for now investors are glued to their screens and are uncertain about what to do.
In such an environment it is best to return to investing basics. In its simplest form, investors in stock markets are buying businesses. They receive dividends from the profits that these companies generate. It is not just profits generated in the current year that matter but also profits in future years. In fact, the value of most companies lies ahead. But because something in the future is less valuable to us than something we can hold in the present, we discount these dividends back to today at prevailing discount rates, a metric that accounts for the time value of money and risks involved.
In the near term, the trajectory of stock markets depends greatly on the extent to which COVID-19 and its global spillover can be contained. But investors would be wise to remember that while we do not know how big near-term growth concerns will be, the long-term outlook is still intact. Discount rates are also coming down, another long-term positive for equity valuations.
This is the time to take the wide view and revisit long-term themes in markets, like demographic trends such as the growing group of Chinese empty-nesters whose children have left home, single-person households or growth in second tier-cities in ASEAN and India. We also know that technology will be different in the future and that 5G and data usage will continue to rise. These themes do not change, even with all the swings in stock prices we see on our screens today.
First published 17 March 2020.
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The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Herald van der Linde, CFA and Frederic Neumann
Equities: Stock ratings and basis for financial analysis
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From 23rd March 2015 HSBC has assigned ratings on the following basis:
The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce.
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Prior to this date, HSBC’s rating structure was applied on the following basis:
For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.
*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
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