Last week I wrote quite a lot about the coronavirus and what it might mean for investors and their share portfolios. The one thing I would like to stress if you hold individual shares, is to understand the importance of studying a company’s history and particularly how it performed during the last recession.
The chances are that if a company suffered badly during the last recession and saw a big fall in its profits then, unless the business has significantly changed or improved, it is likely to suffer again in the next one. It never ceases to surprise me how many investors think that they have invested in a high quality business with sustainable growth prospects when instead they have bought a slice of a cyclical business at the top of the cycle when it tends to look at its best.
The other thing to understand is the concept of operational gearing - how a company’s profits change in relation to a change in its revenues. Cyclical businesses with high fixed costs tend to look great and also very cheap at the top of an economic cycle - as profits increase faster than revenues - only to look horrible when profits subsequently crash and operational gearing works in reverse.
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