Investors should avoid businesses with over-hyped valuations

 

The over-hyped valuations of the unprofitable businesses will create many opportunities across less popular sectors but this will require investors to focus on finding companies with a history of strong cashflow, according to Spheria Asset Management. 

However, this might be tricky given that since the onset of COVID-19 stocks that were losing money had significantly outperformed stocks with sound cash flows that were making money, Spheria’s portfolio manager, Marcus Burns, warned. 

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“We saw signs of a reversal of this distortion late in 2020 and we believe the scales will continue to tip in 2021. Investors focussing on stocks with strong fundamentals will be the beneficiaries at the expense of those relying on the greater fool,” he said. 

Additionally, the more profitable businesses with strong fundamentals and positive cash flows would become highly attractive take-over targets with merger and acquisition activity on the increase. 

“2021 could see a flurry of merger and acquisition activity, which could prove lucrative for investors holding potential future takeover targets. There’s an abundance of liquidity, extremely low interest rates and corporate confidence is on the rise. This is very likely to lead to more merger and acquisition activity in the small and microcap space throughout 2021,” Burns said. 

However, most acquirors would be seeking profitable, cash-generating companies with modest gearing in order to support their merger and acquisition rationale. 

“Also, with the IPO pipeline having been in abeyance for most of 2020, we would expect a combination of private equity sell-downs and entrepreneur-led businesses to seek to initial public offerings during the calendar year,” the firm said. 

 




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