10 quality mid-caps made cheap by October's stockmarket sell-off

A rational approach is to use market dips as an opportunity to find value in previously expensive shares. Stockopedia's Ben Hobson finds the high-flyers at attractive prices.  

Volatility has rattled the stockmarket during the first half of October. It's proved to be a sharp reminder of just how quickly fear can spread when equity prices start tumbling.

For British quoted mid-caps however, the reality is that many have held up well during the past couple of weeks. A 6.4% dip on the FTSE 250 index since the start of the month is some way off the 10% fall that you’d typically get with a genuine market correction. It's certainly nowhere near market crash territory of 20% or more.

Leading the top five list of the biggest fallers over the past month is travel operator Thomas Cook. Relative to the index, it's down by 38%. The next four - Keller, ConvaTec, Superdry and IG Group - have all issued profit warnings. Between them they are underperforming the index by between 26% and 34%.

But these are extreme cases. It isn't all bad news. More than 100 stocks on the FTSE 250 have resisted the market wobble and managed to post positive gains during October. It's a reminder that the instinct to sell during periods of market uncertainty can end up being costly for investors. It leads them to act in haste to avoid losses but then miss market rebounds that leave them left behind.

The fear of losing

On its own, loss aversion is one of the reasons why investors sell winning positions too readily and hold losing positions too long. But it can also trigger other decisions that don't work well in investing. 

For a start, it can cause investors to sell positions at the wrong time, particularly when faced with uncertainty. It may also lead us to become too risk-averse and forget that, as an asset class, stocks do encounter short term volatility. Nonetheless, they still tend to outperform other assets over the long term. 

This problem is made worse when you combine loss aversion with the other well-known emotional tendency of constantly watching portfolio performance. When that happens, you get something called myopic loss aversion. The more you look, the worse it gets before, ultimately, you become paralysed by fear and make costly decisions.

In many respects this dilemma was tackled in a classic quote by Warren Buffett - a man not easily shaken by price swings:

"If you expect to be a net saver during the next five years, should you hope for a higher or lower stockmarket during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."

What Buffett meant of course, is that falling prices often mean cheaper stocks. There's no doubt that the October wobble has slimmed down the price-earnings (PE) ratios of many shares on the FTSE 250. 

For investors looking at higher quality, strong momentum but potentially expensive shares, that improved value may not be enough. But it's still worth considering how a market dip can actually improve the attractiveness of some shares.

This week we've pulled together a list of FTSE 250 stocks with the strongest blends of quality and momentum - what Stockopedia calls High Flyers. Many of these shares have easily outperformed the index over the past year, but most have undershot it in the past month.

Source: Stockopedia              Past performance is not a guide to future performance

This list tells a good story about how some of the market's most popular names are affected by volatility. Some, like A.G. Barr and Euromoney have managed to rise above the falling index, but many others have come under pressure and have actually underperformed the index over the past month. 

In many cases these were (and maybe still are) expensive looking shares. On a PE basis, some of the most highly rated stocks here include Softcat, Hunting and Diploma. 

For watchers of these kinds of shares, a market dip can offer an ideal entry point. Others will prefer to see a much deeper correction in prices before buying in.

Overall, evidence suggests that risk-averse humans find it hard to stomach the kind of short-term variations in stock returns we’ve seen in October. That's despite the fact that shares generally outperform most other assets over the long term. 

A more rational approach would be to use market dips as an opportunity to find value in previously expensive shares. As Warren Buffett once said:

"Whether it's stocks or socks, I like to buy quality merchandise when it's marked down."

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