Should you buy shares in an overvalued market?

It seems that with every passing week, the stock market is reaching new all time highs. Over the duration of this current bull market, many have predicted that the market will come crashing down due to highly elevated and over inflated share prices. But time and time again, the market has proven them wrong. Just look at the past 12 month, many people thought not only a correction was due but a market crash of 30%+ will be upon us. But the stock markets and investors seem to have a mind of their own these days and stocks have raced higher even with all the problems surrounding the oil price crash, the slowdown in china and Brexit.

I won’t even lie, I will be the first to put my hand up and say that I am surprised to see markets go higher this year considering I think stocks have been overvalued since 2014. In my portfolio, I currently have 45% in cash in anticipation of a 2008 style crash that will enable me to pick up ownership stakes in great businesses at bargain prices. But that crash hasn’t come and I facing the reality that market timing is impossible.

There are two types of investors, ones that know they can’t time the market and ones that don’t know that they can’t time the market. Terri Smith on Market Timing.

What to do in an overvalued market?

I have come to the realisation that the best thing to do is to purchase dividend paying stocks on a monthly basis. This way you do not miss out on any upward appreciation of a stock and the dividend limits any downside.

Take a look at Royal Dutch Shell (RDSB) for instance. In January 2014, right before the oil price crash, the stock was trading 2270p. Today, it is trading at 1970p. Just by looking at the share price, many people would think that RDSB has been a bad share to own over the past two and a half years due to the share price dropping over 13% in this period. But what most people don’t factor in, and what does not show up in the share price is the dividend Shell has paid over this time frame.

If you bought Shares in Shell at the beginning of 2014, you would have received $1.88 in dividends in 2014, $1.88 in 2015 and $0.94 so far in 2016 for each RDSB share you owned.

All in all, it’s been an investment that has thus far generated exactly $4.77 in dividends since the first quarter of 2014. This equates to about £3.20. With Royal Dutch Shell Class B shares trading at £19.70 as of Friday’s after hours trading, the investor that has owned the stock in a tax-advantaged account since the first quarter of 2014 has actually made a profit on the purchase of Shell when you include any payments received. Just think about that for a second, buying shares in a company on the eve of its main product crashing in price by over fifty percent has still yielded the investor a profit. Just imagine what would have happened if things went well!

Shell is by no means the only company that’s had its share price fall over the last year but has seen its shareholders still end up with a positive return. Pharma giant GlaxoSmithKline was seen by many to be trading at an elevated value when it had a share price of 1749p in 2013. This saw its share price fall over the next few years and it has only recovered recently. Even with this recovery, shares still only trade at 1648p today, a 5% drop on the 2013 price. So while GSK seems like dead money on the face of it, when you include dividends that the company has paid over this time period, investors are up 10%!

That’s the advantage of investing in solid blue chip companies. Even if the share price is a little overvalued and falls over the next year or two, the dividend usually acts as a safety net for investors in that company. This is the reason that I have continued to make monthly purchases of solid blue chip companies even in this inflated market. Besides, what’s the alternative? Leaving money in a 1% current account that has a negative real return.