How investors should respond to Hurricane Sandy
Hurricane Sandy is currently bearing down on the major population centres of the US east coast.
There have been scores of lives lost in the Caribbean, and we hope any further loss of life is limited or preferably avoided entirely as the storm crosses the American coast.
Our thoughts are with those in its path and in its wake.
The US markets might have been closed last night and will be closed again tonight, but the rest of the global markets, including the ASX, remain open.
And while we have one eye on the natural disaster, investors are wondering how it will impact on companies in their portfolio.
In the first line of consideration are the insurance companies – in particular QBE Insurance (ASX: QBE). QBE has significant US business, and will likely be hit by claims from the storm, which have the potential to reduce earnings in the current financial year.
On the flipside, construction businesses will be busy in the next year or two if Sandy has a significant impact. Companies like James Hardie (ASX: JHX) will also tend to benefit if that's the case.
Perhaps unsurprisingly, QBE shares opened down this morning, while James Hardie shares opened in the green.
Before investors get too despondent or excited, it's time for a few deep breaths.
Understanding the impact
Insurance company shareholders are notoriously – and surprisingly – fickle. They should know better.
Insurance is a terribly "lumpy" business. It's a game of probabilities. These operations are run to make money over the medium and long term and recognise that Mother Nature refuses to adhere to financial-year schedules.
In some years, insurance companies will be enormously profitable, when there are few or no significant disasters.
In other years, profits are hard to come by as disasters strike. The bean counters make sure the companies make money over the medium term – by pricing policies according to probability – but no one expects them to be able to forecast where and when disasters will happen.
When you know that, it's amazing to watch insurance company share prices fluctuate in line with the latest disaster, as if investors have only just realised that they happen. The savvy investor uses the pessimism to buy cheap.
Construction companies, on the other hand, will have the opposite impact. If there is significant reconstruction required (and we hope there isn't), there will be a 12 to 18 month boost in revenues and profits as order books fill up.
Just as the insurance claims are one-offs, so a construction boom will be relatively short-lived. As always, it's the sustainable underlying business that investors should be focused on.
While we'd all prefer natural disasters didn't happen, there is at least a silver lining.
The reconstruction effort will actually stimulate economic activity, creating demand for businesses and jobs for workers. It won't add to the US national wealth – it will simply be replacing infrastructure that was destroyed – but the extra economic activity should give America at least a little momentum.
Successful investing requires the ability of investors to discern the difference between underlying and one-off impacts on a business – and using that information wisely. In the case of insurance companies, using a long-term average profit is wise.
It's also a good time to remember that investing is important, but not everything.
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Scott Phillips is a Motley Fool investment analyst. He owns shares in QBE Insurance. You can follow Scott on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).