How should I respond to a booming stock market?

Lately, the headline UK stock market index has been performing well. While its 4% increase over the past 12 months might not sound like the stuff of legend, the FTSE 100 hit an all-time high this week.

One of the keys to success as a long-term investor is not overpaying, even for shares in great businesses. So what investment strategy am I adopting in this environment?

All-time high

It is worth beginning by noting that the FTSE 100 is not the same thing as the “stock market” in general. It is made up of 100 of the companies that have the biggest capitalisations in the market.

So while that makes it a fairly good bellwether for the UK economy in general, there can actually be quite a significant difference between how the FTSE 100 performs and what happens in the stock market more broadly.

The FTSE 250 index of medium-sized companies did not hit a new all-time high lately. In fact , it has lost 8% of its value over the past year.

Looking to the US, the benchmark Dow Jones Industrial Average index has slipped 5% over the past 12 months. The tech-heavy Nasdaq index is 18% lower than a year ago.

So, yes, the FTSE 100 has hit a new high. But the stock market in general has shown mixed performance in recent months, on both sides of the pond.

A market of stocks

How should I respond as an investor? I think it is always useful to remember the old idea that it is not a stock market, but a market of (individual) stocks. A cricket team lifting a trophy does not necessarily mean every player performed well. Similarly, there is a difference between how an aggregate index performs and the individual performance of each share in it.

Even with the FTSE 100 hitting its highest ever level, I continue to see particular shares within it that I think offer my portfolio value.

For example, British American Tobacco has fallen 9% in the past year. But I think the company continues to offer my portfolio good value. Its dividend yield is 7.4%. This morning, it announced the latest in more than two decades of annual dividend increases – this time by 6%.

Warren Buffett on value

Equally, what seems like a cheap stock market can still contain overvalued shares. When prices plummet, some investors fill their boots thinking that sharply lower prices equal good value.

However, as billionaire investor Warren Buffett is keen to point out, price and value are not the same thing. In Buffett’s view, price is what you pay but value is what you get.

He likes to invest in shares he thinks are much cheaper than what he sees as their long-term valuation. When he first bought Apple in 2016, many investors already thought it was overvalued – but it has been a massively rewarding investment for Buffett.

Like Buffett, I respond to a booming stock market, or a tanking one, in the same way – by hunting for great value shares I can hold for the long term.