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Investing Advice for the Coming Interest Rate Hike

Brian-Hillegas-Flickr

The US dollar is hitting new highs at the moment.

The new highs seem to indicate that folks are expecting the US Federal Reserve to raise interest rates sooner rather than later. As you can see below, the Federal Funds rate has been kept low for the past five plus years.

Fed Rate

The expectation of an interest rate increase has allegedly been the cause of volatility in the stock market as some believe, and patience is in short supply. 

In such a scenario, what is a Foolish investor to do? 

Peter Lynch’s golden rule

For some help, we can perhaps turn to Peter Lynch. He is someone who might be worth listening to when it comes to investing matters.

After all, Lynch had led the U.S. based Fidelity Magellan Fund to phenomenal annual returns of 29% over 13 years (from 1977 to 1990). In his bestselling investment book Beating the Street, Lynch offered his thoughts on interest rates:

“Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’re invested.

The advice from Lynch really isn’t too different from what we at The Motley Fool like to do – and that is, to focus on the business behind the ticker.

When interest rates matter less

To find out why a focus on the business can work, let’s take a look at how the balance sheet and free cash flow of vehicle inspection unit Vicom Limited (SGX: V01) has changed over the years from 2003 to 2014.

Vicom's free cash flow (FCF) and dividends, and total cash and total on balance sheet

Source: S&P Capital IQ

From above, we can see that VICOM has been able to grow its free cash flow over the years without taking on much debt.

The end result? Cash starts to pile up on its balance sheet as well, giving the firm a stronger financial base.

What’s even more notable is that the company’s growth in free cash flow had occurred regardless of the wild movement of interest rates (in the period under study) as a result of the financial crisis and all that happened in the few years before and after it.

The final result of all that growth Vicom has seen in its business is that its shares have increased by 1,048% from S$0.625 at the start of 2003 to S$6.55 today.

In any case, it’s also worth pointing out that for companies with strong balance sheets, we may rest easy that they have the resources to grow further without sweating over the direction of interest rates.

Foolish take away

Foolish investors may be better off heeding the words of Lynch and focusing on the actual business of a share itself. The current scenario – where financial pundits are wont to guess the Fed’s decisions on interest rates and their subsequent outcomes – may be aptly summarised in a tweet below:

Stay patient, stay Foolish. Fool on!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Vicom.