Most of the time, I only talk about investments. It is something I consider a joy and a privilege to discuss with you because financial security is one of the most important topics of daily life. But of course, it is a second to health.
With that in mind, I proceed with the premise that: (1) your first priority should be ensuring that you and your loved ones remain safe, taking no more risk than is necessary while the coronavirus spreads; and (2) maintaining adequate liquidity, as unemployment could reach a generational high the longer “shelter in place” type of arrangements remain in force.
Simultaneously, it is also true that the moments of uncertainty and deteriorating economic conditions are when the stocks of the world “go on sale.” Since the American stock market reached its generational low in March 2009, we have been on an almost non-stop march upward with twelve years of gains that were only occasionally interrupted with a modest detour here and there.
Stable and gently sloping markets can lead to bad habits. People invest money that they may need in a year or two. Stocks in companies like Tesla rose from $300 to $900 in January/February 2020 just because of some speculative tweets about ambitious developments. Speculative companies came to occupy every-growing portions of America’s portfolios. The slower growth that came with the territory of doing things in the manner of what our grandparents would consider “the right way” was replaced with overleveraged operations that could handle any business disruption without needing emergency capital or risking bankruptcy.
Amid this change, we as a nation and world are dealing with unprecedented, deliberate shutdowns of business activity. Hotels, airlines, and the entire travel and hospitality industries have seen their demand evaporate overnight while carrying large debt burdens that does not provide room for cash flow disruption. Hence, talk of bailouts and new market rates for borrowing that we would consider punitive under most of any other circumstances.
Now, the consequences of balance sheet literacy when evaluating an investment is extreme. Every publicly traded company has to make regular filings with SEC (freely available online through the EDGAR services) that includes documents such as an annual report. You have to read about a company’s debt covenants and obligations now. When are the notes due? How much? What is the cash on hand? How does it compare to cash flows? How about the credit facilities–are they subject to conditions precedent or can they be withdrawn, or is the money freely drawable once notice is provided? For companies that are now facing 80% or greater declines in product demand, money due and owing in 2020 can spell doom. Conversely, companies that are still profitable, with ample cash and/or no major debt obligations due and owing soon, can be some of the greatest opportunities available in the market.
There is a reason why, for instance, I have written over 100+ articles since 2011 praising the business model of Coca-Cola (KO). Lord knows it has probably annoyed many of you with the repetition. But there is a reason for it. Although not a mathematician, I realized that years and years of super-compounding is all for naught if ever multiplied by a zero along the way. Strong perpetual product demand with ample liquidity is non-negotiable to investing.
Right now, even though Coca-Cola has fallen off its highs of $60, the operational story remains fully intact. The beverage giant has $13 billion in cash. Even after paying all of its taxes, debt, and other expenses, it has still managed to generate $9 billion per year in profits. Because we all need beverages to live, and because Coca-Cola has over 500+ brands supplying over 3.5% of the world’s daily beverage consumption (you read that right), there are still cash profits flowing to Atlanta’s headquarters. Maybe the profit engine has been impaired temporarily and it may only generate profits of $6 billion this year, but it is wonderful to own a business where unprecedented down times means that only $500 million cash profits are sent to headquarters each month instead of $750 million.
In contrast, there are hotel companies where properties are either leased or owned with a mortgage and billions of dollars in losses will now result from vacancies (which is especially terrible because losses necessitate borrowing of their own, which becomes coupled with pre-existing debt that must be paid). There is a reason why I’ve never spoken favorably of purchasing Marriott or Hilton stock–the debt load is enormous and the cash flows cannot suffer disruption without requiring external funds from some financier who will want to charge exorbitant rates consistent with the heightened risk.
On the whole, stocks have fallen 30% in less than a month. As always, not all declines are equal. For some American blue-chips, they are trading at once-in-a-generation or once-in-a-century type of valuations because investors are only worried about 2020 and 2021 earnings, not realizing or perhaps not even caring that the business is being given away once the future prospects for 2022, 2023, 2024, and so on are included.
The purchase price of your stock sticks with you forever. It is the basis from which you calculate your compounding and whether any wealth has been made over time. Many of the strongest companies in the world are now offering the prospect of 15% annual compounding over the 5-10 year run. Others, particularly those with strong balance streets operating in industries where demand has fallen off a cliff, now offer the prospect of 20% annual returns commensurate with the risk of an extended coronavirus-related shutdown.
My own view is that one should prioritize having adequate cash/liquidity for the family, and after that, begin deploying capital gradually into companies with strong balance sheets that have fallen along with everything else (my own ideas are shared over on Patreon). I have seen more opportunities in the past week or two than I have at any point since I began finance writing in 2011. During abrupt market declines, the selling is indiscriminate. TAs a result, the opportunities come at you like a malfunctioning tennis ball machine shooting out balls all over the court. You only have one racket, and one swing at a time.