Six months into the Covid-19 crisis, many of us feel like Manny, Diego
and Sid: hurtling through a world on the edge of life-changing cataclysms, not
sure what tomorrow will look like.
Nowhere has this angst been clearer than in the stock market. Cruise lines have tanked, which is understandable given the industry very high fixed costs, high debt leverage and its inability to operate (in the US, as per the No Sail Order). Airlines are likewise in an existential crisis for similar reasons. At the other end of the spectrum, Zoom Video Communications (ZM) has experienced a massive rise in both customer usage and stock price. Generally speaking, companies involved in physical activities have suffered while those that are associated with at-home or virtual activities have flourished.
But the stock market is supposed to look ahead, to discount future cashflows; monoclonal antibody treatments are proving useful, vaccines are expected to start being distributed by next spring, and the second wave of infection has so far been much less lethal than the first. Trillions in savings remain on the sidelines which, at some point, will either be spent on Main Street or invested on Wall Street.
Why is it that the stock market seems to believe that we are and will remain mired in the Ice Age, confined at home, watching streaming videos and leaving home only for quick dashes to the supermarket? Or are the fears of a change in the White House and the Senate so great as to stamp any feeling of hope and optimism?
Are we entering a new era where, among other changes:
·
No
one flies for vacations or business reasons?
·
No
one shops for clothes, be they fashion or sports oriented?
·
Alternative
energy sources quickly take the place of oil and natural gas?
I don’t think so. The question
then is (a) which company to invest in and (b) when?
There is no magic recipe. Logically, in times of stress and uncertainty about the future, it pays to be selective. We will not give up flying, but we may fly less (at least for a while); in this case, only the strongest might survive; why invest in the #5 airline stock which could return 150% if investing in the #1 could return 50% over the same horizon but with a lot less risk?
In the fashion sector, uncertainly is the nature of the business. I would ask myself: ”what is a reasonable value for this brand and does the enterprise value of the company (market value + debt - cash) reflect it?” There is no set formula but a commonsense approach (looking at comparable products and companies, historical data, likely future earnings, etc.) should yield a range of values to work with.
Energy, being the single most important factor for economic growth, has strategic, political and social dimensions in addition with concerns about global warming. While it is reasonable to assume that oil and gas will fade as energy sources just like coal did, such transition will likely take 20 to 30 years: the demand for energy keeps increasing, solar and wind power are both expensive and not easily scalable, nuclear fission is unpopular in the US and Western Europe and nuclear fusion is still at the experimental stage. Fossil fuels are widely used because they have several big economic advantages (such as energy density, ease of transport and storage, scalability, cost) which solar and wind lack, and will continue to lack.
In all of these sectors, given their depressed valuations, investors willing to take the plunge should stick to the top companies: those that have enduring market positions, the riskier the sector the more reason to stick to the #1 firm. Targeted companies should also enjoy very strong financials to carry them through extended periods of volatility or low growth, and high quality management; it is worth emphasizing that high quality management usually translates into a strong company culture which facilitates good execution and overcoming hard times.
The other question is when to get in. Picking a good entry price is the most important decision in an investment cycle. It is easier to determine if a good company is selling at an attractive price than to try and guess when market bottoms may be reached. Finally, in times of stress and volatility, picking realistic goals is key: a stock which may rise by at least 30% over the next 3-4 years while paying a 2.5% dividend would return around 40% over that period while a US treasury would return 4% at best. Why be greedy?
