The Next Phase (Covid-19 Update #7)

18th March 2020

The above charts show the Dow Jones Industrial Index (the American share market) price movement over the last few days (the chart on the left) and over the last 12 months (the chart on the right).   

So, we enter the next phase. 

The next phase is where we start taking advantage of lower prices, which means investing, using some of the cash that has been sitting around for a while and now all of a sudden has become very useful.

“When markets rise, any amount of cash is too much.  When markets decline, any amount of cash is not enough.”

                  Peter Flannery.

It can be tricky, working out that balance between being invested and participating in growth, against keeping some aside for a rainy day, so to speak, and having enough ‘fire power’ to make a real difference while prices are low. 

For us as value/eBiz Investors, we have a couple of indicators that help.

One of those is looking at the trading price and comparing it with the underlying intrinsic value of the business.  That gives us a good starting point, particularly when markets are unusually expensive, like they have been over the last several years.  That seemed to go on and on for a very long time. 

Markets are arguably now no longer expensive (ignoring central bank intervention).  That said, I do not believe markets are necessarily overly cheap either; however, value is emerging and already, at WISEplanning, there has been some serious activity, as we take advantage of those lower prices. 

This does not mean that we are in ‘boots and all’ so to speak. 

What to do?

Assuming you have cash available, whether it be inside the portfolio or outside the portfolio, now is not a bad time to be taking advantage of lower prices. 

Although everyone’s situation is different, typically, for those that are more advanced, we might be allocating somewhere between 20% and 60% of cash available into good businesses, whose prices now represent reasonable buying.  The more advanced your investing strategy, the sooner you will invest and the sooner you will deplete cash.  The more defensive (less advanced), the more measured you will be and the more protracted the process of investing the cash. 

Is it too soon to move?

No.

As you know, we are not interested in trying to time markets. 

We might get it right from time to time but I guarantee you we also get it wrong when trying to time the market.  In the end, we are much better off to price for risk.  In other words, let’s see where the trading price is in relationship to the business’ ability to generate sustainable profits and grow in the future (that is my job). 

The Rule of 5 applies – some businesses will perform better than others. 

The idea here is that markets will likely remain volatile for some time yet but at the same time being invested across the bottom is key to maximising ROI.

A couple of examples

Moving our discussion from the portfolio level to the individual business level, if we look, for example, at a small company, such as dotDigital in the UK (you may or may not have this business within your portfolio, as it depends on a number of factors as to whether or not you would) this is a small business and all small businesses are more vulnerable than larger businesses.  In general terms, however, they can grow faster than large businesses. 

Alphabet (Google) and Apple are two examples of businesses that were once small caps and are now huge.  The growth in the intervening period has been significant and just quietly, the money that investors have made along the way is significant too. 

Will the Coronavirus have an impact on dotDigital?

The Coronavirus will have little impact directly but indirectly, dotDigital’s end users may be impacted to a greater or lesser extent.  Therefore, one would expect its customers who are affected by the Coronavirus to generate lower profits and potentially strike tough times. 

Well, if it is going to be tough times, why do we not get out, sell DOTD?

If you have read my material for any length of time, you can just about guess what I am going to say now … it is because we are business owners and not share market speculators.  We do not play the share market.  We invest in businesses.

What about if we know Coronavirus is not going away anytime soon and indeed, is only going to spread?  Surely that will have a growing negative impact on the likes of small companies, like dotDigital!?

Quite possibly and whilst we are unhappy about the human toll that Coronavirus causes and the financial impacts are not always pleasant, the lower prices that emerge as a result of these conditions allows the value that we crave as value/eBiz Investors to emerge.  The financials (the numbers) of a business will report to us about the state of the business.  Those financials, though, do not drive the success of the business.  That is where the economics of the business come in. 

Admittedly, this does take a solid methodology and perhaps some experience to really understand it; however (don’t worry, I do not think I have reached guru status just yet!),  once we understand that even though the quarterly, six monthly or annual profit might be lower and that the market really dislikes this and so down-sells these companies, we also take into account the economics of the business.  That way, we are better placed to assess whether or not the business will be permanently or significantly compromised or damaged, in which case that can be a time to exit.

On the other hand, even with profits lower and changing conditions creating headwinds for a business, those economics help with business resilience and provide us as value/eBiz Investors with the opportunity to increase our ownership of the business. 

Isn’t it funny how opportunity is sometimes dressed up as falling share prices!? 

The trick with this phase is …

This phase is about taking advantage of lower prices … pricing for risk … not timing markets.

It is about the initial first round of buying. 

It is not just buying up because prices are lower but rather a measured and iterative approach to gradually taking advantage of lower prices as the volatility unfolds over the next three to 12 months or so, in line with your investing strategy. 

So, an initial round of buying is in order and how we go about that, of course, is something that I may have spoken to you about already or that I can talk to you about in due course as your review cycle comes up.  You can always get in touch in the meantime if you want. 

The trick though is to avoid the temptation to time the markets. 

The way to do that is to remember that we are business owners, who invest in businesses and we increase our ownership of businesses as market prices decline, so that we are  invested across the bottom of the market price dip.  My job is to ensure that you do this in line with your investment risk preferences and your long-term goals, along with any current income requirements.

Let’s keep the focus

Our focus should be on your long-term goals, the methodology, your investment risk preferences, your investing strategy, your income requirements now (if any), oh, and did I mention your long-term goals ( Yes I did repeat that on purpose!). 

Nowhere in the above sentence did I mention to be anxious about trading prices that bob up and down, or obsess about trading prices, however sharply they move.

“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given business and, above all, the durability of that advantage”.

                                             Warren Buffett