In times like the ones we are experiencing today, it is reassuring to know that we have invested in stable companies, whose business model has proven itself, that are profitable and in good financial health. (Image: 123RF)
GUEST EXPERT. As of this writing, the stock markets continue to fall. And contrary to what we’ve seen for some time, downward pressure seems to be rampant. Even stocks that are considered highly defensive and relatively immune to sharp declines are being dragged down, swept away by the whirlwind. Over the past few days, titles like Wal-Mart, Apple and Google have been corrected.
Such periods are never easy for the investor to navigate, although, as I wrote earlier, stock market corrections are normal and repetitive.
However, I believe that the long -term investor who promotes the “value” investment philosophy has a huge advantage over other investors, particularly speculators.
In fact, in times like the ones we are experiencing today, it is reassuring to know that we have invested in solid companies, whose business model has proven itself, that are profitable and in good financial health. In these cases, you can try to evaluate the downside risk of a security you hold in your portfolio by asking yourself two questions:
- How much can the company’s revenue fall? It is likely that an economic slowdown, or even a recession, will occur in the coming months. What could be the impact on the company’s revenue?
- Based on this estimate, what valuation ratio are investors willing to pay for this company’s stock, assuming a pessimistic scenario?
When I review each of the securities in our portfolios under management, I get a good idea of the answers to these two questions. A very pessimistic scenario could result in a prolonged decline in the value of our securities in the coming months, but I nonetheless believe that this amount is limited.
What about companies that are currently unprofitable and likely to continue to lose money for the foreseeable future? In this case, it is difficult, if not impossible, to estimate the value of the floor. The problem for many losing companies is that they will likely need capital to continue their operations, even as the capital market closes further.
It was a situation where I didn’t want to find myself.
This is also true for companies with large indebtedness. These companies find themselves in a situation where access to equity capital is suddenly very limited, while new debt is suddenly more expensive than in the past. For example, according to the Federal Bank of St. Louis (St. Louis Fed), the spread between junk bond rates and U.S. government rates climbed to 4.71% on May 16 compared to only 3.27% on April 5. and 3.03% on December 29, 2021.
Same thing for those who own cryptocurrencies. What benchmark should be used to get an idea of the downside risk of bitcoin or other cryptocurrencies? In my opinion, the big problem with these “currencies” is there is no way to assess them.
For my part, in the excitement, I try to review each of the securities we hold in the portfolio. And I am comforted by the confirmation that each of our businesses 1- is profitable; 2- have a stable and sustainable business model; 3- are in good financial health (at least, most of them) and 4- that their title is reasonably valued.
In such conditions, all you have to do is be patient and let the storm go.
Philippe LeBlanc, CFA, MBA
Chief Investment Officer of COTE 100