Markets are functioning well. The trading stops are working as designed. After nearly a 30% drop, investors will begin to consider buying. But, with a global recession at hand, the fundamentals on which value decisions are based will deteriorate. It’s a guess as to how far.
So what’s the right price to pay for something that is facing deteriorating sales and earnings? The answer is at a price low enough to cushion against worst case outcomes.
Ask yourself if you’re willing to buy your favorite stock at its current price today? No? Well would you buy it for $1? Yes? Then we know that you are a buyer at a price between today’s price and $1.
Investors will come back at a price, but dispassionate patience and discipline are required. This is not over, and there is more pain ahead, but we were trading at all time highs a month ago and are much nearer a bottom now. But not yet.
Traders work on the floor of the New York Stock Exchange on March 10, 2020.
Spencer Platt | Getty Images
Market movements are biased towards near-term earnings expectations. The next 12 months earnings’ estimate is a common valuation measure, and usually can be forecast with a good deal more precision than five-year earnings.
Currently, amidst a pandemic that is causing wide cancellations of travel and public events of all kinds, the near term numbers are imprecise to the point of being little more than a good hunch. Will air travel resume to Europe next month? Will the U.S. go on lockdown? Without answers to those questions earnings estimates will remain unclear.
Clarity on earnings will proceed at a different pace for different companies. Speaking generally, consumer staples and utilities find a reasonable range of earnings earlier: Their earnings are not as cyclical, so some reasonable forecasts can come together before we fully understand how sharp or long the downturn will be. Speaking generally, industrials and transports need a clearer understanding of the macro environment to forecast earnings in an accurate range.
Of course, as this shakes out, some companies will not have positive earnings at all, again, ever. The long-term investor needs to look through those numbers to the prospects at three, five, seven years and beyond, depending on the time horizon for your investment goals.
As an investor, pick your companies carefully as you re-enter the market. Don’t look to “call a bottom” for the market. Instead dispassionately research the prospects of a company in the current range of macro- economic outcomes. Determine your discipline as to how much uncertainty (risk) you are willing to tolerate in your forecast.
Determine your time horizon — if you need cash in 2021, you are not a long term investor. If your time horizon is five to ten years, and if the valuation falls in a range where your discipline says it is a buy, then buy — don’t worry if it was cheaper last week, or will be cheaper next week. It often takes time for strong fundamentals to prevail.
It feels awful to buy in a bear market. It feels worse to buy and see your shares fall another 10%, 20% or more. Yet, if your thesis is intact, “I believe this company will be worth more in five years because …” then you stay with it.
Likewise, if you no longer believe the shares will increase in value, and not because of a hunch, or emotion, or despair at the movement of the market over the last week, but because your analysis of the material prospects of the company have changed, then sell.
Emotions will lead you astray, especially in times like these. We believe dispassionate analysis and discernment, the ability to look through the short term, will serve you well. COVID-19 curses all of us with a wide range of unknowable outcomes. During challenging periods like this, Americans come together, set aside differences and persevere and prevail as only Americans can. Keep well. Take good care. And have faith in our great American spirit and determination.
Michael K. Farr is president and CEO of Farr, Miller & Washington, LLC, a Washington, DC-based wealth management firm. He is chairman of the investment committee and is responsible for overseeing the day to day activities of the firm. Prior to founding Farr, Miller & Washington in 1996, he was a Principal with Alex, Brown & Sons.