The bears have taken over the stock market, and the market volatility has spiked up due to financial and economical uncertainty. For the past couple years, as a value investor, I have been sitting back and looking at the stock market irrationality. As of March 22, 2020, financial markets are in a panic mode; liquidity has dried up and cash, once again, has become king; the Federal Reserve has started buying back assets to inject liquidity into the economy; congress has passed bills to provide financial support to counter the disruption and unemployment caused by the coronavirus outbreak. As consumer spending drops and businesses shut their doors amid this virus outbreak, the productivity of the country is bound to drop. With negative GDP numbers around the corner, the United States and many other countries would be in a recession. In this week’s blog post, I will share my thoughts on the current US stock market conditions.
I read a book last year called “The Dhandho Investor: The Low-Risk Value Method to High Returns“, written by Mohnish Pabrai, a famous value investor. In the book, he talks about the difference between risk and uncertainty. Wall Street hates uncertainty because the market can not differentiate risk from uncertainty. Pabrai says that it is in uncertain times when an investor should aggressively deploy his capital (using Kelly Formula). Regardless of market uncertainty, one still needs to analyze the business to ensure that the potential loss is minimal.
For instance, right now, both oil and airline industries are in a slump. Oil and gas stocks are down due to uncertainty around crude oil prices, while airline stocks are down due to uncertainty around travel disruptions caused by coronavirus outbreak. While analyzing companies within these sectors, the first ratio I focus on is the current ratio. The current ratio compares current assets to current liabilities. This ratio tells me if the company has enough oxygen to survive for the next 12 months during times of distress. So, I want this ratios to be at least 1.0 i.e. enough assets to pay off the liabilities for a year. When I looks at all the leading airlines in the United States – Delta Airlines, American Airlines, United Airlines, Southwest Airlines, they have a current ratio below 1.0; in fact, southwest Airlines has the highest current ratio of 0.67. What this tells me is that the airline industry carries high risk, and could be a potential candidate of a government bailout (which is detrimental for shareholders of a company). On the other hand, when I look at oil and gas companies such as Chevron, Shell, and Valero, I am happy to see that their current ratios are above 1. These oil/gas sector companies appear to be well prepared for distressed times. While both airlines and oil/gas are in midst of uncertain times, I focus my attention towards oil/gas companies as they carry lower risk than that of the airline industry. In conclusion, you should be able to confidently say, “Heads, I win; tails, I don’t lose much!” when making your investment.
Now more than ever, I am reminded of Warren Buffett’s 1987 letter to the shareholders, where he talked about the attitude towards market fluctuations. I would like to quote 3 paragraphs from his 1987 letter. Buffett wrote:
“Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.“
As we navigate through these uncertain times, there are going to be times when the market will drop and times when market will unexpectedly go up. As an investor, you need to understand the 3 paragraphs above, and know that just because the market went up one day does not mean that the market’s manic-depressive behavior won’t be displayed the next day. Most importantly, Mr. Market is there to serve you, not to guide you. Understand what you buy, and then disregard what the market says. Don’t let Mr. Market’s wild fluctuations play with your emotions.
Hope you learned a little and found this blog post helpful. We talked what I thought about the current market conditions. We discussed about the difference between risk and uncertainty, which is a topic discussed by Mohnish Pabrai. We also went over Mr. Market’s behavior. As always, you can sign up for our free mailing list here. You can sign up for our paid subscription services here. Like us on our Facebook page here. Thank you!
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