Last Updated on April 26, 2022 by Rational thinking
As of writing most stock markets around the globe are down around 30%. That is a big decline, especially considering it happened in just three weeks. However, unless you are about to sell assets today or in the very near future, for whatever reasons, you should consider the drop as an opportunity to add to your holdings. No doubt the virus has a huge impact on the economy, but markets adapt to future earnings pretty fast, and today might be the chance to deploy idle capital at much lower prices than last month.
Some companies with bad business models, bad management and/or too much leverage will go belly up, acquired or reorganized, but for a few companies, the intrinsic value has not changed much. As an example, let’s look at Disney. They are hit extremely hard by the virus, but do you think Disney is worth more or less 20 years from now? Their theme parks and movies will still be in demand after the crisis (I’m long DIS). Their brand is not impaired, in my opinion.
May I recommend reading the thoughts from Warren Buffett in October 2008: Buy American.
Avoid the risk of ruin
The primary goal of any investor should be to avoid the risk of ruin. In the shareholder letter of 2005 Warren Buffett said the following on page 20:
Over the years, a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero. That is not an equation whose effects I would like to experience personally, and I would like even less to be responsible for imposing its penalties upon others.
It does not matter if you have 10% annual returns for 25 years if you risk ruin in the 26th year. Your track record is a big fat zero. This should always be in the back of your mind. Hendrik Bessembinder concluded in his study from 2017 that the majority of the public companies perform worse or equal to short-term treasuries. Just a very few companies have been worth owning.
What about future estimated returns?
If you manage to survive a crisis without too much damage, what can you expect of future returns?
Today, with markets down 30%, you need a 43% gain to get back to break-even:
The bigger the drop, obviously the bigger the percentage return required to recoup the losses.
Will markets recover? They will, but no one knows when. Many like to throw in the charts of Japan at the end of the ’80s and the fact that the market has still not recovered, 30 years later. However, the markets in Japan were much more overvalued than for example the US market was one month ago, and it’s a much less flexible and mobile society.
Some simple math can help to keep a distance from the hysteria in the media and on social media. The table below shows the CAGR if the markets recover in x years time:
The CAGR does not include dividends (which must be added). For example, if your portfolio has a dividend yield of 2% and markets recover in 4 years, your return will be about 11.3%. Not bad!
I think it makes sense to buy during a panic. Goods and services will still be produced unless you think the world will end. FED prints more money and in aggregate corporations make a profit. It’s impossible to hit the exact bottom, so don’t focus on timing.
Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.