A bear market is usually defined by a 20% or more drop. At the time of writing, it seems that Mr. Market is entering panic mode and perhaps a recession. It’s just a bit over a week since I wrote about the market going into uncertainty. Amazing how fast things can escalate.
Washtub, Not A Thimble
This is the time to be buying. Yes, I said it. A recession can create great bargains, and if you’ve had a watch-list of stocks to buy when the price is right, its time to pull the trigger. Granted you have the liquidity.
Remember you are buying businesses, with real operations and real people behind them. These businesses have an intrinsic value, based on what they can produce. Price and value do not mean the same thing. When its raining gold and Mr. Market is acting erratic, you wan’t to be out with a washtub, not a thimble.
“Valuations Don’t Matter!” Until They Do…
At the end of all bull market cycles, you always hear the same thing, even from the financially savvy: “Who cares about valuations”, “Things are great”, “Value investing is dead”, “This time, it’s different”. Yes, value by traditional metrics (e.g. low P/E, low P/B) has been a lousy performer for many years. While these metrics might be good starting points to look for cheaper assets, its not how I define modern value investing. At the end of the day, the value of a business is the amount of free cash flow it can produce during its lifetime. Earnings and cash flow are not the same thing. A recession is always a reality check to those who have disregarded price in their buying.
Straw On The Camel’s Back
Value investing is always dead, until it isn’t. A recession or correction at minimum was long overdue, and the Wuhan Flu panic might just be the straw that broke the camel’s back. Here’s some perspective:
Historically, the long-term average P/E of the S&P 500 has been around 15. It had been hovering above 30 for a long time. Is the collective mind of Mr. Market so knowledgeable about the future that it can discount future earnings 30 years into the future? To the rational investor, its obvious that the market has been like a bag of chips: Much air, little product.
Now the chickens are coming home to roost. Buffett has many great quotes, and here’s one of my favorites:
“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities, that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future, will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”
Compounders
For the long-term investor and especially if you have been patiently gathering ammo for an event like this, compounders is the way to go.
The greatest businesses are long-term compounders. What this means is that have demonstrated year-over-year their ability to grow their equity base and have high ROIC. In order to do this, in most cases they have a deep moat and able management. Of course Mr. Market knows that these are valuable businesses so they are rarely on sale. Events like the one we are experiencing and a recession, however, create a rare opportunity for you to take advantage and get them for less than what they are worth.
“price is what you pay, value is what you get”
During the tech bubble of the late 1990’s, an article by the Wall Street Journal was questioning Warren Buffett whether he was losing his touch because he wasn’t participating in the mania. Since we know what happened, it’s a fun read today.
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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