Many years ago in London, when store sales were limited to a time period just after the Christmas holiday, the waiting and anticipation game in the run up to these events was exciting. Knowing that those luxury, high-end brands you had been lusting after all year were about to become affordable at 30 to 50 percent cheaper was as good, if not better than Christmas Eve. The catch? You would have a limited time to get them (so you had to make sure what you wanted beforehand) and you had better be first in line otherwise they would be gone before you could take advantage of the sale. That’s if you made it through the scuffles on the door of course. One year, I distinctly remember finding out about the Burberry sale. I desperately wanted to get the industry standard beige colored trench coat. For years actually. I lined up for hours, bored senseless, cold, but also, at the same time, filled with excitement. I eventually got one at a great discount, which I still own to this day. Incidentally it’s one of my better apparel investments and served me through many rainy days.
I’ve been in the financial industry for over 30 years and have seen great times as well as times I’d like to curl up and die when I looked at my returns in the short-term. The hardest part of investing are drawdowns, but even great companies experience them and expecting this should be paramount for investors every once in a while. What’s important is how you manage them in your portfolio. It’s been a rough start to the year as an equity investor. The previous years have been somewhat, let’s say, “easy,” but in my experience, capital preservation and accumulating the right investments in these times are the key to real future wealth creation.
Don’t Invest On Broader Market Direction
Everyone is looking for a direction to the market. I tend to say to them that quality companies grow in any conditions, and it’s a good time to take your eyes off the broader market and macro issues and look to invest in individual companies. Otherwise, you should have a 30-year view and I’m sure a good quality index such as the S&P will return you 9%-10% per annum. Compounded. However, on a current note, there are so many macro issues holding the overall index back. You may need to wait a few years for it to bounce back, so the index play will have to wait in my opinion. For example, when stocks crashed in the fall of 2008, the U.S. stock market did not sufficiently recover until mid-2013. Also, to put the move in perspective, it took the S&P 500 nearly 12 years to break the tech bubble highs of 2000 and hold onto those gains.
If you are a straight-forward vanilla ‘buy stocks’ investor and are struggling with your current drawdown on your portfolio, view the market pullback as a sale at the finest clothes shop. Do your research, wait, and get the best stuff whilst it’s cheap and hold on to it, because the sale will be gone sooner than your beaten down emotions will realize. Those names, like my Burberry trench coat, will serve you for years to come and unlike my coat, may pay you in the form of some handsome dividends too. Always think long-term but be prepared for a lot of short-term volatility as the macro picture takes hold. Stick to your process and what you know and more importantly, understand. Lastly, refrain from using leverage. It will kill you. Also, keep a bit of cash on the side for those ugly days to accumulate the names you’ve carried out research on. You’ll feel a lot better knowing you have some ammo to fire and whilst I don’t advocate averaging as a strategy, it can be useful when Mr. Market is pricing the underlying companies incorrectly or when there is inherent volatility. Remember, buying when it feels most painful can turn out to be some of your best purchases. You’ll realize that later down the road however.
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How Do You Find An Edge In This Market?
This is a market with everything on sale. Particularly technology. However, historically tech has always run away with itself ahead of what actually is needed at that point of time. The industrial revolution of 1929 and the 2000 bubble were prime examples. Even the last two years will be a good textbook example. There is no reason to believe some of these names will ever recover. 90 percent of tech stocks went to zero in 2000/02 and Amazon AMZN (finally one of the better companies to emerge) lost 95 percent of its value before it recovered. To crystallize the point, don’t think that stocks that have fallen a great deal will return to some of their obscene valuations anytime soon, if ever. Stop losses are just as important. If your initial thesis doesn’t hold, and you are just waiting on a bounce, it may be time to get out. The good news for you is that prices are bounded by zero. Just try not to get there.
To find an edge, an investor should be looking towards catalyst events that will move price to value, not just what is cheap. Some companies will stay cheap forever or even for a long while and tie up your capital. Spinoffs and breakups that release value are places where X marks the spot for investors as Joel Greenblatt mentioned at The Edge’s recent conference. The area of Spins won’t all be pure gold, but historically they are some of the best places to dig, and with the right research, investors can make supernormal profits.
If you are not familiar with the term “Spinoff,” it is a corporate transaction where the parent company splits into two or more companies capitalizing on the fact that there is hidden value in the sum of the parts. The businesses can be separated for a number of reasons, including better valuation for the individual parts, totally separate lines of products or services, and/or regulatory issues, amongst other things. Investing on value creating transactions will put you ahead of the wider market, which is just looking for companies to rebound which may not be anytime soon.
The most successful company investments in terms of wealth created for shareholders at the decade horizon also involved very substantial peak-to-trough drawdowns. Wealth is created on the way down, although it will never feel like it. Investors should try to separate the stock’s price from the company and concentrate investing into that. This mindset and strategy can be extremely rewarding longer-term. Even those investments that are the most successful at long horizons typically involve painful losses over shorter horizons. Netflix NFLX shareholders suffered the worst — a 79.9 percent drawdown (over 16 months) in the 2010s.
Spinoffs Produce Returns Through Any Market Downturn
With over 30 Spinoffs tabled on the calendar for the next year, the hunting ground is exciting.
The Edge Group has provided regulated research for over 15 years. The data has shown that some of the most compelling businesses to buy on large market pullbacks have been Spinoff companies and there are a number or reasons for this.
- They are the first investments to be sold on a downturn. What you don’t know about, you sell. This goes for nimble and well as institutional investors. This can make Spinoff companies cheap.
- They remain misunderstood and undiscovered value for a long time. They can be some of the best investments that are not spoken about and therefore can be undervalued.
- There is little or no coverage which makes them interesting at the very least. Wall Street takes at least 6 months to pick up these companies and cover them. Substantial opportunity before then.
- The Edge’s 20-year study with Deloitte shows they preform over any economic environment. The average return over 1 year is 10.5 percent.
- 35 percent of Spinoffs are acquired around the 2-year timeframe at a premium. A great reason to invest in some of the niche businesses, which frequently Spinoffs are.
- Sectors that have exceptional outperformance include Materials, Consumer, Tech & Industrial. Knowing this will help you narrow down the best investments.
So finally, to sum up, don’t go chasing markets. Concentrate on preserving your capital and invest your money where you can be confident with the knowledge that you are betting on good companies that are creating value and not just cheap stocks that are getting cheaper because of a bad macro outlook. To discuss the forward calendar of Spinoffs and how you can capitalize on the research, contact The Edge here.