How long is long-term? - April Lee Tan

Many stocks are trading at cheap valuations, providing investors an opportunity to make money, the problem is there are compelling reasons why those stocks are cheap now. Because of the COVID-19 crisis, corporate earnings are seen to drop significantly this year. Moreover, it is still unclear how low earnings will go or how long the pandemic will last. Therefore, stocks that are cheap today can still become cheaper. And cheap stocks can stay cheap for a very long time, creating value traps.

During bear markets such as this, only investors who are patient and willing to invest for the long-term will be profitable in the end. However, how many months or years is long term? This is difficult to answer as each crisis is different and the time it takes for stocks to recover can be a few months or a few years.

For example, during the global financial crisis, it took 14 months for the market’s downtrend to reverse after the Philippine Stock Exchange index (PSEi) broke below the 200-day moving average in January 2008.

During the Asian financial crisis, it took six years and two months for the market’s downtrend to reverse after the PSEi broke below the 200-day moving average in March 1997.

For the COVID-19 crisis, it has only been seven months since the PSEi broke below the 200-day moving average in November 2019. Although the stock market has been rallying since March of this year, as discussed in my previous column, I don’t think the rally is sustainable. Because of this, I don’t think the bear market is over. Note that during the Asian financial crisis, the stock market also rallied strongly in November of 1998. However, it started to fall again in August 1999, hitting the bear market low in 2003.

Rather than giving a specific time horizon for long-term investing, let me explain what it means to think long term when buying stocks today.

When buying stocks today, we should have the same mind frame as the people who put up businesses or buy properties. When we put up businesses or buy properties, we typically don’t think about selling them. In fact, as Filipinos, we usually dream of keeping our busine­sses or properties forever so we can pass them on to our children and they can pass it on to their children. This is what I mean when I say think long term.

This is also what successful stock market investor Warren Buffett meant when he said, “Only buy something (stocks) that you’d be perfectly happy to hold if the market shut down for 10 years.”

Buying stocks to keep for the long term is like entering into a marriage. We must avoid buying stocks just because they are popular or actively traded. We must seriously evaluate whether the stocks we want to buy are worth keeping for the long term.

When buying stocks for the long term, one important factor to consider is whether the company we want to buy can survive this crisis. To survive this crisis, a company needs to have a strong balance sheet with minimal debts and no lumpy maturities this year or next year. Now that business is bad, highly indebted companies will find it difficult to continuously pay their obligations. There is also no guarantee they can refinance maturing debts. Because of this, there is a risk that the assets of highly indebted firms may be foreclosed by their creditors and they will be much less profitable in the future. There is also a risk that they will no longer be around in the next 10 years.

We also need to determine whether the business of the company we want to buy will be seriously disrupted by ongoing trends, including the new normal. Or will the crisis be a mere rough patch that it can easily survive?

We also need to evaluate when buying stocks for the long term the company’s majority owners and management team. Focus on companies that are owned and managed by people who are competent and ethical, or those we can trust. As retail investors, we own a small share of companies that we buy and have little influence on how these companies are run. As such, we need to make sure that the people who are running the company can do a good job and that our rights as minority owners will always be protected.

Finally, do not overpay. Although a company can have a great business and an excellent management team, we can still lose money if we pay too much for a company’s stocks.

There are many ways to evaluate whether we are overpaying for a stock. We can compare a company’s current valuation to its historical valuation or to the valuation of its peers. How many years of earnings am I paying for the company based on its current price? Is this high or low compared to the multiples of other companies in the same industry? If it is high, can it be justified by factors such as its stronger balance sheet, better track record or more resilient operations?

We can also try to determine what kind of earnings a company needs to generate to justify its current price. For example, if the company’s stock price today is the same as what it was at the start of the year, are we confident that in the next two years, it will earn at least the same amount it did in 2019? If the answer is no, then the stock is expensive, and it would be better to wait for prices to go down. Remember, we are still in a bear market, it is easier for prices to go down than go up.

Aside from doing a careful evaluation of the business and valuation of stocks we want to buy, we also need to diversify. If COVID-19 has taught us something, it is that a lot of unexpected things can happen. To minimize the impact of unfortunate events, buy more than one stock. If picking stocks is too difficult, just buy an index fund which is composed of 30 stocks that are part of the PSEi.

With these tips, I hope I was able to explain what long-term investing means, and how to pick stocks that are worth keeping for the long term. With this knowledge, I hope you can take advantage of the opportunities that are available only during bear markets.

By: April Lee Tan|INQ

Source: Peso Economics