What COVID-19 Hasn’t Changed

Note: This article was first published in The Business Times on 13 May 2020.

Our lives have been upended. 

Where once we could walk freely and gather in groups, we’re now huddled at home and have adapted to social distancing. 

Where once parents would send their kids to school in the morning before heading to work, they now have to assume the tough twin-roles of educator and working-professional at home. 

Where once malls and businesses were open, we now see shuttered stores all over town. 

COVID-19 has brought tremendous changes to our lives. 

And there’s a massive ongoing debate about how investors should be investing because of these changes. 

Interest rates are at generational lows, and even negative in some instances. Central banks are racing to keep their financial systems – particularly the credit markets – humming. 

Governments are handing out cash to save their economies and many are taking on tremendous amounts of debt to do so. Unemployment has increased sharply in some cases, or are expected to rise significantly.

Adding to the confusion is the massive rally that US stocks have experienced after suffering a historically steep decline of more than 30% in February and March. In Singapore, the Straits Times Index has also bounced 16% higher after falling by 32% from its peak this year in January. 

What should investors do? 

Plus ça change (the more things change)… 

I will humbly suggest one thing. 

Instead of focusing on positioning their portfolios to handle the things that are changing, investors should focus on the things that are not changing. This inverted thinking has tremendous value for investors. 

Jeff Bezos is the founder and CEO of Amazon.com, the e-commerce and cloud computing giant based in the US. He once said:

“I very frequently get the question: “What’s going to change in the next 10 years?” And that is a very interesting question; it’s a very common one.

I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time.” 

Similarly, we can build a successful investment strategy around things that don’t change in the financial markets.

…plus c’est la même chose (the more they remain the same) 

I believe that investors should only invest in things they understand. I only understand stocks well, so they are my focus in this article.

The first stock market in the world was created in Amsterdam in the 1600s. Many things have changed since. But stock markets around the world still share one fundamental attribute today: They are still places to buy and sell pieces of a business. 

Having this understanding of the stock market leads to the next logical thought: A stock will typically do well over time if its underlying business does well too. That’s because a company will become more valuable over time if its revenues, profits, and cash flows increase faster than inflation. There’s just no way that this statement becomes false.  

The fundamental attribute makes the stock market become something simple to understand. 

But it also means that we have to be investing for the long run (with an investing time horizon measured in years) for us to take advantage of the relationship between businesses and stock prices. 

Over the short run, the stock market is governed by the collective emotions of millions of investors. That’s not something that can be easily divined. 

But over the long run, business-strength prevails.

An enduring investment framework 

How then can we find businesses that can grow well over a long period of time, to utilise the unchanging long-run relationship between stock prices and business performances? 

I cannot speak for everyone. But what I do is to reason from first principles. What characteristics do I want if I can design my ideal business from scratch? 

There are six traits I have come up with, and they have served me well through my years of investing in both a professional and personal capacity. The six traits in a company are: 

1. Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market.
2. A strong balance sheet with minimal or a reasonable amount of debt.
3. A management team with integrity, capability, and an innovative mindset.
4. Revenue streams that are recurring in nature, either through contracts or customer-behaviour.
5. A proven ability to grow.
6. A high likelihood of generating a strong and growing stream of free cash flow in the future.

A word of caution is necessary. Companies that excel in all my six criteria may still turn out to be poor investments. It’s impossible to get it right all the time in the investing game. So I believe it is important to diversify, across companies, industries, and geographies.

Don’t put your eggs in one basket

The concept of geographical diversification is particularly important for Singapore investors. 

Look at the stocks in our local stock market benchmark, the Straits Times Index. There’s no good exposure to some of the important growth industries of tomorrow, such as cloud computing, DNA analysis, precision medicine, e-commerce, digital advertising, and more.

Chuin Ting Weber, the CEO of bionic financial advisor MoneyOwl, made a great point recently about global diversification. She said that as people who live in Singapore, we already have heavy economic exposure to our country through our jobs. If our investment portfolios also have a high proportion of Singapore stocks, we are taking on significant levels of concentration-risk.

The risks involved 

Every investment strategy has risks, mine included. 

A key risk is that companies that excel according to my investment criteria tend to carry high valuations. Even the best company can be a lousy investment if its share price is too high. So it’s important to weigh a company’s growth prospects with its valuation. 

What’s not changing

The emergence of COVID-19, and the responses that countries around the world have mounted to combat the virus, may have caused huge changes to the growth prospects of many industries. 

Travel-related companies, for instance, may suffer for some time until countries reopen their borders to accept international travellers at scale.

But crucially, I think that COVID-19 does not change the fundamental identity of the stock market as a place to buy and sell pieces of a business. So, I don’t think that the presence of COVID-19 changes the long-term relationship between stock prices and business performances in any way.

Most importantly, I don’t see COVID-19 changing humanity’s ability to innovate and solve problems. 

There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – COVID-19 or no COVID-19. 

This is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will occasionally wreak havoc. But I have faith in the potential of humanity – and to me, investing in stocks is ultimately the same as having this faith. 

Unless stocks become wildly overvalued, I will remain optimistic on stocks for the long run so long as I continue to believe in humanity.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.