Investing is when one buys an asset with the expectation of a profit over time, based on fundamental analysis that provides a strong rationale for this expectation. It is also known that publicly traded securities, by definition, fluctuate and can change prices violently based on short-term emotions of market participants. There is a reason why for many people, their best investment is a home or investing in their own business, and this reason is that they don’t have access to quotes on those assets each day.
The beautiful thing about investing is that you do not have to swing for every pitch and you only need a few great hits to make a great deal of money.
Just like you don’t have to buy a stock at a certain price, you don’t have to sell one either unless you are obtaining a fair price. Determining the fair price is where fundamental analysis comes in.
Emotion has zero impact on fundamental analysis or intrinsic value, yet most market participants are led by the leash of emotion.
Short-term Market Fluctuations are inevitable…
Stay focused on your time horizon
Current market conditions are a prime example of the impact that emotions have on the stock market. Fears over a Brexit are pervasive, but the actual impact on most individual companies is really not that substantial. It is not as though the UK is going to start defaulting on its sovereign debt or that banks are going to go belly up as a result of the vote. The reality is that the stock market hates uncertainty and that causes short-term market participants to seek safe havens when uncertainty rules the day. This can cause stock prices to sell off and trade at deeper discounts in intrinsic value over the short-term. While frustrating for those that view their accounts each day, these short-term movements will have very little impact on long-term investment results.
Ultimately, it is a combination of earnings and intrinsic value growth that drive stock prices over the long-term.
Berkshire Hathaway has had several occurrences where the stock has sold off by over 50%, which would meet anyone’s definition of volatility. The fundamentals didn’t decline by that amount, but stocks fluctuate and that is just part of the game. Selling Berkshire Hathaway during these declines was never a good idea and neither is reacting based on emotions on any security.
Financials are strong
You’d think based on the financial media that banks are really struggling due to low interest rates. While returns on equity would be higher if rates were higher, the reality is that the big banks are making many tens of billions of dollars and have grown intrinsic value each year since the Financial Crisis. Case in point, over the last 12 months Bank of America (BAC) has made roughly $15.5 billion. Over the last 3 years and not including the impact of dividends, tangible book value per share has grown by about 25%, despite having to pay out tens of billions in litigation stemming from the Financial Crisis. The company is in the best shape financially in its history as determined by capital and liquidity ratios, yet the company trades at 84% of its growing tangible book value. If you’ve been following the industry conferences this quarter, you’d know that earnings are likely to be pretty solid in the 2nd quarter and dividends and stock buybacks are likely to be increased pending the CCAR process at the end of this month. This doesn’t mean that the stock might not go lower between now and then, but the fundamentals keep improving.
When “Mr. Market” once again feels more confident, stock prices will reflect that and Bank of America could easily be 50-75% higher.
Sell BAC at current prices at your own peril as this is a very low risk and high return opportunity, because the price is so cheap relative to intrinsic value.
Citigroup has also gotten hurt over the last week and now trades at $41.96 after being healthily above $45 the last few weeks. Since December of 2012, tangible book value has grown from $50.57 per share to $62.06, or 23% after dividends. The company has made about $16 billion over the last 12 months, despite paying many billions in litigation that is now mostly a thing of the past. The balance sheet and capital ratios have never been better, yet the stock price is back to where it was several years ago. This is a reflection of a lack of confidence.
It is an unbelievable buying opportunity and a terrible selling opportunity.
If you were able to rent out your house for $20,000 a year and believe that a 5% capitalization rate was appropriate, you might believe that your home is worth $400,000. If tomorrow somebody offered you $350,000 for it, you wouldn’t sell, nor would you lose sleep over it because you are happy with the cash flows. Just because you have another price input doesn’t mean you have to react to it, as ultimately it will be the fundamentals that drive prices. For those of us that can maintain the same perspective on equities, long-term performance will undeniably benefit. We must be aware that we are in a period of incredible uncertainty, which is reflected by the hundreds of billions of dollars trading at negative interest rates, which most economists believed was impossible. There will be brighter days and the fundamentals of our investments continue to improve.
Great time to add to positions
Many people are taking advantage of the volatility to add to positions, but for those not in a position to do so, rest assured that we have some of the best opportunities we have seen in many years as a result of this pessimism.
Prepare for a bumpy few weeks but once we get more clarity I believe we should indeed see a strong recovery for those that are patient. We are in those positions where the payoff should be huge and we own them in size. We have options sold which will generate considerable cash flows upon expiration. We will keep a steady hand while others panic and that will define our long-term results as it always has.