How do you catch a falling knife?
“Carefully,” is one answer; with a special glove that won’t cut could be another.
But most people would say, "don’t try.”
When stock markets are falling quickly, the common answer offered in the falling knife example works just fine..."don’t try.”
But there comes a point where long term investors have to stop looking at the price and start thinking like Warren Buffett.
This means they must begin to consider other variables that become more important than price like:
- Value (Relative and absolute)
- Your own financial plan objectives.
Let’s start with the value part of the equation.
When a solid company pays a healthy dividend it has a measurable value relative to other INCOME INVESTMENT choices available.
If company XYZ was trading at $100 per share a month ago and it paid a $4.00 per share dividend (4%) it could be compared to what a GIC, bond, or even a rental house, paid net of expenses.
Maybe it looked like this a month ago:
XYZ – $100 per share, $4.00 dividend so therefore, paid 4%
A GIC – 2.4%
A bond – 1.95%
Rental home – 3%
At the time, the calm, complacent world we once lived in deemed all of these investments to be “fairly valued.”
Fast forward to the present.
XYZ – Is now $60 per share, still $4.00 dividend so therefore, pays 6.67%
GIC – 2.10%
Bond – 0.85%
Rental home – 3%
The relative value equation has changed completely!
An investor has to ask themselves…are all these returns properly representing the risks associated with each investment?
For some companies, the answer will be yes. The risks associated with holding these companies have grown due to the new world we live in.
But for others, well, they are kind of like the old expression says: “The baby gets thrown out with the bathwater.”
It is not a perfect linear relationship to define relative or absolute value for the overall stock market. But on a company by company basis, good homework can be done to ascertain value.
Now, let’s talk about your personal plan.
As the stock market was rising and dividend yields were low, investors had two choices.
They could buy high growth investments, forego the dividends and makeup the rate of return in growth. That worked fine for the past two years and now it has cost investors a lot of money.
They could buy a few dividend paying utilities and bank shares and hold the balance of money in bonds, GICs and cash. That was what my clients generally chose to do. Yes, our portfolios dropped when the sudden decline in the stock market came. But we have bonds, GICs and cash to take money out of to buy cheap stocks at some point in this decline.
So what rate of return does your personal financial plan require you to make per year to live out your life goals?
Most plans I have done for clients were between 3% and 6%.
Guess what?
There are a lot of quality investments to choose from that are paying around 6% dividends right now…today.
Oh, I know, who wants to buy stocks now with all that is going on in the world? Who wants to catch a falling knife?
Isn’t that the rub?
It was so easy to buy stocks when they were expensive…but what about now when the dividend yield is equal to the rate of return you need to live out your retirement as defined by your personal plan?
That is why we bought all those boring investments over the past few years. We were waiting for a “$1.49 Day” sale on income producing investments that will likely grow in time.
So I’m not saying “back up the truck and load her up” right at this moment, but you have to have the courage to stick to your plan in the days and weeks to come.
You won’t feel like buying…the world never looks awesome when great values are present.
Last week I mentioned that I like to look at the relative values of S&P 500, US Treasury bonds, and Gold.
To update you…
Bonds are still by far the most expensive asset class. Holding bonds for the next five years makes no sense. (Although they might look great during the next two weeks).
The S&P 500 has not really gotten that much cheaper even though it has fallen 26% because corporate earnings are getting slashed due the economic slowdown. But certain companies within the index are really cheap.
Gold made the biggest improvement on a relative value basis. With bond yield sinking back to generational lows, stress in the high yield bond markets, and the central banks printing more money than ever before; gold looks to be back in a value position.
So as the new week starts and the news is filled with all the new cases of the COVID-19 being “discovered,” please remember the financial markets will look past the disease and try to smell out relative value.
Our job is to do the same.
Stay safe and socially distanced. It has been awesome to see all the people who are stepping forward to help others in these trying days.
Megan and I are both working remotely, but are available through our regular phone numbers and email addresses, so please don’t hesitate to reach out.