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Buying in Market Meltdowns

The most important condition for the emergence and continuation of panic is a feeling of entrapment with an impending threat.  Enrique Quarantelli (The Nature and Conditions of Panic)

As I sit writing this* on a Friday evening in March 2020, the World seems in meltdown. The words above of Quarantelli seem almost prophetic and the man even has an Italian name. Entrapment is particularly apposite. We know high risk elderly people who are planning to “self-isolate” for months. Many businesses have asked their employees to work at home for an indefinite period. In the UK we all know the threat is coming and will peak in coming weeks and months. It is scary and induces worry.

Thursday March 12th 2020 should have seen horse racing at Cheltenham jostling for attention with the peak day of the largest world property shown in Cannes. The horses were far from the headlines and the property jamboree was cancelled. The reason? The threat of Covid-19/Corona Virus had induced full on Market panic. The World Stock Market falls were the steepest in 33 years. To put that in perspective? Liverpool FC have won two league titles since then….

The only time I’ve known a reaction like this to a growing threat was the blind panic of mid-September 2008 when the World was in financial calamity. Even then the one day falls were not as precipitous as we saw last Thursday. With the damage that was done by the 2008 financial crisis, it took a full six months for Markets to hit the bottom in March 2009. Although the ride up after that hasn’t been smooth, if you’d bought most equities in the Market in March 2009, you’d have made a lot of money by January 2020.

And that’s the thing. Savvy investors can make good money by buying over-sold stocks at times like these. Lots of people and institutions have sold their stocks because they see the threats that present as immediate and that survival depends on instant action. Potential bargains start to pile up to be sifted through by the opportunist.

In times like these, one metric that I like to look at when sifting companies is dividend yield. Now before you say, “beware of the dividend trap”, you do of course need to be very mindful of this. This classically afflicts companies who are sinking in price due to poor earnings reports or other matters that lead them to be marked down by the Market. Invariably their dividends become less and less well covered by earnings and they end up cutting them. The investor is hit with the double whammy of a sinking share price AND a dropping dividend. It’s a classic trap.

However, where a share has been perhaps irrationally sold off due to no other reason than everything is getting sold off, it’s no bad idea to look at shares with lovely dividends and thinking- if this is unlikely to be cut, them there is every chance that this share will rise back to the Mean and I’ll be well rewarded along the way with a chunky dividend, which I can reinvest and buy more.

Just by way of example, as of 13th March 2020 here are the top 6 dividend payers in the FTSE100 (with estimated dividend cover for 2020 in brackets):

      1.       Imperial Brands (IMB) (Tobacco)- 15.78% (1.22)   
      2.       Shell (RDSB) (Oil)- 13.49% (1.26)
      3.       BP (BP.) (Oil) - 12.10% (1.22)
      4.       BT (BT.) (Telecoms)- 10.22% (1.55)
      5.       WPP (Advertising)- 10.78% (1.45)
      6.       HSBC (HSBA) (Banking)- 9.14% (1.28)
(Source- Stockopedia)

These are really attractive dividends. I do however look at them with a note of caution, as dividend coverage is so key. In short a company will not be able to maintain a dividend pay-out at the present levels if it is not well covered by earnings. The 2020 estimates are based on present earnings estimates and we have no idea how earnings will be impacted by a recession caused by a worldwide pandemic. Equally Shell (for example) has not cut its dividend for 75 years and that included the oil crises of the 1970’s.

As I’ve mentioned before, I bought Persimmon in the heat of the 2016 crash in the UK after the Brexit Vote. I doubled my money and was well rewarded along the way. Dividend is certainly one interesting factor to look at. For the record I hold none of the above shares mentioned.

Another factor I like to look at is a strong balance sheet. Does the Company have low or manageable debt and cash on the balance sheet that will enable it to withstand softer Market conditions or even a recession? Two shares that have been heavily sold this week are Dart Group (DTG) and SCS (SCS), the latter of which I must admit I hold and the former of which I’ve held previously. Both operate in cyclical sectors which will get pummelled in a worldwide travel ban (Dart) and/or a Recession (SCS). Yet with stronger balance sheets, they will have a much better chance of survival than their competitors. Dart produced some fantastic earnings results this week and in my view would have soared to about £20 a share had the Corona Virus not hit. It’s currently trading at £8.71 per share.

I then like to apply some Buffett methodology and ask what the level of competition (or “moat”) is that the company faces? For example, some may say that banking is an area with narrow moats. However, the truth is that (certainly in the UK) the barrier to entry for new banks remains impressively high. Although there is margin pressure, it is very difficult to set up as a challenger bank (see Metro’s recent woes).

Finally, I like to look at the specific industry within which the Company operates. Is it in one that will see a consistent or growing demand for its products in years to come? I personally believe that people tend to be overly pessimistic about some sectors. I was made to hold up a sign in a school assembly in 1986 proclaiming that oil would run out by 2006. It didn’t. Equally (whilst I could never bring myself to invest in such an industry) I don’t believe that tobacco is going out of fashion any time soon.

When I’ve completed my analysis, opportunity awaits to buy. However, I’ve learned not to dive in too soon. You can always buy a stock cheaper in Market panic. There were people saying to me today that the Market cannot go any lower.  I do not hold that view. I believe it can and almost certainly will venture lower until we have greater certainty over the Pandemic and its economic impact.

Yet one truth remains. Over time equities remain an astonishingly good investment. If you back test over the past century, they outperform almost every other investment. They key to success is to buy low and sell high. Times like these present opportunities to the savvy investor to buy low.

*This blog is published subject to this disclaimer.


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