Investment Thoughts

To build generational wealth, successful long-term investors must have the discipline to keep their emotions in check. In normal times, such discipline is not difficult. However, in times of fear, prices gyrate wildly, headlines blare bad news, and panic trumps rationality. In such extreme periods, self-discipline becomes both more difficult and more essential.

Today, with the market, the economy, and country in the grip of panic, rationality and perspective are more important than ever. The purpose of this note is not to make short-term predictions regarding spread of the COVID-19 virus nor on the timing of its containment. Instead, our goal is to provide a longer-term perspective that can serve as a framework for navigating the turbulence and uncertainty of the current environment. Armed with such a framework, investors will be prepared to unemotionally distinguish between the short-term volatility and potential long-term opportunities presented in the current market.

As human beings, we do not welcome times of fear and panic. However, as investors, we welcome the bargain prices such emotions produce. While we are in a volatile period and do not know what the future will look like, today, many wonderful businesses are on sale. The opportunity to buy such businesses at bargain prices is both rare and potentially valuable.

After more than 50 years of successful investing, we can think of no better advice for navigating today’s market than the timeless words of our founder, Shelby Davis, who famously said, “You make most of your money in a bear market. You just don’t realize it at the time.” With many high-quality, durable businesses trading more than 50% below the prices they traded at just a few months ago, investors have the opportunity to make decisions today that may build wealth tomorrow.

Short-Term Predictions Versus Long-Term Probabilities

Today, investors are bombarded by a wide range of short-term predictions regarding the course of the current pandemic over the next 3–12 months, though we would suggest that the containment of the virus in countries such as South Korea, Singapore, and China should lead us to question the most extreme predictions, which seem more based on fear-mongering and publicity than data and analysis. While the wide range of short-term predictions may be unsettling, longer-term probabilities fall into a much tighter range. Though there is limited knowledge and uncertainty about the impact of the disease, as we get out 12–24 months, it is possible that the virus will have run its course, a vaccine will be available, and, as a result of the lessons learned from this first modern pandemic, we should be far better prepared for future pandemics. In other words, while we don’t know the precise timing, we do believe this period of uncertainty will come to an end, infection rates will fall, venues will reopen, businesses restart, and normal life resume. As a result, while there may be a powerful emotional cost, we believe there may be little lasting economic cost.

Portfolio Update

With the short-term cloudy but the long-term clearer, we have analyzed our Portfolio through three lenses to distinguish which companies to avoid, which to hold, and which to buy.

First, investors should avoid those companies whose business model or precarious financial structure create the risk that they may not be able to survive short-term dislocation. In particular, industries with high fixed costs, plummeting revenue, and high levels of debt are especially vulnerable. While it is likely that many of these will receive some sort of government support to get them through the short term, the availability of such aid is uncertain, and its terms may be punitive. While we recognize that a favorable intervention could lead to a snap back in the shares of some of these companies, buying before the terms are made clear is a speculative gamble, not a long-term investment.

Second, investors should recognize that for some companies, the current environment may have a favorable short-term impact. Today, for example, services such as online shopping, video conferencing, distance learning, streaming entertainment, and gaming are seeing sharp increases in usage. In many cases, the share prices of such companies have bucked negative trends and risen while the rest of the market has fallen. For long-term investors, the challenge is to distinguish between those companies for whom this effect is likely to reverse as life gets back to normal and those for whom the effect is more likely to be sustained. The former can be a good source of funds in the current environment, while the latter may be long-term holds.

Third, and most importantly, investors must analyze those companies for which a steep, short-term decline in economic activity is an unpleasant but manageable reality. Here, the investment opportunities may be the greatest for the simple reason that investors are more concerned with short-term uncertainty than long-term durability. Whether it is dominant technology leaders, such as Alphabet, high-quality global industrial companies, like Raytheon Technologies, or well-capitalized financial leaders, such as American Express, share prices of select durable businesses can now be purchased at 50–70% off. Energy, similarly, has been deeply discounted. We hold small investments in the energy sector where we believe the liquidity profile and staying power, as well as the production potential in the future, may not be appreciated by the market. Ovintiv is one such holding. To fund new purchases, we sold our position in Adient. In stores, shoppers are quick to respond to such dramatic sales by buying more. In the stock market, emotional investors are more likely to sell or remain on the sidelines. By focusing on facts rather than emotions, rational long-term investors can build wealth for tomorrow by buying these valuable companies at bargain prices. However, it is important to remember that there is no guarantee these share prices will appreciate in the future.

Conclusion

Over 50 years of successful investing, we at Davis Advisors have weathered many storms and crises by being rational when others were fearful. Whether it was the bear market of the 1970s, early 2000s, or the financial crisis, buying after significant price declines have historically rewarded long-term investors who could keep their emotions in check. Although each period differed in its peculiarities, all share a similar pattern to what we see today. Fearful investors sell after prices have gone down, waiting on the sidelines until ‘things feel better.’ Rational investors buy after prices have gone down, recognizing that prices have the potential to be higher when ‘things feel better.’ In every case, fearmongers argued that this time was different and that a recovery would never come. And, in every case, our society, our economy, the market, and our portfolios proved resilient, recovered, and went on to new heights. We believe today is no different. Investors who can keep their emotions in check may once again have the opportunity to buy durable and resilient businesses at bargain prices and pursue generational wealth over the long term.

As stewards of our clients’ savings, our job is to make rational, long-term decisions and remain dispassionate at all times. However, we are also human beings who understand the stress that fear places on our families, friends and communities. While we know that a period of recovery and healing will follow this difficult stretch, we sincerely hope that, until then, you remain safe and healthy. We thank you for the trust you have placed with us.