How We Navigate Stock Market Volatility

We hope this message finds you and your loved ones well. We’re reaching out during a period of high political, economic, and market uncertainty and hoping to help you find some level of control during a time when it may feel like we have very little.

During periods of market uncertainty and turmoil, we like to go back to basics and look at our investing process and why/how we do what we do. With that in mind, we’ve put together an overview of how we take advantage of the difference between stock market prices and what a company is worth (its value). This allows us to find good companies trading at significant discounts (price) to what they are worth (value).

With increased uncertainty and market turmoil comes more market volatility. Stock prices are moving around a lot more. That means there are more opportunities to buy good companies at a discounted price. We use times like these to take advantage of these opportunities. And there are a lot of opportunities currently.

Investment markets in the US are down around 10% from their peak late last year. We have, so far, been impacted a decent amount less. It helps that we are diversified globally, and international markets have performed much better than US markets. We have been able to find more promising companies (than is typical) to research and are completing research on companies that are likely to be added to your investment portfolios soon. Our expected annual returns on these new investments are the best we’ve seen in years and a decent amount higher than what we expect from the overall market over the next 5 to 10 years.

If you can commit more funds to your investment accounts, this is a good time to do it.

Why Can We Buy Good Stocks at Large Discounts to Their Value?

Our investment process often means that our largest holdings are (initially) some of the least liked and/or least followed companies. This is because there must be a reason why we can buy something worth a dollar at a price of fifty cents (or less). We aim to buy companies that are temporarily out of favor but are still good companies at their core. This provides a strong foundation for great long-term investment returns.

As the temporary event/events fall into the rearview mirror, more investors focus their attention on the present and the future. Prices start to move back towards what a company is truly worth. Warren Buffet famously said that over the short-term the stock market is a voting machine and over the long-term it is a weighing machine. Popularity turns to reality over longer time periods. There is no knowing exactly how long that process will take. Sometimes it’s only a few months and, often, it can be multiple years. All we know for sure is that implementing our process well provides us with better investment returns.

Another important reason our largest investments are often in some of the least liked and/or followed companies is because we continue to add to these investments as they get cheaper. We may look to buy a company worth a dollar for fifty cents initially, but if it falls in price to thirty cents, we’ll buy more of it. If our initial reasons for owning it are still valid.

There is simple math at the root of this. If we buy a company at a price that represents just 50% of its value, once its price moves back to that value we double our initial investment. At a price that’s 30% of its value we more than triple our initial investment. Even if this takes five years to play out, our annual return would be close to 15% if the price were to double, and 25% if it tripled. Investment markets tend to return 9%-10% each year, on average. The price moving back towards a company’s actual value represents only the return we get from a stock being undervalued. We also get additional returns based on what a stock typically earns when it is fairly valued – which tends to be between 8% and 12% per year. That means if we can buy good companies at a 50% discount to what they are worth, our annual returns can be between 20% and 30% for many years.

So, where does that leave us now? As we’ve touched on several times over the past year and a half, investors have been increasingly focusing their attention on an ever-smaller number of technology stocks. This has led to very high prices for these companies versus their underlying value. At the same time, the number of undervalued, under-appreciated stocks has risen. Over time, given our focus on buying companies that produce a high level of profit (value) at a relatively low price, this should translate to higher investment returns for the companies we own.

Unfortunately, over shorter time frames this can lead to the opposite. It takes time for this process to play out. During a period when popularity has, for now, kept reality at bay, our investments have underperformed index returns. We expect this to happen for periods but also understand this can be a frustrating part of our process. If you’d like to talk about this in more detail, please reach out.