The coronavirus served as a powerful trend accelerator, compressing time to such an extent that, in many respects, 2020 seems like a three-year period: we saw unprecedented lockdowns, the steepest stock market drop in history (by intensity), and equally historic fiscal and monetary stimulus. As a trend accelerator, COVID has been credited with advancing digitisation in every sense, in addition to consumer habits and demand, healthcare (and the miracle of science for managing to find a vaccine in record time), and even the geopolitical scenario. With regard to investment specifically, 2020’s intense volatility helped reinforce many of the principles that guide our investment style.
One of those principles is the importance of invariably investing the capital that we do not need in the short term, and taking the time and energy to select good businesses with reasonable valuations without attempting to anticipate market swings, which are unpredictable by definition.
In particular 2020 reminded us of a fact investors sometimes forget, which is that often, even a hypothetical ability to anticipate the course of economic and political affairs does not necessarily imply accurately predicting stock market trends.
Imagine we are at the beginning of 2020 and we know in advance that there will be a global pandemic, forcing worldwide confinement with a never-before-seen impact on trade flows and economic activity around the globe. Faced with this scenario, few would correctly anticipate that financial markets would ultimately trend upward. In addition to this time for reflection, 2020 taught us another valuable lesson that reinforces our investment style.
The COVID-19 crisis has underscored the fact that the best protection against short-term market unpredictability is long-term investment in quality assets. By quality assets, we mean profitable, growing businesses (with a high return on invested capital), with strong cash generation (available equity to invest and grow), a healthy balance sheet (minimal debt), and a competent, honest management team aligned with shareholders. Dividends do not appear on this list, for example, because although their existence may be attractive insofar as they fit our risk profile, they are not synonymous with quality; also omitted are low P/E ratios in light of value traps, meaning, companies with depressed valuations attributable to objective causes.
Another valuable lesson from this tumultuous year is the enormous advantage that market volatility can bring to long-term investors focused on value. As Warren Buffett once said, ‘Markets are very unpredictable in the short term, and very predictable in the long term.’ Those who kept a cool head in March and April, confident in their investments, should have remained calm in the knowledge that, once again, time would prove them right: by December their portfolios would be positive for the year. Those in the habit of investing periodically or with excess liquidity, who managed to invest in that window of time, secured tremendous deals for half (or often less than half) of fair value.
This approach reminds us of one of the last major lessons of 2020: the importance of developing investment convictions. It is the adherence to certain principles—including obtaining in-depth knowledge about the solvency and quality of companies—that then allows us to navigate financial markets with guaranteed success.
In short, this past year reinforces the message that what is truly irreversible in a portfolio is the risk of insolvency, derived from highly indebted, poorly managed assets with little growth or cash flow problems. However uncomfortable it may be, volatility is much more innocuous that we think.
In the current scenario of excess liquidity, automated management, booming non-professional retail investment, and the persistence of extraordinarily low interest rates, we will surely see further episodes of volatility, that will once again remind us of the value of excellent, rigorous stock picking, an activity to which we will remain committed.