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Skinny Dipping at High Tide

By Rob Shears on August 30, 2021 in Other

Timing is everything. Photo: Richard Wrinkles

“You only know who has been swimming naked when the tide goes out.” – Warren Buffett
With markets hitting all-time highs this month, it is an obvious time to ask the question, “Is this the top?”
No one knows when markets will top. What is knowable, however, is whether you are in turkey stocks or thoroughbred companies.
Turkey stocks follow the chart of a Thanksgiving turkey – they grow consistently until their head gets chopped off – and include loss-making businesses, overleveraged companies, testosterone-driven acquisitive managers, fads, frauds and failures. There are far more turkey stocks than great companies.
Turkey stocks thrive in times of easy credit and loose markets, and we currently have the easiest credit and the loosest markets I have ever seen.
When the party ends, it can be disastrous. A few years ago, a client came to me with a portfolio that had crashed from $15 million down to $500,000 because they owned a bunch of turkey stocks at the top.
Thoroughbred companies, however, are companies that have withstood the test of time. They have few to no competitors, consistent outstanding returns on capital, little to no leverage, conservative and patient managers. Many of them thrive in difficult times. Some of these companies have survived two world wars, depressions, pandemics and countless competitors, yet they are still around and thriving. They are also very rare.
A few companies actually do better in a downturn. Companies that have excess cash can buy back stock during hard times. Most stock buybacks are wasteful, however. The Aussie banks raised capital at the bottom of the market last year and are now buying back shares! This is typical of poorly run companies, and I have no doubt the banks will be forced to raise capital again in the future. A very small number of companies buy back large amounts of shares during downturns. These are often some of the best investments available.
At the top of the market, thoroughbreds can be overpriced. In the late 1960s we had a bubble in thoroughbred stocks. Be careful overloading in a portfolio of expensive overpriced companies.
Have you got a portfolio full of turkeys, or are you invested in the very few reasonably priced thoroughbreds?

How to prepare for the
inevitable changing of the tides
1. Avoid leverage, both directly and indirectly (inside the businesses).
2. Buy high quality (little competition and high return on capital), resilient companies.
3. Beware of the seasons.
4. Valuation matters.

Be careful out there. Many have already forgotten the devastation of the dot-com bubble in the late 1990s, the 2007 asset bubble and the ensuing Global Financial Crisis, and the 2011 mining bubble. History rhymes, don’t get caught in your birthday suit when the tide turns.

Rob Shears is an Authorised Representative of Valor Financial Group (AFSL 405452). This advice is general and does not take into account your objectives, financial situation or needs. You should consider whether the advice is suitable for you and your personal circumstances.