This is no time for investors to reach for the panic button

Panic can be defined as an irrational fear and yet, in some respects, there is nothing particularly irrational about the panic that has gripped markets as a result of the Covid-19 pandemic. Panic is simply part of the human ‘fight or flight’ response to dangerous or unfamiliar situations and so might even be seen as entirely natural. In investment, however – and the same may be said of its opposite state of euphoria – it is not helpful.

At times like this, we are all reminded how uncertain the world is – and yet, here on The Value Perspective, one maxim we always hold to is, the moment you think something is certain in investment, you have lost your objectivity. If we start thinking we know what the future holds for a business, the chances are we will end up being disappointed so we genuinely want to feel a little uneasy about every company we own.

That uncertainty, of course, is why investors hold portfolios rather than risking everything on a single stock. And, thinking in a portfolio context, investors now need to be asking themselves where they can buy businesses that could trade at much higher share prices five years from today. That, after all, is the kind of timescale equity investors should be thinking in.

Long-term potential

Just as importantly, do they think those companies have what it takes – strong balance sheets, sensible debt levels and so on – to survive this difficult period and emerge to fulfil their long-term potential? If you can identify those sorts of businesses, you have a very attractive combination of ‘heads I win, tails I hopefully don’t lose too much’ – and ultimately investing is about putting together a portfolio of these stocks.

Mind you, with some share prices falling 30% or 40% in a matter of days, we can understand why investors might be reaching for the panic button and selling out. Before doing so, however, we would suggest they think hard about why they were happy to hold the stock just a couple of months ago – because the reality of investing is that most businesses have both positive and negative aspects to them.

What happens is, when markets are calm, investors tend to accentuate companies’ positives; and when markets are volatile, they will focus myopically on their negatives. Incidentally, no businesses are universally ‘good’ – and those that are perceived as being so will usually trade at valuations that are so expensive it becomes very difficult to make money on them in the future.

Stronger case for buying

So investors thinking about selling a company should first try and call to mind what they had previously thought were its attractive attributes – and then ask if anything fundamentally has changed. If it has not, then there is a stronger case for buying than selling because you will be able to pick up those attractive attributes a whole lot more cheaply today than you could a couple of months back.

The second point investors need to consider carefully is the solvency of the businesses they own. Here on The Value Perspective, after the markets crashed, we spent weeks revisiting the balance sheets of every company in our portfolios – making sure we know what debt they have, the state of their pension funds and what other obligations they might have taken on.

To be clear, this is not about disposing of any business with obligations – all businesses have those – it is about ensuring you have an objective understanding of what you own and why you own it. Take emotion out of the equation and, so long as you are able to take a long-term view, current market valuations are suggesting now is not so much the time to be selling out of equities as adding to them.