February 29, 2020
We have been getting a lot of questions from investors and friends in regards to coronavirus and its effects on the global economy. As you can see from the table below, S&P 500 is down -12.3% from its highs just 8 days ago, which marks it the 26th correction of larger than 5% since March 2009 low. They were all painted as the end of the world at the time by the media, hungry for sensational news headlines.
The purpose of this note is to focus investors’ attention on the essence of investing and to tune out the sensational headlines and the daily manic-depressive behaviors of the stock market.
Warren Buffett published his annual letter this past weekend and no one can drill down to the essence of investing like he can:
“Charlie and I do not view the $248 billion detailed above as a collection of stock market wagers – dalliances to be terminated because of downgrades by “the Street, ”an earnings“ miss,” expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour.
What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20% on the net tangible equity capital required to run their businesses. These companies, also, earn their profits without employing excessive levels of debt.
Returns of that order by large, established and understandable businesses are remarkable under any circumstances. They are truly mind-blowing when compared to the returns that many investors have accepted on bonds over the last decade – 2 1⁄2% or even less on 30-year U.S.Treasury bonds, for example.
Forecasting interest rates has never been our game, and Charlie and I have no idea what rates will average over the next year, or ten or thirty years. Our perhaps jaundiced view is that the pundits who opine on these subjects reveal, by that very behavior, far more about themselves than they reveal about the future.
What we can say is that if something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.
That rosy prediction comes with a warning: Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater. But the combination of The American Tailwind, about which I wrote last year, and the compounding wonders described by Mr. Smith, will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!”
Joe and I have exactly the same view, coronavirus or not! The top holdings in the Rowan portfolio are all extraordinary companies, run by talented management teams with “skin in the game”. Our top holdings grew their revenues in the range of 30-55% over the past 3 years and they are estimated to grow revenues in the range of 22-35% in 2020. All of them have very solid balance sheets and enjoy strong competitive advantages in their markets.
Let’s compare owning the businesses in the Rowan portfolio over the next 5-10 years versus the two investment alternatives: cash “under your mattress” and bonds. Cash will likely erode ~2% in your purchasing power over the next 10 years (Fed’s long-term inflation target is 2%), so $1 million under your mattress for 10 years becomes $817,000. The 10-year Treasury bonds currently yield 1.3%, which equates to ~77x earnings! Would you buy a stock that trades for 77x earnings and is guaranteed to NOT grow its earnings for the next 10 years?
With that, the best course of action is to tune out all the noise, turn off CNBC, stop watching the ticker tapes daily and to focus on what we are doing in the first place - compounding capital over the long investment horizon. The only way to do that is to stay invested in a handful of extraordinary businesses that have a long runway to grow and that can reinvest their excess earnings at above-average rates. Doing just that and controlling our emotions gives us a pretty good chance of accomplishing our goals over time!
Stay healthy and be well!
Alex and Joe