There is no denying that the Coronavirus pandemic is turning out to be the crisis of the century and it is negatively impacting economies, businesses and individuals across the globe but that does not mean that opportunities will cease to exist.
As governments struggle to find a delicate balance between restarting their economies and containing COVID, investors are starting to look for unique opportunities in what is shaping up to be a prolonged period of heightened volatility. The current low interest rate environment makes equities an interesting asset class for investors to consider over fixed income but equities are by nature volatile, which makes disciplined and informed investing essential to generate alpha.
We suggest that you consider the below approach as a good reference point while making equity investment decisions during these challenging times.
Balance sheet strength becomes more important than earnings in short to medium term
Near term visibility on earnings impact from pandemic related shutdowns and loss of revenue is hard to predict. For most companies, 2019 earnings will become meaningless in 2020 and possibly even into 2021. As multiple sectors of the economy go through structural changes during the pandemic, business models and viability are being severely impacted. Accordingly, common valuation multiples – PE, EV/EBITDA, ROE – may be misleading and irrelevant when it comes to decision making going forward. However, even if companies lose money this year and possibly struggle next year, the strength of their balance sheet will be more indicative of their future viability than their earnings. If they have a strong balance sheet—meaning high cash balance, low leverage, liquid short term investments, limited risks on receivables—the chances of them surviving the pandemic and rebounding becomes significantly higher. Any major correction in the share price of companies with strong balance sheets can be an interesting starting point for further analysis by investors.
Operating leverage plays a crucial role
Companies with low operating leverage will have better chances of adapting to the new normal of declining sales for the duration of the crisis and quickly lowering their variable costs. While companies may not be able to control revenue impact due to government-imposed shutdowns and business closures, a company with low operating leverage can quickly scale down costs to minimise the impact on its bottom-line and cash flows. Consequently, investors should identify these companies through an analysis of their cost structure with a particular eye on the measures that are being taken to mitigate negative impact on their bottom-line. Although companies with high operating leverage may benefit significantly once business normalises, the current focus should be on companies that are successfully riding out the storm.
Carefully assess sector versus risk dynamics
The impact of the new normal imposed by the pandemic—work from home, travel restrictions, governmental regulations—have affected some sectors more than others. When weighing in on an investment decision it is important to keep in mind the degree of damage that any given sector has suffered or is likely to suffer in the coming period as COVID cases continue to surge. Examine the future prospects of the sector in question and decide on the level of risk that you are prepared to take in order to invest under the given circumstances. Sectors such as HORECA (hotels, restaurants, catering) or travel and tourism (airlines, ticketing) are obviously worse hit and have limited visibility on when and if things are going to normalise. One should tread carefully in this space as there will only be a select few that have decent chances of surviving. While there will be some affected sectors that are going to bounce back faster than others, there are also sectors, such as digital and ICT, that have done exceptionally well under the new normal with demand for video conferencing, augmented reality and gaming applications increasing exponentially. Within GCC region, Consumer Staples (especially Groceries) and telecoms have been relatively less impacted. With these caveats in mind, investors should asses their individual risk appetites and shortlist sectors and stocks to add to their portfolios accordingly.
The importance of government bailouts and central bank intervention cannot be understated
Across the globe, governments and their central banks have provided temporary relief measures to both companies and individuals in an attempt to cushion the economic fallout from the pandemic and help the most vulnerable survive. A careful survey of these measures should be taken into consideration as investors assess impact on companies that they wish to invest in.
Companies with strong management, effective communication and agility deserve a premium
Listed companies whose management teams are effectively engaging with all stakeholders in a proactive and consistent manner that clearly articulates their strategy and regularly addresses investor concerns, will witness more investor interest over other peers. Management will also be put to the test on how effectively and quickly they were able to revamp their business models and adapt to the new realities. For instance, brick and mortar retailers who have not successfully transitioned into e-commerce will struggle significantly more from the crisis than those who have.
Investing during a pandemic implies embracing considerable volatility
One common temptation that investors often fall into is investing in companies that have corrected steeply from their 52-week highs. While they may get lucky to buy into these stocks at lower prices, there are usually reasons that validate the drop in price which means that the price can fall further in the future. It is however advisable to keep a portion of your investable pool as cash so that you can have the flexibility of taking positions in quality names with good fundamentals at attractive price levels in case of steep corrections. Additionally, one should keep emotions aside, be objective, and avoid the temptation to book profits early or hold onto losing stocks for too long.
While there are still many factors and variables that one needs to keep in mind when investing in equities, particularly during volatile times, the above reference points and approach can be a good starting point.