How to Invest in Uncertain Times
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I think one of an investor’s biggest fears is uncertainty. There is a certain market dynamic that is seen when a headline crosses that causes us to question what we thought we knew to be true. When a company misses an earnings forecast or the unemployment number comes in below where it was expected, the natural reaction of some is fear. The gauge most widely used to demonstrate current investor sentiment is the VIX or “fear gauge” as it’s also known. When the VIX spikes it means investors are fearful.
I’m sure we all know the famous quote by Warren Buffett, “Be fearful when others are greedy and greedy when others are fearful.” In essence it is his plan for uncertain times and that’s how he’s managed Berkshire Hathaway (NYSE: BRK-B) through the decades. We’ve seen this play out in some of the so called sweetheart deals he’s been able to secure for his shareholders. He’s also used his plan for uncertainty to begin selling off shares of a holding that the market is valuing too richly.
As investors we need to look at those leading the companies we invest in to see how they manage uncertainty. Noted author Andy Stanley said in his book Next Generation Leader that, “the goal of leadership is not to eradicate uncertainty, but rather to navigate it.” I think there are two key takeaways for investors; one is to watch those leading companies we invest in to be sure they are able to navigate through uncertain times. The second is to look at your own investing plan and really look at how you’d manage your portfolio if fear induced volatility started to come to a head.
How can a company set themselves up to navigate uncertainty? One of the questions Andy Stanley asked at a recent seminar on leadership was to think in the context of what would a great leader do? If you take a look at Warren Buffett and the deals he’s been able to make, there are a few things to notice. He always has capital to invest because he has a fortress balance sheet. Debt is a necessary evil to drive a capitalist economy but taking on too much debt through it is akin to just being greedy and should be a red flag to investors. Whether it was General Electric (NYSE: GE) during the financial crisis or Bank of America (NYSE: BAC) more recently, Buffett was able to get great terms on each investment because he had the credibility in his balance sheet where as both GE and BofA were suffering due to uncertainty in theirs.
Unfortunately the landfills are piled high with the now worthless paper of companies who went bankrupt or were acquired at a fraction of their value because they were not set up to navigate themselves through uncertain times. They were not prepared for their liquidity source to dry up; there was no Plan B in place when prices fell more than expected. They were caught off guard and flat footed making them unable to reposition themselves for opportunities that were soon to be springing up. Bank of America for example spent much of the early part of the credit crisis as a rescuer by taking over both Countrywide and Merrill Lynch. Unfortunately sometimes just because you are able to do something it doesn’t mean you should, and investors in BofA have seen their share price drop with their credibility.
The same can be said about GE as their reliance on the commercial paper market before the credit crisis had them straying from what had made them great. One of the great leaders of GE, Jack Welch was known for saying, “Control your own destiny or someone else will.” It was when GE was relying on external funding they were in a sense giving control of their destiny to the market.
Steve Jobs was criticized continually for having too much cash on the balance sheet at Apple (NASDAQ: AAPL) yet that cash cushion has given them the confidence to invest billions of dollars into projects and people which has driven their success. Should uncertain times arise, Apple has the cash not only to run their business through the uncertain times, but to invest in order to grow once those times past. As I mentioned earlier, the goal of leadership is being able to navigate through times of uncertainty. The stronger a company’s balance sheet the easier it will be for them to navigate through any crisis.
What are the takeaways for investors in these uncertain times? Look for companies with fortress balance sheets that will enable them to navigate no matter what. Secondly, make sure your own balance sheet is in order. Do you have cash to ride out the uncertain times? Do you have hedges or shorts in place to provide a source of liquidity? Or will you be one of the fearful ones when greed has run its course?
latimerburned owns shares of and has a Bull Call Spread in Apple and has a Diagonal Call on Berkshire Hathaway. The Motley Fool owns shares of Apple, Bank of America, and Berkshire Hathaway. Motley Fool newsletter services recommend Apple and Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.