What should be your investment approach to benefit from COVID-19 pandemic?

The COVID-19 pandemic has not spared any nation or individual; everyone is impacted either directly or indirectly. Two months ago, no one even thought of the kind of bloodbath which we have witnessed in the past two months’ time. The year 2020, started on a very positive note with major world equity indices testing an all-time high in January 2020, led by softening trade rift between world's two large economies (US and China), which had deeply weighed on global growth in 2018 and 2019 as well. By the end of 2019, British citizens handed a stonking majority to PM Boris Johnson-led conservative party to deliver Brexit, and on January 31, 2020, the first stage of Brexit also got delivered, and the UK entered into 11-month long Brexit transition period. This development also mitigated the risks of a no-deal Brexit, which was weighing largely on European markets, especially the UK market.

In the initial days of 2020, many foresaw that a lot of uncertainties would soften this year ranging from improving the relation between US and China after one and a half year-long trade rifts, Brexit related uncertainties cooled down to some extent. Also, global portfolio managers were reported saying that they believe 2020 is going to be a year for UK stocks, as they have relatively underperformed their global peer indices since Brexit fog started hovering over. But, unprecedently thing turned out to be different and beyond one’s imagination.

A deadly novel virus emerged from the mainland of China and soon grappled many other countries across the world. At the time of writing as on April 17, 2020, the data available on worldometer exhibits that the novel virus has so far marked its presence in over 210 countries, with more than 2 million confirmed cases been reported, and about 1,15,000 people died till date.

At present, there are three models to contain the spread of this virus. 1) The Chinses model of stringent lockdown, 2) The South Korean model of testing at large scale and isolation and 3) The Japanese model of stern personal and social hygiene. The mix of these three models could help us to win over against COVID-19 pandemic.

The market reaction has been utterly disappointing, and the stock market across the world has witnesses steep sell-off. FTSE 100 is oscillating near the levels last seen in January 2016, and FTSE 250 is hovering near levels of February 2016. This offers many wealth creation opportunities amid the present circumstances.

So, the question is how one should identify stocks which could help them in wealth creation in future.

Here, we are explaining some back tested approach to win over in a bear market or market crash.

1. Identify companies with PBV ratio below 1.0: Price-to-Book Value ratio is widely associated with the concept of value investing. A stock with PBV ratio below 1.0 implies that it is trading below the per-share book value of the company; certainly, they are undervalued stocks. But while setting the hunt for value stocks through this strategy, one should also look at their historical PBV ratio trend and if during normal times also it had been trading below PBV ratio below 1.0, then it will not the serve the purpose because then there is some other problem also associated with the company, like declining earnings, low Return on Equity or negative ROE, overstated assets in the balance sheet. Your screener should be set in direction to search for companies, those who have historically traded above PBV ratio of 1.0 and because of steep market correction that took place recently, they are trading at a discounted per-share book value price.
2. Bulls of last market rally: Look for the companies who recorded splendid performance in the past bull rally and are now trading at a sharply discounted price. As, all bulls of the last rally will not turn out be a good bet, therefore identify companies who rallied in the past bull market because the company has built upon strong fundamentals in terms of sound financials, committed management, high cash-generating businesses, and competitive advantages of their products over peers offerings. Because these were reasons for a past market rally, then they will show recovery and deliver a risk-adjusted higher return in future.
3. Find a business with a higher spread between WACC and ROCE: Weighted Average Cost Of Capital which is abbreviated as WACC is the cost which company has to deliver through their operation and Return on Capital Employed (ROEC), calculated as Earnings Before Interest & Taxes/ Total Assets – Current Liabilities, is the return company generate on the funds it uses in the business (debt and equity). So, if a company's ROCE is less than WACC, it's wealth destruction company from an investor’s point of view because it is earning that much to cover the financial liabilities, hence despite how much better products it is offering and lucrative industry in which they are playing, it is not a good bet for investors. Therefore, one should look for the companies which are consistently maintaining a large spread between their Weighted Average Cost Of Capital (WACC) and Return on Capital Employed (ROCE), because higher the difference between WACC and ROEC, a higher margin of safety the investment is offering.
4. Buy quality management: If you find that company’s management is not trustworthy and there has been a consistent mismatch between their commitments and actual output, then stay away from those businesses, no matter how alluring the stock price or valuation is.

But the problem is how you will judge someone’s quality when you hardly know anything about them. Yes, you don't know them personally, but how they are running businesses, it can be seen through their financial reporting. Some of the indications of shifty management and poor corporate governance are, 1) Poor quality of earnings, 2) excessive management remunerations, 3) excessive related party transactions, 4) Auditors remuneration are increasing at a higher pace than business growth and 5) a quite low remuneration of independent auditors. These are some checks which raise a red flag against the quality of management.

However, there are many other ways to identify better investment opportunities amid a market crash, but these are backtested strategies which have handed decent return over the time and more importantly, protected investors money against fraud and misconducts.

Disclaimer

The website has been prepared for informational purposes only and is not intended to be used as a complete source of information on any particular company. The above article is NOT a solicitation or recommendation to buy, sell or hold the stock of the company (or companies) under discussion. Kalkine does not in any way endorse or recommend individuals, products or services that may be discussed on this site.