Are we there yet? Editor's note
How do we know it is time to buy when markets keep dropping.
Mentioned: American Tower Corp (AMT)
I landed in Sydney this morning after a trip to the US. The flight can be a character-building experience. The trip from Los Angeles clocked in at just over 14 hours and towards the end it feels like time is standing still. Bear markets can feel the same way. As the market drop drags on for longer and reaches lower depths many investors echo the anguished cry of the proverbial traveller—are we there yet?
I have spent the last three to four years building up cash in my investment accounts. I was ahead of schedule on my goals given a historic market run and I was wary as investors collectively descended into a speculative frenzy. My reaction to the market environment was far from drastic. At no point was I screaming into two telephones so I could unload my positions at precisely the right time. I simply started to accumulate dividends and kept most of my new contributions in cash. This has left me in an enviable position in a down market with a 25% allocation to cash. Now I just need to figure out the right time to put this money to work.
Investing is ultimately an expression of optimism about the future. And like any bear market, optimism is currently in short supply. The same scepticism that served me well during the bull run may now be my Achilles heel. An underappreciated contributor to investing success is self-awareness. As I reflect on my own investing disposition, I see strengths and weaknesses. A long-term orientation and a focus on cash flow generation instead of my net worth has anesthetized me to volatility in my portfolio. That is a good thing as I am far less likely to panic sell. Conversely, I have a pathological need to get the best deal possible when investing. Oddly, this quality does not apply to any of my day-to-day spending decisions. But from an investment perspective it makes it harder for me to pull the trigger because I keep imagining further falls and better entry points.
Here are some things I’ve been thinking about in the current environment and another plea to put some structure around investing. Structure won’t eliminate emotionally driven investment decision making. But it will reduce the impact of greed and fear on your returns. That reduction may be enough. Investment success over the long-term is often just preventing the big mistakes. Now is the time when many of those mistakes occur.
A smart investment decision isn’t about catching the bottom—it is about achieving your goals
We need to call a spade a spade. What I am doing is basically market timing. And market timing generally doesn’t work because most investors can’t determine when to sell and when to buy. The major distinction is that I didn’t sell at the top—I just didn’t buy more when I was uncomfortable with valuation levels. And I didn’t buy more because I was still on track to achieve my goals. Many will disagree but I consider that a structured approach to investing. Right now I’m not trying to catch the bottom. I am trying to make sure that each dollar from my cash hoard is invested at a point where there is a strong probability of achieving the long-term return needed to reach my goals.
To achieve my goals I need a 6.9% return over the next 20 years. I know that because I took the time to figure it out. I calculated my required rate of return and regularly track it as the market fluctuates, I contribute additional funds and as time ticks away. Listeners to Investing Compass know that Shani and I go through this exercise at least every six months and review the results on the podcast. This structure matters. Finding investments that earn at least a 6.9% return to achieve a specific goal is very different than a focus on wealth maximisation. The reason the “get as rich as possible” crowd often fail is because there is a constant attempt to do the impossible. In this market environment it is about catching the bottom. In rising markets, it is about constantly switching to an investment that will perform better.
Acknowledging the fact that the market will likely keep falling after I buy anything—and being ok with it—is the right mindset for this trying environment.
Is it time to buy?
For me the answer is not yet—but getting really close. There is an obvious but important caveat to that statement. I am talking about the right situation for me. Your situation is different, and therefore your decision-making process should reflect that reality. I hope expanding on my thinking provides a bit of perspective.
I always keep a list of my “dream” shares. These are companies that I think are great and fit my investing style. I have this list because I’ve taken the time to figure out the investing approach that works for me. A plan and an investing approach makes it easier to establish the criteria that needs to be met to determine if an investment is the right fit for my portfolio. That is a deeply personal set of criteria. Investment opportunities that don’t fit fmy approach aren’t bad. It just means they don’t fit my goals and my investing style.
The greatness of the companies on my list is widely acknowledged. I’m ok with that because I’m realistic about my competitive advantages as an investor. It is not my ability to analyse a company better than everyone else. Some people can do this. I don’t think I’m one of them. I think part of my competitive advantage is discipline around buy and sell decisions—my behavioural edge. I combine this with the self-awareness about which investments are right for me.
My hope is that this formula leads to buying great companies at reasonable prices and holding them for an extremely long period of time. Patience is the final source of my competitive advantage. A long-term orientation eludes most investors despite their best intentions and proclamations to the contrary. A long-term approach is a major contributor to achieving your goals and an underappreciated advantage that individuals have over professionals. It is an advantage that so many people carelessly give up by chasing returns and fads. Figure out a structure that truly allows you to take a long-term approach.
How does this inform my decision making in the current environment? An example may help. One of the companies on my list is American Tower (NYSE:AMT) which provides mobile phone towers to wireless companies. I like boring companies with moats that do reasonably well in all market environments. I like companies that operate in relatively stable operating environments and aren’t subjected to investor hype and the fluidity inherent in new industries. I like companies that pay and grow their dividends. I like companies that are conservatively geared. This combination often results in predictable and strong cash flow generation. American Tower fits the bill. It is a company that suits my investing criteria.
American Tower has had an incredible run as they’ve benefited from the explosion of data needs by mobile phone customers in the last decade. The share price has performed well and they’ve grown their dividend by at least 20% a year since 2013.
That track record certainly won’t be replicated going forward. But I don’t need that to happen to achieve my goal. I am looking for a total return of at least 6.9% going forward. To see if this is reasonable, I look to the three drivers of equity returns—dividends, changes in valuation levels and earnings growth.
The current dividend yield is 2.75%. Not earth shattering but it is close to 40% of my total return needs and I expect the dividend to keep growing. This is also the highest yield for American Tower in more than a decade.
On the valuation front the shares are trading at a price to earnings ratio that is 37% below their 5-year average. According to our analyst the shares are fairly valued with a 3-star rating. The last time they traded at a 3-star level was 2018 and they haven’t been undervalued at a 4-star rating since 2016. None of this makes me think that increases in valuation levels will be a driver of returns. But I also don’t see a falling valuation level negatively impacting returns.
The final driver is earnings growth. Our analyst sees revenue growth of mid to high single digits over the next 5 years with expanding margins further boosting earnings. I need earnings to grow 4.15% a year to hit my 6.9% required return if the dividend isn’t raised further and if valuation levels stay at the same level. Seems reasonable and achievable. I would like to see the share price fall a little further to build a bit more of a margin of safety but as I said—things are getting close.
If I make the decision to buy American Tower it will be at a level that is right for me. That likely won’t correspond with the bottom of the market and I’m ok with that. Prolonged and intense market falls impact great companies and terrible companies. Keeping structure around your decision making and having a clear idea what you need to achieve is the key to keeping your cool in this challenging market.
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