It is reasonable to feel like walking with a blindfold in a desert looking for water (yield) during these uncertain times. Hence, I recommend the following principles and a strategy for investing during COVID 19 outbreak.
Principles to adopt
Being a value investor or a long term investor requires one to adopt an optimistic outlook. Though too much optimism can blind one’s judgment, it is essential for an investor to believe that the world will overcome hard times and return to normality eventually.
Some companies will suffer and could end up in bankruptcy or worse. However, some companies will survive this and will lead its industry as competition becomes scarce. There is an extremely slim chance that every company in the USA will close its door because of COVID 19 effect on the economy. In other words, there are still companies to invest with higher confidence than others.
There will be three separate periods: the period of economic activity during COVID 19 outbreak (DC), economic activity after the end of the outbreak (AC), and eventually the return of full global economic engine (HT, stand for happy times). DC period will continue until there is clear evidence of the cure or containment of the spread. Hence, it kicks off the AC period. It is unclear when the AC period will end and will probably be seen in hindsight than foresight. HT is the time when the COVID 19 outbreak seems like only a chapter in a history book to most of us.
Strategy: Value Stock + Covered Call
Choosing the right company to invest is at the root of this strategy. A company that can weather the DC and AC period and reaches the HT period with enough balance sheet strength and customer base to come out stronger than its peers. There is no magic one number or characteristic of a company that can tell us which company to invest in. Fortunately, there are few proven qualities of a company that can be analyzed on. These are:
1. Competitive advantage. A company that stands head and shoulders among its peers. A monopoly in its industry is a showing of competitive advantage.
2. The demand for its products. Certain services and products are considered necessities in current society. It is up to the investor to identify what these are or will be during AC and HT times. Air travel is a good example as there is no alternative fast transportation to flying at this moment.
3. Management, management, and management. It is important to remember that an invincible ship can be sunk under the wrong captain and crew.
4. Cash flow generation. It would not mean anything if a company is making 100 million on revenue but only booking a few thousand in operating cash flow.
Once a quality stock is selected, it is presumed that the stock is undervalued. Hence, the investor expects the stock to reach its intrinsic value. However, with the above-mentioned investment periods, it is unclear when the stock will reach its potential price target. However, if an investor believes a stock is destined to go up, a covered call strategy could be used to create an income while waiting for the stock to reach its potential. There is one caveat to this strategy, choosing the right exercise price so that the call option is not used by the buyer. The goal of this strategy is to hold on to the quality company stock without having it exercised.
As an example, let’s say the quality company’s intrinsic value is $30 and the current price is $15. An investor would buy the stock at the current price and could write a call option with an exercise price of $20 at $0.5 premium. This could generate a small but material yield. If this option can be repeated multiple times in a given year, we are looking at a large income generation while waiting for our value stock to reach its intrinsic value.
Though the current market creates infinite uncertainties, an investor with a value stock can take advantage of this volatility via a carefully constructed option strategy.
This is about as much help as:
“but low, sell high”