Crisis brings opportunities for equity investors

Justin Floor, fund manager at PSG Asset Management

It has been a long winter for many SA investors and we don’t know when it will turn around. In fact, there is still very little we know for sure about the current crisis, other than that it is entirely unprecedented and is being accompanied by fear and declining security prices.

We don’t know how long it will last or the degree of economic deterioration to come. And we don’t know whether the playbooks of previous crises, such as the Global Financial Crisis (GFC) and the dotcom crash, will be relevant to this scenario.

Behaviourally, it’s an incredibly difficult time to be an investor. But for those who can manage the challenging behavioural factors, it is also a very exciting time to be putting money to work. It’s been a very long time since we’ve seen so many high-quality assets available at such attractive valuations. 

What should investors do now?

Despite everything we don’t yet know about this crisis, we are confident that maintaining a long-term perspective is critical. It’s important to remain focused and not to be distracted by the noise and excessive share price movements.

Asset prices only signal opportunity when contrasted to a well-considered and unemotional assessment of intrinsic value. While the underlying value of many businesses and securities have reduced in these times (in some cases very substantially), some have seen their inherent value change very little. In some rare cases, intrinsic values have even risen as there are always beneficiaries in every crisis. If we’ve been doing our work well and our intrinsic values are relevant and broadly accurate, then we are witnessing the widest gap we’ve seen between price and intrinsic value in the last 10 years and more.

We see an outsized opportunity for prospective returns in South African equities in particular, many of which we believe have the potential to more than double in the years ahead. In many cases, shares that were already undervalued have become even cheaper, even with appropriate consideration of the undeniable challenges faced in these uncertain times. This offers a rare opportunity for those who are willing to buy now. However, conditions are likely to remain tough for a while, and we expect that many companies will fall by the wayside or require dilutive capital injections – so doing your research and having a robust and repeatable investment process is more important than ever.

Process is better than prediction

We constantly remind ourselves we cannot control share prices, yields or currencies. What we do control is our process, namely how we decide when to buy or sell shares. We continue to follow our tried and tested disciplines, and we believe the following factors are now crucial when deciding in which companies to invest. 

• Bottom-up research and balance sheet resilience is a friend in these times of uncertain short-term cashflows. Look at the level of debt, but remember that how debt is structured is often even more important. What are the debt exposures, and how diversified are they? There are a number of companies out there that appear to have a lot of debt, but where this is incredibly well structured. Where this is the case, high debt levels do not automatically negate investment. 
• We spend a lot of time identifying the resilience of our intrinsic value estimates. Be flexible, unemotional and realistic in this assessment as the intrinsic values for some companies have changed.
• We look at the company’s ability to generate cashflow, as this is going to be incredibly important predictor of survival in the months and years ahead.
• Continue to think probabilistically. Uncertain times require a framework than can handle uncertainty and get the odds of success in your favour.
• Having an adaptable and trustworthy management team is more important than ever. A strong management team can steer a business to come out ahead during times of crisis, and this may be a make or break factor for many SA companies.
• Lastly, retain discipline and a long-term approach, without being dogmatic. This crisis will pass and we have little doubt that whatever that outcome, investors will look back to the current era with envy given the abundance of attractive prices on offer.

The crisis won’t last forever

This crisis won’t last forever, though it may feel like it at times. It’s also important to remember that the crisis is a necessary precondition for being able to buy some of these high-quality companies at these attractive prices, which lays the groundwork for strong long-term returns.

It is the investment decisions we make in tough times that are often the ones we are most happy about, and that deliver the best outcomes, in the years ahead. It’s true that it’s still a cold, dark winter for SA investors right now, but we believe there is good reason to be optimistic.

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