Panic journal (2) – Fear & Bullet proof your portfolio

Upfront remark:
Although this blog is mostly about investing, I hope that none of my readers will lose any dear ones because of Covid19. Stay safe, stay at home as much as possible and don’t take any unnecessary real world risks especially if you belong to or have regular contact to people who are most vulnerable.

Panic turns into fear
At the time of writing, Spain and France have gone into lock down after Italy last week and the US has implemented a National Emergency and Austria even tries to ban meetings of more than 5 persons. In Germany, Schools and Kindergartens are closed and the coming week will bring more lock downs as well.  So it is pretty useless trying to predict what will happen with the economy in the coming weeks/month. It is pretty clear that there will be a recession, but it is close to impossible to figure out how deep and how long this will go.

The initial panic has now turned into fear. The week before, the main discussion was among experts on how international supply chains would be disrupted. This weekend, in my local “DM” drug store, the shelves for toilet and tissue paper were completely empty as well as most of the canned/durable food section. People now fear the worst although even in Italy, grocery stores are still open.

Most tabloid newspapers run front page “Corona specials” and on (linear) TV one Corona virus special after the other goes on air. Within a week, the sentiment has turned from “This is a Chinese/Italian problem” to “Oh my god, everything is going bust” attitude.

To be honest, I am not sure if for instance my small purchases into 2 Italian stocks was really such a good idea. Lats week I thought that Covid19 really is “Only” some kind of more serious flu, but the last week led me to reassess my overall opinion.

It is pretty clear that Government actions will trigger a much stronger economic impact that will reach all areas of the economy, not “only” leisure and tourism or industries that get supplies from China.

Implications for investors

Even for the most battle hardened investor, the current situation is clearly a unique one which has never happened like this before in our lifetime. No one knows how exactly this will develop over the next days, weeks and months.

On the other hand, I dare to make one prediction: After some time the world will go back to (almost) normal, however I do not know when this will be the case and what will happen in between.

So the question clearly is: How to “survive” the coming days, weeks and months as an investor.

Strategy 1: All cash now

One possibility is clearly to sell everything now, go into cash and then wait to reinvest when the crisis has cleared sufficiently. This strategy always sounds great in theory but never works in practice. The main reason is that reinvesting in these scenarios is always hard and if you haven’t been into cash before I dare to bet that these investors who cash out now will most likely either reinvest at a higher level than today or not invest for a very long time. This is something I have seen over and over again during both, the crash and the GFC and the playbook is always the same: people will miss the early recoveries, come in late, get nervous again etc, etc.

Strategy 2: Do nothing

The second extreme would be to do absolutely nothing and just sit and wait. My hunch is that this strategy is slightly better than strategy 1, but after a 10 year bull market I am not so sure if this is a good idea. Why ? Because most investors will have added some cheaper or more speculative positions over the last few years as “quality” has become too expensive. So many investors will have vulnerable positions that might get in deep trouble even if the crisis normalizes relatively quickly.

Strategy 3: Try to directly profit from the Corona crisis

Some publications now recommend to invest into companies that profit from the current trend to stay at home like, Slack, Netflix, toilet paper manufacturers etc.. As I have mentioned before, I don’t think that this is a good idea as you are most likely to late for that party.

Strategy 4: “Bullet proof” your portfolio

How do you “bullet proof” an investment portfolio ? As with bullet proof vests, it is unlikely that an investor will come thorough this crisis completely unharmed. It is very likely that it will hurt and you will have some black spots but you can make sure that you get not hit lethally. So what should one do right now ?

A) Most important: Make sure that you are not forced to sell
– if you have leveraged your portfolio, reduce leverage NOW. As I have mentioned, use “up days” to sell
– make sure you have enough cash on hand to meet expected and even unexpected outflows (broken car, repairs, etc.) for at least 18-24 months
– in general a “quick and dirty” planning exercise makes sense, including some finanical stress scenarios (job loss, support of relatives etc.)

B) Make sure that you know your own risk bearing capacity
check your historical behavior:
Have you been invested going into the GFC 2008/2009 ? What did you do ? What was the maximum draw down you did experience ? What did you do afterwards ? My rule of thumb would be that your actual risk bearing capacity is actually maybe half of what you would intuitively think it is.

C) Make sure that your portfolio is as bullet proof as it gets
It sounds boring, but in my opinion quality is the only alternative, It doesn’t matter how cheap a stock looks based on historical financial, this will likely be a “survival of the fittest” scenario. The chances of survival are best for:

  • no surprise: Companies that are conservatively financed
  • and with really good management who might even come out stronger from a crises
  • Companies with relatively high profitability, low fixed cost ratios and relatively flexible variable cost basis
  • A portfolio with some level of diversification.

One absolutely needs to avoid these companies that are gone first, as most Government support programs will need time and the early casualties will most likely not be saved. So avoid already vulnerable companies. For the third point I will add a small excursion at the end of the post.

My personal action plan:

For me, clearly strategy 4 is the only option. I have started late last week already with improving the quality of the portfolio by selling positions that I am not 100% happy (Draegerwerke, Metro Bank) and increasing positions where I think quality is highest (Admiral, TGS Nopec). I will continue to do so.

I will clearly need to check if my other actions (starting a small German basket, the Italian position plus Sixt and FitBit/Google) makes sense and adjust if necessary in the coming days.

Finally, I will need to think about my true risk bearing capacity. Personally, I have seen a -70% cumulative draw down in 2002/2003 but back then I was a lot younger and had less money at stake. I still have a long enough runway to ride out most crisis, but the runway is 17 years shorter than it was back then.

Excursion: Why quality stocks are better in such situations

A lot of Graham inspired investors might be tempted to go for the “cheap” stocks now. However we are at the very beginning of a potential significant down turn and what is cheap today might be expensive in the future. The current crisis will most likely drive a significant demand shock: People will consume/buy a lot less for some time.

For any company this means that sales will shrink, but costs will remain. Some costs are fixed (rent, depreciation) some costs 100% variable (COGS), some costs are only semi-variable. In order to show the impact of such a shock, a created a very simple model where I calculate the impact of the shock on a simple company. Let’s start with one example:

Company A, has in normal times a net margin of 5%, 50% of its cost are fixed and Variable cost go down only half as quickly as sales. The table shows now the impact of a one time drop in sales for a single year. a -20% drop in sales eliminates one annual proft, a -50% drop in sales more than 4 years of profit.

This is a very similar company with the only difference that they only earn 2% net margin:

It is pretty obvious that such a company is hit much harder. The same drop of 20% in sales creates a loss of 4x normal earnings which is almost 4x in relativ terms to the first company.

Finally a company with a 10% margin, all other things equal:

Even with a 20% drop in sales, this company still makes a profit.

The 3 examples clearly show that low margin companies (all other things equal) are much more vulnerable against a pure demand shock than high margin ones.

Of course this is not the only factor that determines future stock prices, but I think it shows that just looking for “cheap” stocks with high fixed costs might be not the best strategy at least in the beginning of such a crisis.






  • Thanks for thoughtful post. On TGS Nopec, if you go back over the accounts since 2004 the average cash operating margin is around 22-23%, ie using actual cash outlays on library acquisition, or roughly 17% after tax. If you put normalised revenue at 500-600 then that is around 8x normalised cash. Definitely better than 30-35x in late 2018 but with the price of oil where it is and CGG being so eager to win business I’m a bit hesitant even at these levels

  • I like your concept of taking this crisis as an opportunity to revisit your portfolio. I only sold a 5% so far, but I would recommend setting a clear trigger point to buy again. I don’t know where we are heading, it is possibile that a lot of airlines will go bust, followed by hotel chains, entertainment venues, etc. My personnal trigger point is when the US has been in full lock down for 3 weeks….

  • Given you have spent some time looking at the Australian market can I suggest you look at Sydney Airport? A monopoly asset that has seen value almost halve. It was very fully prices before but share price reaction has been extreme for what will be a temporary impact on travel.
    I’ve not done any work on this but could be interesting if it’s capital structure can sustain it.
    Nb. There is another airport that will at some point open in Sydney’s West (years and years away but a risk no less) but this will never be the go to airport for business travellers given current airport proximity to city.

    • Replying to my own post here but given you are a German speaker, and in a related vein to the above, what about Flughafen Wien? It has zero debt and at 5.5x LTM EBITDA is surely the cheapest airport in the world? Of course this will be a bad year but you don’t value businesses on a 1 or 2 year outlook

      • Sorry for not answering. I am not sure about Airports yet. They have relatively high fiexd costs (I view in this case depreciation as a real cost) and they will need to change a lot of things if and when travel resumes. For me this is not high on my priority list.

        • Yes but that particular fixed cost you are referring to (maintenance capex) is at least deferrable for a period so it is not the same as staff or rent costs.

          Why do you think there would be any meaningful change to their business and economic model after this?

        • If you believe in the “Hammer and the dance” scenario, air travel will look VERY different for the next 1-2 years at least. Airports need to make sure there is ample distance between passengers which will be not so easy to achieve. I have no idea how and to what extent air travel will ramp up to old levels. For me a reason to stay away. If you have a different opinion, then byuing might make sense.

      • Hi Kjay, this stock is also on my watch list. Few debt, but also fe PE at the moment. Also what can grow earnings exponentially in airport sector (except buying/building other airports wisely) ?

        • I don’t think you need anything above relatively modest long term passenger growth to make this investment work at the price it’s available at

        • I don’t think this is enough. Great companies develops different ways of creating value. It may happen to this company, but at the moment this is not a “Google company” that is wondering what to do with the cash, it’s a mid cap. I hope to see cheaper price, otherwise I’l pass.

  • Where does Uber fit in all this?

  • Love the crisis journal, keep going!

    A few ideas:

    – on directly trading the crisis: as the market has hysterical fits individual stocks are less likely to be accurately priced than normal. For example you had time to sell Cinema and Cruise companies at good prices relative to their dire situation (and they are probably still priced more than they’re worth).

    – good time to prudently sell volatility. Usually you’re exposed to vol moving violently against you, but now it can’t get much worse.

    – be aware that markets may be closed (eg your reader with the IBEX short won’t do well if Madrid closes when he’s in and reopens during a post crisis melt up)

  • GNP-GlobalNosePicking

    Short IBEX35 (and anything smelling spanish) like the Pest.

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