The worst mistake you can make as an investor in turbulent times like these is to think you are smarter than the market.
The market, after all, is made up of thousands of individuals, many of whom are trying to outsmart all the others. But in reality, unless your last name is Buffett, Klarman or Ackman (none of whom make any attempt to outsmart anyone else) you are guaranteed to fail miserably trying to be clever.
I've argued before that the single-most important determinant to future stock market returns -- even more important than growth -- is valuation. In 2008, U.S. GDP grew by about 2%, but the S&P 500 dropped nearly 40% as the index started the year near an all-time high. Against economic contraction in 2009, the S&P 500 roared higher during the year. Growth, of course, is of paramount importance, but it takes a close backseat to valuation.
Valuation and growth are joined at the hip over the long run. A couple of weeks ago, Netflix (NFLX) shares were trading above $300 apiece, or more than 60x earnings. Such a valuation was absurd, but the only plausible argument Netflix bulls could make was for the future growth potential of the business. That future-growth scenario was shattered when the company abruptly announced a split of the DVD rental business and its online streaming business. Before many investors knew what to do, the share price shriveled more than 50% in a matter of days.
Sitting at 1130, the S&P 500 is moving into attractive valuation territory. But the problem is that the current economic landscape shows little sign of future growth over the next 12 to 18 months. Just this morning, the top brass at PIMCO predicted that advanced economies will see little or no growth over the next year. Of course, predictions are never 100% accurate, but signs certainly point to a slowing economy. In 2009, when the S&P 500 was bottoming at 666, many businesses were trading well below replacement costs of assets, even at then-depressed prices. So even though the economy was contracting, the market was absurdly cheap.
I certainly wouldn't wait for the S&P 500 to hit 700 to buy again, and prices are getting interesting, but investors need to be selective. Case in point: Berkshire Hathaway (BRK.A) (BRK.B) this morning announced that it had authorized a buyback of its Class A and Class B shares. The buyback numbers weren't specific but the company said that at current prices, the shares were trading well below the intrinsic value of the business.
What's interesting about this announcement is that it's only the second time in 40 years it has happened. Berkshire shares were trading at similar levels in 2008-2009, yet no buyback. That's because equities were absurdly cheap at the time. Today, according to Buffett, equity prices generally aren't as attractive and buying Berkshire is the better bet.
In fact, other big-cap names today offer the most appeal in this environment. For many, prices have fallen hard, yet these businesses have the financial wherewithal to navigate the next year or so safely. Shares in Deere & Co. (DE) are trading around $66, 11x earnings, and yielding 2.4%. Deere is a fantastic franchise business but make no mistake, a global slowdown would likely hurt sales. The share price, however, is starting to look interesting again.
Then there's Dell (DELL), which trades for about $14.30 and has a balance sheet with more than $4 per share in net cash. With an enterprise value of $18 billion, Dell trades at less than 6x EV/FCF. Dell is putting its money to good use by buying back tons of its shares, which at current prices, are valued at 7x earnings.
Sometimes winning means not losing money. In today's world, preservation of capital takes on an entirely new meaning as the global economy copes with the new normal environment.