From DKAM’s ROE Reporter:
We do not believe that buying and selling stocks based on a short-term outlook or according to the latest headlines translates into a long-term winning strategy.
Picture an independent car dealership that has been operating a single location for a decade. Say this shop has been making $1m a year in cash flow. They have a great location and loyal customers and in normal circumstances you would expect this trend to continue.
Due to Covid-19, their revenue drops to zero and their cash flow declines to negative $250k in 2020. This business runs responsibly, carries zero debt, and plans to fully re-open in 2021. Using a discounted cash flow analysis under this scenario, how much value has the Covid-19 pandemic taken from this car dealership? Doing the math, you find that a full one-year shutdown lowers their value by just over 6%.
Obviously, what is happening in the real world right now is not as clean and crisp as this. Real results will range over a vast spectrum. On one end of the spectrum you will have bankruptcies, and on the other the strong companies will grow and gain market share.
The point is that the stock market can be emotional and what we saw in March was that people would rather sell now and ask questions later. If the car dealership were a public company, their stock probably would have sold off more than 30% in March, just like many small-cap stocks.
This is why we think there are good opportunities in this bifurcated market. There are stocks that are now down 50%-70% from their highs, where the underlying value of the business is only down slightly. If you are confident a business will survive, then a one-year downturn is not as punitive to a company’s value as one would assume.