<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Over the last 10 days, billionaire hedge fund manager Ray Dalio (Trades, Portfolio) has spoken out twice on the spreading coronavirus, its impact on markets and the best course of action for investors. The first time was when he published a LinkedIn post titled, "My Thoughts About The Coronavirus," in which Dalio discussed the potential economic impact of the outbreak. From an investor’s perspective, the most noteworthy advice given by the guru was:” data-reactid=”12″>Over the last 10 days, billionaire hedge fund manager Ray Dalio (Trades, Portfolio) has spoken out twice on the spreading coronavirus, its impact on markets and the best course of action for investors. The first time was when he published a LinkedIn post titled, “My Thoughts About The Coronavirus,” in which Dalio discussed the potential economic impact of the outbreak. From an investor’s perspective, the most noteworthy advice given by the guru was:
“My guess is that the markets will probably not distinguish well between those which can and cannot withstand well the temporary shock and will focus more on their temporary hit to revenues than they should and underweight the credit impact–e.g., a company with plenty of cash and a big temporary economic hit will probably be exaggeratedly hit relative to one that is less economically hit but has a lot of short-term debt.”
As it often happens, investors have been quick to punish great companies with massive growth opportunities by looking at the short-term impact of the novel coronavirus. This is exactly what Dalio predicted.
On March 9, the guru reiterated his belief that this pandemic is creating very attractive opportunities for prudent investors.
Source: Twitter
As he pointed out, the majority of investors are focused on the risks to companies and global economic growth. This is true for the media as well. Only a very few are focusing on the other side of the trade, the opportunities.
In this analysis, Dalio’s principles will be used to identify a couple of companies that could make it big once the pandemic fears subside.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Two companies that fit Dalio’s description” data-reactid=”28″>Two companies that fit Dalio’s description
According to the guru, the main focus should be on identifying companies that are cash-rich and have little to no debt. It is also important to assess the long-term prospects of these companies to determine the possibility of future capital gains.
Based on this advice, Facebook Inc. (NASDAQ:FB) appears to be an obvious choice. The company, surprisingly, has no long-term debt on its balance sheet, which is not common among high-growth companies. Also, its outlook has not materially changed due to the outbreak. The company has grown its revenue by double-digit rates in each of the last 10 years and the future looks even better with the increasing popularity of concepts like the internet of things (IoT).
There are a few ways that Facebook will continue to grow in the future. First, the company is tapping into the billion-dollar online dating market in developed countries. Second, there are plans to monetize WhatsApp and Instagram better, which are two platforms with over 1 billion daily active users each. Third, Facebook is tapping into the online video streaming industry as well through its Watch platform, and the focus is on developing an advertisement-based rival to the likes of Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) Prime that only provide subscription-based services.
The table below shows consensus estimates for revenue and earnings growth through 2025.
|
Fiscal year |
Estimated earnings per share growth |
Estimated revenue growth |
|
2020 |
8.19% |
21.04% |
|
2021 |
18.34% |
19.05% |
|
2022 |
19.25% |
16.33% |
|
2023 |
13.23% |
15.34% |
|
2024 |
11.12% |
12.76% |
|
2025 |
17.86% |
12.76% |
Source: Reuters.
Despite this projected growth, Facebook shares are trading at a forward price-earnings ratio of 18.8 and a trailing multiple of 26. Even though they might look expensive in isolation, it’s important to note that shares have hardly traded at such a low ratio in the last five years. Considering that the company will likely grow at better rates in the future, however, this creates a disparity between the expected earnings and the stock performance.
Shares have declined 23% in the last month, which fails to reflect the true economic reality of the company. This anomaly has created a very attractive opportunity for investors. In a similar way shares picked up following the scare in the fourth quarter of 2018, a strong comeback can be expected once markets resume their normal operations when coronavirus fears dissipate. At the end of fourth-quarter 2019, Facebook had $54 billion in cash and short-term investments, which makes it entirely possible for the company to not only survive but continue with its expansion plans.
Skyworks Solutions Inc. (NASDAQ:SWKS) is another company with zero long-term debt and attractive prospects. As one of the leading semiconductor companies in the world, Skyworks is poised to benefit from the rollout of 5G technology toward the end of the year. According to Helpnet Security, the number of connected devices on a global scale will grow from 22 billion in 2019 to over 40 billion in 2025. This exponential growth will benefit chipmakers since there is a very high probability of increased demand for chips in the next five years as devices with advanced technological capabilities will hit the markets, supported by the 5G technology.
None of this could prevent the stock from falling approximately 29% over the last month, however, driven by fears that the slowing global economic growth will hit semiconductor companies hard. While this might prove correct in the short term, this is not an accurate representation of the long-term outlook for the company and the industry. The company had $1.1 billion in cash at the end of September, and with no debt repayment obligations, the company will likely continue its dividend distributions even if earnings get hit for a couple of quarters.
According to Goldman Sachs, the recession fears are overblown and the coronavirus will have a temporary impact on global growth. This is good news for Skyworks. Long-term-oriented investors should ideally focus on the opportunity to invest in great companies at a fair price.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Avoid companies with significant debt” data-reactid=”60″>Avoid companies with significant debt
There is uncertainty as to when the Covid-19 virus fears will weaken. According to the latest data from Bloomberg, the number of cases reported outside of China is growing at a rapid pace.
Source: Bloomberg.
The economic impact of the virus could turn out to be more severe than previously thought, which could exert pressure on many companies across the globe. Under these circumstances, investing in companies with high amounts of debt relative to equity might be a bad decision as these companies might find it difficult to honor their debt repayments in the short to medium term. It wouldn’t come as a surprise if a few businesses file for bankruptcy. For instance, the recent decline in oil prices could push poorly-managed energy companies out of business. Energy Aspects analyst Amrita Sen told Bloomberg:
“The U.S. is going to be the collateral damage here. The products here are going to be suffering so much. They (shale drillers in America) were already suffering and there’s no lending. There’s no money right now for them. This is really going to crush them.”
Even though investors might be tempted to bet on companies that are trading at very cheap valuation multiples, it’s important to avoid value traps. These are stocks trading at depressed ratios and look undervalued, but in reality, there are valid reasons behind the decline in the share price.
Even though a cash-rich business with a healthy balance sheet will easily survive this short time period in which generating revenue and earnings will be difficult, it will be drastically different for companies with weak balance sheets. Avoiding shares of such businesses will be the best course of action.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Takeaway: search for the qualities that Dalio is looking for when hunting for bargains in this market” data-reactid=”76″>Takeaway: search for the qualities that Dalio is looking for when hunting for bargains in this market
There’s no doubt that falling share prices provide an opportunity to hunt for bargains. Since the economic impact of the virus cannot be quantified at present, however, it’s important to select companies with certain qualities that enable them to survive this difficult time period. Dalio highlighted a couple of such critical characteristics. A low level of debt is key to remaining relevant and a healthy cash balance will be helpful as well. Following the guru’s advice will help investors find the best bargains in the market today.
Disclosure: I own shares of Facebook.
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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="This article first appeared on GuruFocus.
” data-reactid=”86″>This article first appeared on GuruFocus.
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