Of the stocks you hold, do you know what each division in that company does? Do you know what their tangible assets are worth in comparison to their trading price? What about the company's value to a competitor prowling for an acquisition?
Does the company pay a dividend? If so, how much will its profits have to drop before it has to cut the dividend? How much cash does the company have on its balance sheet? How is the CEO compensated? Is the management's compensation aligned with your goals as an investor? What about the sales force? What will the company's cash flow generation be in 2007 or 2008? What are the changes taking place at the company and at rival companies? What are the greatest risks to the company-now and over the next five years? What will the company likely look like in five years? Why did you invest in the company in the first place? Did you record your reasons for investing? Have your reasons for owning the company changed?
Most investors lack answers to these questions. Those who invest in mutual funds or alternatives don't get off any easier: The same questions apply to whatever the funds hold.
To safeguard your clients' capital during these times and to give them a sense of long-term calm, consider the following:
Know what you own. Clients should invest with a definable margin of safety. You must be able to accurately value a company, its assets and liabilities, and understand the probable future cash flows. If you don't have the resources for this kind of exhaustive analysis-and many financial advisors don't-work with money managers who do.
Don't let the turmoil trick your clients into selling solid securities. The credit crisis may affect companies that borrow heavily; look for companies that don't require new financing to continue their operations and grow. Record your reasons for making each investment.
Don't fear volatility. When everyday investors panic and markets fall uniformly, it is a tremendous opportunity to buy quality companies at a discounted price. In these times, the price performance of a stock is often unrelated to the company's intrinsic value. Put your trust in managers who analyze companies deeply and regularly meet with company management. Volatility can be a friend if you buy when others are fearful-and sell when they are greedy.
Own quality companies that have a margin of safety with some growth potential. Companies must be able to self-fund growth, have an identifiable and well-regarded "brand," offer visibility into future cash flow and be able to grow.
While many stocks appear expensive, some are not, in particular those benefiting from the export markets. Keep some cash on hand for bargains.
Once the carnage is over and we finally ascertain where the leverage is buried and how deep, punishment will be harsh for those who drank the Kool-Aid. Yet, having learned an important lesson, the cleansed markets will offer a solid investment environment for well-run companies with solid balance sheets that create value for shareholders. Lest we forget, Wall Street will continue to invent esoteric products to separate investors from their money. In other words, wash, rinse and repeat.
Steven Holt Abernathy is principal and portfolio manager of The Abernathy Group in New York, N.Y. The firm specializes in asset protection and wealth management. Contact him at [email protected] or at http://www.abernathyfinancial.com.