In the current COVID-19 crisis, investors are understandably only looking at the short-term implications when it comes to stocks.
But money managers are urging their clients to consider the long-term prospects of companies. Most critically is their capability to bounce back regardless of their current struggles.
NAOS Asset Management wrote a letter to its shareholders this morning saying plenty of companies that are down now won’t stay that way forever.
Chief investment officer Sebastian Evans could not say when he thought a recovery would occur, but he urged investors to remain rational during these times when many investors were panicking.
“Our core focus is to ensure that all current investments have the means to remain liquid and solvent for the foreseeable future and make it through to the end of this pandemic,” he said.
“Businesses that can do this will find themselves in a much stronger position compared to those that are unable to do so and will reap the benefit of highly accommodating fiscal and monetary policies.”
All about the money
While conceding that most companies will face a hefty revenue plunge and feel the effects into next financial year, Evans believes investors should consider some specific metrics.
One of these is the demand for the company’s products and services. While on one hand retailers such as Woolworths (ASX:WOW) and JB Hi-Fi (ASX:JBH) had seen an uptake in sales, on the other travel stocks like Qantas (ASX:QAN) and Rex (ASX:REX) had witnessed demand evaporate overnight.
NAOS also urged investors to consider the company’s annual recurring revenue, a metric now commonplace in the software industry.
“Most of the software industry now operates in this way, and we have seen numerous examples of companies adjusting their business model to a subscription-style offering,” Evans said.
“Not only does this benefit the customer, but also the company as they now have a more predictable revenue stream and they can become more fully integrated with their clients, who are then even more reluctant to switch providers.”
Another metric to consider, according to NAOS, is the company’s fixed cost leverage — its ability to adjust costs as required. One example of a flexible cost that could be adjusted is staffing costs.
“All companies are likely to have a degree of costs which are fixed regardless of circumstances — rent, utilities, insurance, audit, utilities, etc — but those companies that can scale their cost base up and down with growth are going to stand a better chance of survival,” Evans said.
The final metric to consider is balance sheet flexibility — this means businesses can make necessary adjustments to see the crisis through.
“Never has it been so important to judge a business on the cold hard facts of their balance sheet,” Evans said.
“In our view it will become binary. Many companies will not survive this period, whilst companies that do survive will be those with enough existing liquidity and reserves to simply outlast the unknown duration of these unique circumstances and capitalise upon the opportunities on the other side.”
And while ‘cash is king’, assets are also critical in case businesses need to turn to the banks for a cash top-up.