This article is excerpted from a letter by Mordechai Yavneh, managing member at Focus Capital Management, based in New York.
COVID-19 and the ensuing economic lockdowns have wreaked havoc on many businesses. There are various levels of impact. There are first-order effects on industries that are directly impacted, such as travel, energy, and retail. And there are second- and third-order effects as the ripples (or, better yet, tsunami) spreads out to these companies’ suppliers, business partners, employees, and the rest of the economy. In this update, we will provide our analysis of the effects on our portfolio companies.
Over the last few months, there has been lots of epidemiological and macroeconomic analysis written concerning COVID-19. We will not engage in this. We agree, of course, that COVID-19 is a macroeconomic phenomenon of the highest degree – there has probably never been a coordinated global lockdown to the degree seen now. But we are not investing in the economy, we are investing in specific companies in the economy. The difference is crucial. And while it is difficult to predict with any real accuracy the precise course of the disease and the precise extent and duration of the economic fallout, we can understand what the effects on specific companies are likely to be, and it is here where we focus our efforts. Counterintuitive as it may be, even for such a clear global macroeconomic phenomenon, the real value for an investor is in deeply analyzing specific companies in a bottom-up manner.
We believe that this environment is one where our trademark concentration and deep research can shine. Some investors appear to be like deer in headlights, frozen and panicked by the events. They do not know how to respond because they are spread too thin and do not understand the companies they are invested in well enough. They don’t know which companies will suffer tremendously, which will carry on as normal, and which will even benefit. Which will crash, which will survive, and which will thrive. So they react by throwing out the good with the bad, selling indiscriminately, thereby offering tremendous opportunity for the discerning long-term investor. Focusing on only very few companies and knowing them inside out enables us to put new information in context and understand the ramifications better than many other investors. And indeed, we have seen many such situations in the present market, where the market is indiscriminately selling the good with the bad, offering us tremendous opportunity to profit over the long term.
Before beginning to discuss the specific positions of the Fund, I would like to quote something I have written previously about our investment philosophy and the type of businesses we seek to invest in.
On the investment side, we seek to invest only in companies which are both Predictable and Resilient. … Resilient companies are companies that can survive and recover from an unexpected shock, be it a global macroeconomic slowdown, regional troubles, or an idiosyncratic company-specific issue. Not everything will always go as expected. Even though we as long-term investors are ready to ride out rough patches, this will not help us if the companies we invest in are not themselves equipped to ride out recessions, business cycles, or other issues. Hence the insistence on investing only in Resilient companies. In judging a company’s resilience, there are a number of factors to consider. Resilient companies need strong balance sheets, with little or no debt. What debt they have must be spread out over time so as to lower the risk of needing to refinance during a credit freeze. Resilient companies need to have relatively little reliance on a single big customer or supplier, they need to have low risk of highly disruptive regulatory changes, and they need to have a flexible and secure business model. Resilient companies are generally profitable; money-losing businesses are quite often only one misstep from disaster. Resilient companies need to be in control of their future, not at the mercy of circumstance.
These words are truer now than ever, and we believe this investing philosophy has served us well in selecting companies which can withstand the economic maelstrom we are currently experiencing. I do not claim to have predicted a pandemic in advance or even to have analyzed the effects of a hypothetical pandemic when originally selecting our portfolio investments. But by searching for and selecting highly resilient companies, we have selected companies that can survive, and indeed thrive, in all sorts of unexpected and harsh conditions, including our present situation. It is through the lens of resilience that we seek to analyze our portfolio now.
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