I don’t know if you’ve noticed, but the markets have been a little volatile in 2021. Or have they been volatile for the last 12 months? Maybe even longer than that? It’s getting difficult to say, when this seems to be the new norm.
Take Tuesday 23 February. Here’s what Morningstar wrote about it at 7.27am during pre-market trading time:
“Stock-index futures were mostly lower Tuesday, with tech shares continuing to lead the way down, as investors monitored a sharp rise in bond yields and prepared for testimony by Federal Reserve Chairman Jerome Powell on the economic outlook.
“What are major benchmarks doing?
“Big losses for tech shares left the Nasdaq sharply lower Monday, falling more than 2%, while also weighing on the S&P 500. The S&P 500 suffered its fifth straight loss, the index’s longest losing streak since a seven-day skid that ended last Feb 28. The Dow, meanwhile, benefited from a rotation to more cyclically oriented stocks, eking out a gain of 27.37 points, or 0.1%.
“What’s driving the market?”
Some cynical people might answer that question with, “Nothing but sentiment.” After all, a little after 9:00, the Nasdaq was “only” down 1.67%. And by the closing bell, it had suffered a mere 0.50% fall from grace (-67.85 points).
The S&P 500, meanwhile, gained no more than 4.87, or 0.13%. And the Dow came in even closer to the line with a 15.66 “jump,” or 0.05%. Volatility, thy name is 2021.
Expect short-term volatility, not long-term problems
As Dividend Kings’ Dividend Sensei likes to point out, volatility is part of investing. There’s no way to avoid it. Sleep-well-at-night stocks, he so often says, are “100% about quality, dependability, and dividend safety”. But the designation “has zero to do with how volatile a company can be in the short term”.
Because, in the short term, stocks go up and stocks go down, victims to so many factors, many of which aren’t their fault whatsoever. That’s why he also continuously reminds readers that, “Volatility can’t hurt those with a diversified and prudently risk-managed portfolio.” And I couldn’t agree more.
Does the company have a track record of sustainability or a good shot at achieving it? And is its stock price poised for growth?
But booms and busts? The latter can to a large degree be avoided, whereas the former can be for the most part enjoyed. It’s all about picking and choosing the right stocks at the right times.
This isn’t to say I’m advocating market timing. As, hopefully, my larger market commentary up above shows, that’s a fool’s efforts. At best, it will give you a headache. At worst? Well, that’s just not a pleasant thought to contemplate.
Instead, it’s important to focus on quality and valuation. In other words, does the company have a track record of sustainability or a good shot at achieving it? And is its stock price poised for growth?
A stock that can say yes to both isn’t likely to fall prey to legitimate busts. Again, volatility, yes. But not long-lasting disfavour or failure. Those should be in short supply.
The intelligent REIT investor
One more word about volatility, this time from Warren Buffett. He’s been known to say, “In the short run, the market is a voting machine. But in the long run, it is a weighing machine.”
Of course, some stocks are going to find themselves on the short side of the scales. That’s why I write in my (almost-published) book The Intelligent REIT Investor:
“… if a stock is to rise in price over time, the company’s fundamental value must increase on a per-share basis. There are a number of ways to measure increases in company value. But measuring and valuing streams of income and cash flows is perhaps the most commonly used metric in the world of equities.”
In other words, you want to know how much a prospective investment is taking in over the long term and/or how much potential it has to take in going forward.
If the price is wrong, stacking up higher than it historically has, then it’s almost always a no-go
We’re talking about funds from operations (FFO) and adjusted funds from operations (AFFO) – key measures of profitability for real estate investment trusts (REITs). If those numbers indicate management is making the most of their situations and that their situations are sustainable and then some… we next look at price.
If the price is right, then there’s no fundamental reason not to invest. Perhaps there are personal ones, mind you, but that’s ultimately up to you to decide. If the price is wrong, stacking up higher than it historically has, then it’s almost always a no-go. No matter how much we like the company, if the price tag isn’t worth it, then the price tag isn’t worth it.
Sticking with those kinds of principles isn’t quite a crystal ball. But it is about the best way possible to ride the booms and avoid the busts.
Ride the booms and avoid the busts
The REIT recovery is well under way right now – mall REITs have returned 28% year-to-date, shopping-centre REITs have returned 19% year-to-date, and lodging REITs are up 16% year-to-date. These three sectors struggled the worst in 2020, yet the vaccine has served as a catalyst for these three property sectors that are tied so closely to leisure and travel.
The Transportation Security Administration is looking to hire 6,000 new security officers as it prepares for an extended surge in summer travel. According to CBS, “the jobs will be for positions at 430 airports across the country, including Newark International Airport and John F. Kennedy International Airport”.
While travelling commences, the US economy should continue to accelerate and is set for “stellar” economic growth in 2021. Bank of America said in a note that it had increased its 2021 US GDP growth estimate to 6.5% from 6.0% as it has become “more convinced” that the economy is set for a rebound after the covid-19 pandemic.
Yet US REITs remain cheap compared with equities and are fundamentally well positioned for rising interest rates. When you compare REITs in 2010 to REITs today, they now have less debt with longer-term (debt) maturity dates. Thus, they can raise rents while maintaining record-low level cost of capital.
At Wide Moat Research we spend considerable time analysing balance sheets and modelling cash flows. Since REITs must pay out at least 90% of their net income in the form of dividends, we also spend a lot of time on the safety of the dividend itself.
In short, it’s a great time to be investing in REITs – but pay close attention to fundamentals, so that you can “ride the booms and avoid the busts”.
