Almost exactly one year ago with the world teetering into the COVID-19 crisis, I wrote a blog discussing some thoughts on investing through a crisis and in the blog, I outlined four criteria that investors would be well-served to follow:
- Focus on the long-term and don’t time the market.
- Focus on what you understand.
- Focus on companies that can withstand a high degree of stress.
- Focus on industries where demand will return.
Although the market conditions today could not be more different from then, I would give the same advice to investors today: own high-quality companies that you understand and try not to get distracted by the noise.
With the COVID vaccine rollout in full swing and many places starting to reopen, it is a natural reaction to wonder if investors should sell COVID winners and buy “reopening stocks”. I continue to have no special insights into when the pandemic will be over, whether the current Fed policies will lead to inflation, nor how consumers will behave after the pandemic, However, it does seem logical to expect that the high savings rate from the strong stock markets and stimulus combined with pent up demand for travel and experiences will lead to strong demand for things like plane tickets, hotels, concerts, restaurants, and theme parks.
Yet, one of the biggest mistakes that investors make is to forget that the market is forward looking. Stock prices represent the aggregate view of all market participants, and prices typically react well in advance of actual changes in the data. In 2020, investors wondered how it was possible that the stock markets could recover so quickly even when the COVID case counts remained high and economic situation remained precarious. It is the same mistake to think today that just because the pandemic is nearly over, you should sell COVID winners to buy cyclical stocks.
The way we deal with this uncertainty at Baskin Wealth Management is to ignore it and focus on the long-term. Our core strategy has been to invest in outstanding companies with strong competitive advantages and we believe that these companies will continue to invest in their growth opportunities regardless of what happens to the 10-year bond rate and the timing of the COVID vaccine. At Baskin Wealth Management, we were fortunate to have owned “COVID winners” that benefited from lockdowns such as Activision Blizzard, Domino’s Pizza, Costco, Amazon, Netflix, and Charter Communications. Our investment thesis for these companies has never been that the share price would go up in any given year, but rather that they are well-managed companies that will benefit from secular growth opportunities over the next 5 or 10 years.
It is quite possible that some of these COVID winners will experience a decline in demand (and, as we’re seeing, declining share prices) as society reopens, but that is still a far better position to be in than, let’s say, Norwegian Cruises or AMC Theaters, companies that barely stayed afloat during the pandemic, had to incur large amounts of debt and it is questionable when, if ever, demand will return to pre-COVID levels. By contrast, the COVID winners experienced strong demand, added customers, and generated strong cash flow through the pandemic and, as a result, are well-positioned to invest and further grow their lead over legacy competitors. We believe these advantages will become more apparent over the next few years.
As a case study, one company we own that benefited from COVID was Domino’s Pizza. Domino’s Pizza is the world’s largest pizza delivery chain and we invested in Domino’s stock because of their strong franchisee economics, long runway to open new stores, and a focus on technology investments. In sharp contrast to most of the fast food and restaurant industry, Domino’s benefited from COVID as people stayed at home and ordered pizza for take-out. Same-store sales were up 11% in 2020.
Although Domino’s will very likely experience a decline in demand as society reopens, Domino’s has added many new customers to its loyalty program and mobile app, who consequently will be more likely to order pizza from Domino’s going forward. Domino’s franchisees are flush with cash from the pandemic and will be looking to open new stores, lowering delivery times and improving brand awareness. It’s hard not to be optimistic about Domino’s if we compare its performance to Pizza Hut, which experienced a 7% decline in same-store sales in 2020 and, as a result, closed 6% of its store base. We are thrilled for the opportunity to buy more shares of a high-quality company at current prices.