Over the past several years I’ve used a lot of ink writing in these pages about the “high-quality” companies. What I like most about quality businesses is their resilience in the face of shocks like the COVID-19 crisis we face now. Just as in prior downturns, some companies will limp out of this crisis, others will gallop.
In the Q1 selloff, the market did not distinguish much between high and low quality. Everything got sold. But here are some of the characteristics that I think are particularly valuable in the tough times we face:
- A Strong Balance Sheet. For companies, just like individuals, too much debt can be a killer. First, interest payments on debt represent a fixed cost: it stays high no matter how much sales crater. Secondly, companies with too much debt don’t have the opportunity to borrow more to get them through a rough patch like the one we’re in. Some companies spent billions of dollars- much of it borrowed- repurchasing their stock over the past few years. Today some of those same companies are desperate for cash to get them through the shutdowns. Other companies that have been prudent, now see an opportunity: Chemed (CHE) is one of our long-term holdings; it has a resilient business and conserved its capital wisely in recent years. Chemed announced a new buyback on March 13 to take advantage of their low stock price. Meanwhile, most companies were ceasing their buybacks, just as prices were down! Another example is Berkshire Hathaway (BRK.B), which has been sitting on $100 BILLION of cash, for want of good places to put it. We can be assured that Berkshire’s management team, including famed investor Warren Buffet, didn’t lose a minute of sleep worrying about debt payments. Instead, they are looking for bargains.
- A Wide Moat is what keeps competitors at bay. It is much easier for upstart competitors to gain traction in a strong economy with easy borrowing, than when the economy is in a downturn. Many of the stocks we hold are directly negatively affected by COVID-19 shutdowns: Disney’s (DIS) theme parks, Sysco’s (SYY) restaurant customers, TJX Company’s (TJX) apparel stores are closed. But these stalwarts have assets that can’t easily be replicated or replaced. They will see weaker competitors fall away and will emerge from the shutdowns in an even stronger competitive position than before. It won’t be easy, and the timing is not predictable, but shareholders will be rewarded for holding on.
Today there are many excellent, high-quality companies on sale. Unfortunately, we already owned some before the sale started! We maintain our confidence in these leaders, and we are finding new ones, too. Their resilience, and our patience, will pay off in the long run.