What The Heck Are You Thinking?

On today’s show we’re looking at how investors are investing today.

There’s no question that we are living in uncertain times. The stock market is pushing valuations that can’t be supported by the current level of profitability in the economy. So what’s driving it?

I feel like we need to go back to basics and talk about how investments are made, or at least how they should be made in my view.

Money comes to you through one of three mechanisms

1. Earned Income
2. Residual income
3. Capital Gains

If we’re talking about investing, then it comes through one of #2 or #3 either residual income or capital gains. Residual income, by definition means that a business is generating cash positive cash flow. Capital gains happens either because you bought something at a deep discount to its true value, or the value increased from the time you bought it.

In order to make a good investment, you need to be able to assess which of those is at play. Is there positive cash flow, payable to investors, and if so, how much? If there is a capital gains play, or a value play, are you buying the business at a discount or are they on a trajectory to create enough value from today’s purchase price that you are making a good buy?

If you can’t give an affirmative quantifiable answer to one of those questions, I’m starting to lose track of what you’re doing. That drifts out of the realm of investing into the sphere of speculating.

How on earth are you going to evaluate the value of a company that can’t provide any forward guidance on revenue or earnings? Many publicly traded companies in their most recent investor communications have declined to offer forward guidance. Don’t get me wrong, the executives are doing the right thing. They really have zero ability to provide meaningful guidance. If they gave a number, they’d be making it up out of thin air.

So why have people been piling back into the stock market in recent weeks? It makes no sense to me.

Quite simply, the investments are being made based on a belief that the Federal Reserve, and the Treasury will print as much money as it takes to save key sectors of the economy. If you believe that the airlines will be saved by the government, then Delta Airlines and British Airways must be a good investment, right? Or if you believe that the cruise lines will be saved, then Carnival Cruise line must be a good investment right?

The only thing that makes the investment a little better than another is the notion that the Fed is going to save the company, no matter what it takes. But folks, that’s not the same thing as investing in a company based on fundamentals. In a few short weeks, the stock market has gone from one where investors invested in companies, to one where investors are front running the Fed expecting that if the Fed is going to pump money into it, it’s a good investment at any price.

The Fed doesn’t have the power to grant money. They only have the power to lend money. The money actually will be coming from the government and the terms of those cash infusions haven’t been fully disclosed.

What I’m seeing in the market right now is that people are making investment decisions based on who is getting a government handout. The government handout that is being helicopter dropped from the sky, falling upon some and leaving others behind.

Don’t get me wrong, survival is a good thing. If you’ve decided that you want to hold onto a liquid investment, like shares of your favourite public company, then you definitely want to understand the story. But that’s not the same thing as making a new investment, expecting that you will get residual income, or perhaps you’re secure in the knowledge that you are buying a bargain at today’s price.

I’m parking funds on the sidelines in physical metal, or in real assets where I feel confident in the earnings from those businesses.