Bear market thoughts – COVID is going to change everything

Gavin Baker has a phenomenal chat on the Invest Like the Best podcast. I highly recommend listening to the entire podcast. Three things that stood out for me.

At the start of the bear market just do the obvious

Gavin’s insight is that – don’t fall into the trap that if the idea is so obvious, it must be priced in and you don’t have an edge. Don’t try to be too smart for your own good. Just execute on the idea as most people don’t execute on these ideas at the start of the bear market. People are just paralyzed. As the markets slipped, the wife and I both had the obvious insight that zoom (at that time $85/share) is going to benefit from this newly enforced WFH requirement. However, I fell into the exact trap that Gavin describes and didn’t really execute on the idea. Zoom had gone up a bit and I felt that this obvious idea is already priced in. Zoom is now trading at~$130/share. This one hit close to home 🙁 and this insight is added to my strategy for the next recession.

Risk management has changed for companies

The current financial metrics that have evolved over the years for public companies were all under the initial condition that the companies will always have some revenue. Leverage metrics, cash flow metrics all assume some standard input of revenue coming in every quarter and stress metrics assume a revenue drop of maybe 10% -30% per quarter. Our current situation is so extreme that the only real metric that matters is the number of days of solvency with zero revenue. It’s all about cash in the bank and the reality that zero cash is going to come in. With the economy shut down – there are no customers! Risk management collapses to one single risk – extinction risk. Cash is truly king. This risk management posture is very familiar to private venture-backed startups! It will be interesting to see if large cash balances on public company balance sheets will become a thing after we come out of this crisis.

Regime change in valuations

The companies that survive this crisis will emerge stronger largely because a large number of their competitors will be dead. Post GFC valuations have been defined by recurring revenue streams being at the top of valuation chain and folks paying large multiples for these valuations. A crisis like this can change all of that. With no revenue coming in for an extended period of time, recurring revenue becomes an oxymoron. There will be a small sliver of real recurring revenue – everything else was just plain old revenue that can get deffered or cancelled. Does the emperor have no clothes? A regime change in valuations is coming – what it will be is anybody’s guess, but this was the most interesting question to ponder on.

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