STREET DOGS

Adapted from an article at The Reformed Broker:

What should you buy during a crisis? According to Dan Rasmussen of Verdad Capital there is very consistent information regarding what investments have worked best on the way out of a recession.

We spent about a year and a half doing this research, says Rasmussen, and one of the things we found is that returns are more predictable in times of crisis than they are outside times of crisis. In fact, simple quantitative models tend to have eight times the level of statistical power during recessions than during times of economic growth.

In times of easy money, a lot of stupid things work. A lot of unprofitable companies see massive increase in stock price. A lot of bad ideas get funded, some of those bad ideas turn out to be good ideas. And so a lot of simple valuation models, or simple quant models, don’t really work all that well in times of great growth or easy money. However, when a recession comes, all external funding gets cut off.

So the people that survive are the people that have profitable businesses that generate cashflow. Profitable companies that are bought in times of recession do much better than unprofitable companies. Companies that generate free cash flow do much better coming out of a recession than companies that don’t. And, what’s most interesting is that buying cheap and illiquid companies does massively better. So if you go into the market and say, ‘I’m going to take advantage of this recession by buying small companies, where the stock price has just gotten puked out ... because people are panicking, but it’s profitable and cash flowgenerative,’ if you go and buy that stuff, your returns coming out of the recession are extremely attractive.