Written by Andy Tanner
Original post date: May 25, 2020
Our market has melted down. We have an unprecedented challenge ahead during this market crash.
I’m going to throw you a life preserver. You’re going to see what you think now is a sea of risk and we’re going to calm those seas.
No one on this planet knows what direction this market’s going to go tomorrow, where the bottom will be or how long this is going to last. This uncertainty will fuel fear and volatility.
We’re only a few weeks in and we’re already approaching a record. This is the biggest fear spike that I have seen in my entire investing career.
Don’t freak out.
We’re going to talk about the two opportunities. The first is Warren Buffet-type stuff where I try to model him. Investors like him buy businesses; they don’t buy stocks.
It begins with a long-term faith that people someday are going to start drinking Coca Cola again, put Heinz ketchup on their hot dogs again and get on a plane. We’re just in for a rough one for a few months or a year.
As I describe in Stock Market Cash Flow: Four Pillars of Investing for Thriving in Today’s Markets , the cost at which we purchase shares is a big deal and some of these are on sale. Delta is pretty darn low right now, but the problem you have is you don’t know if this is the bottom or just the beginning. Coca-Cola also is down.
The next thing we care about businesses that have the potential to grow and earn money as we want to be investors in their businesses, via stocks. I’m also going to share some home-run opportunities based on share price. Cost basis and share price are not the same.
Let’s say when Warren Buffet bought Coca-Cola stock, he bought it at $3.25 when the price was low on a cost basis. They crank out a dividend of $1.60 right now.
Now, understand that at that point, Buffet is buying a business, not a stock. He doesn’t care what the stock price is today. If it was $100, he’s not going to sell it.
Because he paid $3.25, gets $1.60 dividend over and over. He’s getting 50% on his original investment, year in, year out. See, he is not buying a trade. He’s buying a business for cash flow.
If you’re an investor, do not sell right now. Everyone else is panicking. The reason that Delta Airlines is in freefall right now is because people are selling. It would be no different than Warren Buffet saying, I’m going to run for the hills.
No, he is in this thing for a long haul.
Do you insure your home? Yes, you do. Do you know whether your house is going to burn down today or tomorrow? No one does.
If you have the choice to sell your house at a certain price, no matter if it burns down or not, you sleep at night. You would be calm, right?
Guess what? Buffett’s an investor and he looks at Coca Cola and sees it’s $39 a share. He then finds options to buy from someone who is willing to sell it at a lower price, like $35 (as that investor wants to get out at that price). If that person is willing to sell it to him for $4 cheaper, he (and I would) take that any day.This is a match made in heaven.
The market will dictate what the “insurance” or option is. For example, I would then say “I promise to buy your stock when it drops to $35. Insurance will be $1.50 per stock”. By doing this method, I can purchase that stock (if and when it drops) while bring in immediate cash. The stock doesn’t need to move. If I put these options out for 5000 shares, I would get $1.50 per share (5000) which would be $7,500 in immediate cash (which I could use to buy stocks or other options). I would get this each month that the stock doesn’t cross the $35 mark from that one option.
On top of that, add that a $1.50 dividend by $35 is 4% over a month or two months. If you multiply that by six times you go to two a month, that’s 25% on his money that is sitting in the bank.
Would you rather get 25% on your money in the bank by promising to buy stuff you wanted to buy anyway?
Buffet-Style Investing does not know where the market is going to go next month. However by thinking of this as investing in a business, with the 4 Pillars of Investing to back it up, you can keep these options working for you, all day long.
We sell options to generate income and reduce cost basis, but we buy options to protect assets such as insurance.
Options give us peace of mind.
The way you decide what to buy is by understanding this and the 4 Pillars of Investing.