“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” - Warren Buffett
Remember the Financial Crisis in 2008-9? The financial world was going in the crapper, housing values were collapsing in the US, mortgage defaults were on the rise and bond markets were shakey because of sub-prime loans bundled together and sold to investors. Lending institutions were reluctant to lend to anybody, essentially paralyzing businesses that needed access to capital or individuals who wanted to buy necessities. It seemed pretty gloomy at the time. But companies were still paying their rent, people were still keeping their money in banks and the vast majority of Canadians were still making their mortgage payments. On a relative basis, all was pretty okay in Canada and at Canadian companies in certain sectors.
But the fear in the US had spread globally... to Europe, to Asia... and to Canada. This lead to a correction in Canadian stocks that we felt was overdone. A Commercial Real Estate company, $FCR that was trading at $16 were now trading at $10 after the drop. Canadian banks that were trading around $60 pre-drop, such as $BNS and $RY, were trading for $30 or below. Upon checking these companies' balance sheets during Quarterly Earnings announcements, we didn't see a markedly big drop in earnings and the companies had enough cash to handily pay out their quarterly dividends. Since the dividends remained the same but the stock prices were depressed, this meant the yields on these stocks had risen significantly. Both the dividends on the RE company and the banks were about 7-8%. Pre-financial crisis, these stocks were yielding about 3-4%. We saw this as a huge opportunity that complimented our dividend-investing style and decided to act. Since we had a good credit rating and had access to investment loans, we borrowed at 3% interest rate and bought big into the Commercial Real Estate company and the two Canadian Banks. Since the dividend yield to interest rate spread was 5%, this was the amount of income we were making on the leveraged investment. This also doesn't consider the capital appreciation we expected to see when people cam to their senses on the value of these companies. We weren't fussed about whether the stocks went up or down in the short term because over the long term, the cash-flow essentially paid for the investment. We used the 5% positive cash-flow spread to help pay down the loan over the next 5 years and we recently paid the investment loan off. Since making the purchase, the stocks have essentially doubled and we turned borrowed money into a fair-sized position within our portfolio.
Imagine going back in time and loading up on quality stocks while they were on sale! Well, thats exactly what we did. We didn't have the funds lying around, but we had access to the capital to make it happen and had the guts to pull the trigger when the stocks were undervalued. We set up this investment loan arrangement with our bank before we needed the money. This one financial move has probably had the biggest financial impact on our cash-flow and net worth. We've told this story to a number of people and they think we took an enormous risk in making this move. We, however, saw the health of the 3 companies, plus their commitment and stability of the dividend as the determining factors in our decision.
Out of chaos comes big opportunities, but you need to be ready when the opportunity presents itself. People often say they'd like to buy investments when they are on sale, but when things actually do go on sale, they aren't fiscally ready to execute or clam up and can't follow through fearing the investment will go even lower. The "clam up" part can be difficult to be ready for, but getting your fiscal house in order so you are ready to act on a deal is certainly within most peoples control. Since we have de-leveraged the borrowed funds from 2009, we are now ready for the next big opportunity that comes our way.
Here is how we are ready to act on the future Big Opportunities:
1. We keep our credit rating spotless. If people want access to credit, they need to show they are responsible in paying back lenders, so make sure we pay our debts on time, and decrease the debt balance over time. Having a lousy credit rating makes borrowing expensive and expensive borrowing can put the kaibosh on an opportunity.
2. Having some money on the side. I'm not necessarily suggesting people keep money in a bank account earning nothing for years and years waiting for an opportunity, but we set up a line of credit well before we needed it and then didnt use it. Ours sits idle with a large unused balance in case we need it or see an opportunity. If a small to medium opportunity came up tomorrow, we'd be able act on it.
3. We do our homework before the chaos starts. There are particular investments that I would like to make, but typically not at current prices. I like a deal as much as the next guy. I generally know that I want to buy certain investments at a particular yield or investment return. If I can't get the rate of return or yield that I want, I wait. If the conditions are never right to make the investment, at least I have done the work to know what price I think would be reasonable, and what would be a smokin' deal.
Some examples of opportunities that we would act on if they happened today:
1. If certain stocks drop based on fear and not based on financial metrics, then we would look to do exactly what we did in 2009.
2. Housing Real Estate crash in certain cities. We would like to live on the West Coast some day.... Possibly within the next 5-10 years. We will not be buying at current prices, but if we saw a 30%+ correction in housing costs, we would find a way to make it happen. We're ready if a crash occurs.
3. Commercial Real Estate in our current city. I like commercial real estate in prime locations. If a particular type of building came up in a prime location, we have the money for the downpayment.
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