Would you buy the whole company for $1? $100? $1MM? $1B? Why price matters.

For lack of a better word, 2020 has been very interesting for financial markets. Volatility hit all-time highs, some fortunes were wiped out, and hundreds of opportunities to make new fortunes arose.

I’ve had a lot of conversations with my friends discussing where we should invest our savings. With investing being more an art than a science, there is never a right answer. People have different interests, varying risk tolerances and different amounts of time they’re willing to devote to market research. A 10-page in-depth review of a special case small cap may be appropriate for one person, while blindly investing in the S&P 500 may be the best approach for others. My personal opinion is that the best way to invest is such that you can sleep well at night without worrying about your portfolio. Unless you’re a trader, this also means being able to go days or weeks without the need to check your portfolio.

Some of the key factors to investing is understanding one’s own values, expectations, risk tolerance and time horizon. Even though everything is going to go up in 30 years, we might need access to that capital sooner and can only stomach large drawdowns for so long.

After studying different investment approaches from various books and podcasts, I personally like to diversify across investing methodologies in addition to different companies, industries, countries, etc… I categorize my investments like so:

• Undervalued Companies: A company that can be bought at a good price using fundamental analysis, and should probably be sold when the price reverts back to the mean.
• Great Businesses: A company with a healthy balance sheet, executes efficiently or continues to either meet or exceed expectations. Though it may not necessarily look cheap, it’s difficult to say if a better buying opportunity may ever arise in the future.
• Dividend Aristocrats: A well-established business with a long track record of paying a good dependable dividend. When bought at the right price, it could be a good alternative to cash but don’t expect a large principal appreciation.
• Momentum: A company or asset that is likely to experience large price movements in the near future using technical analysis. This is often triggered by some sort of catalyst and magnified by narrative and human behaviour.
• Speculation: A high-risk high-reward investment that could either go all the way down to $0 or provide returns of the same magnitude as venture. These investments are mainly driven by narrative as opposed to any sort of quantitative analysis.

It’s important to note that there are no hard delineations, and most investments usually span more than one of these buckets. As someone who is interested in both fundamental and technical analysis, I often find myself in discussions that conflate narrative and valuation. As Grant Williams (@ttmygh) discussed with Ben Hunt (@EpsilonTheory) on his podcast, one does not replace the other.

A company I like to bring up when asked for investment ideas is Chevron Corporation ($CVX); credit to @krupenin who spent a long time explaining it to me years ago. Without diving into all the details, it is a large, well-established, financially stable company in a cyclical industry that pays out a stable dividend, has little debt and has sufficient short-term assets to tread through troubling times.

The usual responses I get to this suggestion are:

I don’t want to invest in a company that is killing the environment.

This is a fair point and a completely valid reason not to invest, but it is grounded by personal values rather than valuation or narrative.

But aren’t electric vehicles and renewable energy going to replace the need for fossil fuels?

This is a fair point and also a valid reason not to invest, but is primarily driven by narrative since it is hard to quantitatively predict precisely when the whole world will move off of fossil fuels.

$CVX is by no means perfect. Its top line may be highly impacted by OPEC regulations, could be hit hard by various write-offs and is heavily impacted by the pandemic. However, it does have a solid balance sheet, so if you had the offer of buying out the whole company, all of its assets, and all of its employees for $1, would you?

The conversation usually proceeds like so:

Me: “Imagine you could buy Chevron and all of its assets for $1, would you?”
Friend: “Ummm, probably yes.”
Me: “Alright, how about $10?”
Friend: “Yup.”
Me: “How about $1000?”
Friend: “Yes.”
Me: “How about $1MM?”
Friend: “Yes.”
Me: “Okay, would you buy it for $1B?”
Friend: “Hmmm… I think so”
Me: “$1T?”
Friend: “No”

Putting narrative and values aside, the mantra of “everyone has a price” could translate well into “[Almost] every company has a price you’d be willing to buy it for”.

In my short investing career I’ve found that Chevron “goes on sale” every few years where you could buy it in the $60s. At this price, you’d be locking in a more than 7% dividend yield from a Dividend Aristocrat in a 0 interest rate world for a company that is Undervalued by my calculations.¹ When the price is this depressed, the downside is low and the margin of safety is high. In addition, it provides exposure to the energy sector which @jessefelder argues has a lot of upside and could become a Momentum play at the right time. Another investment I bucket in the same category is AT&T ($T).

A company on the other end of the spectrum from $CVX is Tesla, Inc. ($TSLA). There is no debate that is one of the sexiest, most innovative and world-changing companies, but I tend to follow Charlie Munger’s advice on this one:

I would never buy Tesla, and I would never sell it short.

The fact that Elon Musk and his team are going to keep innovating and changing the world is a fair expectation, but at what price? Even if the company was losing money every single quarter and deep in debt, wouldn’t you still be willing to buy the company, its IP, assets and strong team for $1? $100? $1B? How about $10T?

$TSLA is a Great Business from an execution point of view and has a great narrative: it has an exuberant leader with a team that executes quickly to develop slick products and world-changing technologies. The stock has a lot of positive Momentum but is also Speculative since a lot of the future growth and expectations are already priced in.

Determining whether or not $TSLA is a good investment isn’t based on what the company will achieve, but a combination of the price you are paying in conjunction with the level of risk you’ll willing to accept. It is already worth more than 9 of the world’s largest automakers combined, but who says it can’t be worth 5x what it is today? At the time of writing, the company’s market cap is ~$650B. If the company had a $10T market cap today, I’d argue that it is a bad investment with little upside. However, if it was only $1B, I’d call it the opportunity of a lifetime.

The short and long-term narratives for $CVX and $TSLA are covered a lot throughout news and media. I’d be ecstatic to buy both of them at a market cap of $1B but wouldn’t consider either one at a market cap of $10T. The differentiator between a good and bad investment is not just the narrative of where the company is headed, but also the price you pay for it.

Personal plug I just published my first iteration of the Market Navigator chrome extension. The first version isn’t interactive and only displays a couple of metrics. I plan on productionizing a lot of the tools I’ve built for myself over the past several years and bundle them in this extension. In particular, I’m really excited to share some momentum investing tools in the near future.

¹ I chose to omit the fundamental analysis details of why I believe $CVX is “on sale” when it trades in the $60s so as not to detract from the main point of the article.

Thank you@abhinavvadrevu and @jeffreyxu_ for proofreading and providing valuable feedback on the draft version of this article.