Why Bear Markets Don't Matter When You Own A Great Business

No Recessions for Coca-Cola (KO) Investors

Every investor or trader in the stock market has two objectives - to make money, and to avoid the catastrophic loss.

Following the stock market crash of 1929, Benjamin Graham, father of value investing, spent the rest of his investing career attempting to minimize risk.

Or as Graham wrote in The Intelligent Investor:

"The essence of investment management is the management of risk, not the management of returns."

And in The Snowball: Warren Buffett and the Business of Life, Bloomberg's Alice Schroeder notes that the first item Buffett considers himself when evaluating a potential investment is what are the possible catastrophic risks involved?

Avoiding Stock Market Catastrophes

In the related article How to Avoid Catastrophic Option Trading Losses, I argued that there were three general categories of catastrophic risk - truly catastrophic macro events, investments in structurally vulnerable businesses, and self-inflicted and structurally disadvantaged trades.

In this article, I'd like to look at this issue from an investing, rather than a trading, perspective and make the case that the best way to avoid catastrophic investing losses is through the ownership of the highest quality businesses you can identify.

As I explained elsewhere, the focus on quality is one of the most powerful and overlooked ways an investor can give himself or herself a margin of safety.

How to Invest in a Bear Market

In my opinion, the best way to invest in a bear market is the same way you should invest in a bull market - by buying the best businesses you can find.

Does that sound naive? A recipe for watching your personal portfolio implode as the rest of the market crashes down around you?

Keep in mind what true investing actually is - it's ownership, plain and simple.

And if you own a terrific, world-class business, why would you ever consider selling it, especially in times of economic turmoil and uncertainty?

When I own a great business, I have more economic security, not less.

Remember as well what the share price really represents - the current liquidation price for your high quality business. That's right, the share price is what Mr. Market will pay you to willingly go out of business.

How Most Market Participants View Bear Markets

I believe that most market participants are just that - market participants, not true investors.

So let's look at the world as seen through the eyes of market participant.

Here's a 3 year chart of Coca-Cola (KO) covering the 2007-2009 period.

As you can see, the stock's share price (liquidation price) peaked between December 2007 and January 2008 before falling for more than a year and bottoming out with the rest of the U.S. markets in March 2009.

How terrible. Imagine all the sleepless nights. Imagine all the stress and worry and hand-wringing. Imagine all the fears of retirements spent delivering pizzas.

High quality company, my ass, market participants say, pointing out that the stock fell for more than a year. What kind of protection and margin of safety is that?

The shares didn't fully recover and hit their pre-bear market levels for a full two years!

How Investors and Owners of High Quality Businesses View Bear Markets

When you have a true investing mindset so that you rightly view yourself as part-owner of world class businesses, you really don't even pay attention to bear markets.

That's because if your business is truly high quality, it's probably not going to be for sale in the first place, and especially not at the depressed prices available in a bear market.

So how can investors remain so calm and nonchalant in the face of spiraling market valuations?

They do so because their focus isn't on the daily fluctuation of what others think their business is worth - their focus is on the underlying operations of the business itself.

Yes, most companies earn more during economic expansions than economic contractions, but great businesses make lots of money in any environment.

So let's go back to the KO example.

This time let's not look at its stock chart (i.e. the historical record of previous liquidation prices).

Let's look at KO's dividend history over the last 40+ years or so and view the world as seen through the eyes of true investors:

The dividend amounts in the table above have been adjusted to account for various KO stock splits over the decades. They represent the historically equivalent dividend per share relative to the 2022 dividend level.

The main point here is to illustrate how, from the record of KO's annual dividend increases, for investors in KO, there are no recessions and bear markets - there is only more income than the year before.

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