Warren Buffett just turned 90 last month. He is the most decorated value investor, with more than 75 years in the investing world. Over the last few months, the stock market has been rallying even though the gross domestic product (GDP) contracted. If we go by the Buffet indicator, which is calculated by dividing market capitalization with GDP, the equities are overvalued by 80%.
Does this mean another stock market crash is inevitable? Not necessarily, because the stock market is rising on the back of technology stocks that have high profits, and they earn a major portion of their revenue overseas. The pandemic has created a great opportunity for tech stocks. But I would not rule out the possibility of another market crash.
Warren Buffett’s rule no. 1: Never lose money
Now, it is difficult to time a market crash as it happens when it is least expected. In the last few months, Warren Buffett made some interesting investments that abide by his two rules, “’Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1.”
You can do two things that Buffett is doing to never lose money even in a market crash.
- Withdraw from stocks that are severely hit by the pandemic and are heading toward losses.
- Invest some of that money in defense stocks that are resilient to an economic downturn.
Withdraw from pandemic-hit stocks
In the last few months, Buffett’s Berkshire Hathaway made some surprising moves. Among them were exiting its position in airline stocks and Goldman Sachs, and lowering stakes in big banks such as Wells Fargo and JPMorgan. This doesn’t mean banks are a bad investment, because Berkshire Hathaway still has some of its top holdings in bank stocks. It even increased its stake in Bank of America by $340 million.
The above sales show that Buffett is exiting stocks where he sees multiple years of losses. The Big Six Canadian Banks have reported $9.07 billion in provision for losses. They are exposed to huge credit defaults when the government aid and loan deferral programs end. Hence, many bank stocks failed to recover from the March sell-off.
However, like Bank of America, Royal Bank of Canada is in a better position than other banks. Its stock has even recovered to the pre-pandemic level after falling 40% in March.
As for airlines, Air Canada has already reported $2.8 billion in a net loss in the first half, vanishing almost 80% of its last three years’ combined profit of $3.55 billion. The airline would take at least seven years to return to profit and show meaningful growth in stock price.
Invest in defense stocks
After exiting its position in the stocks where he saw multi-year losses, Buffett purchased defense stocks where it saw some value. The pandemic has lowered the stock price of companies that have strong fundamentals and good growth potential.
- He purchased Dominion Energy’s natural gas transmission business for $10 billion.
- He bought a $600 million stake in Canada’s gold mining giant Barrick Gold.
- Just recently, Buffett’s company bought more than $6 billion worth of stakes in six Japanese trading houses.
The energy and gold stocks are a good investment as they have limited competition and strong cash flows. You can get exposure to energy by investing in Enbridge (TSX: ENB)(NYSE: ENB), North America’s largest pipeline operator. It earns money from long-term contracts for transmitting oil and natural gas. Its large pipeline infrastructure gives it pricing power. The pandemic has reduced oil demand, which has lowered its revenue from the transmission.
Enbridge stock is still down 22% from its normal trading price, which has increased its dividend yield to 7.69%. The company has sufficient cash flows to continue paying dividends. When the economy recovers and oil demand increases, the stock will return to its normal trading price of $52, representing more than 20% upside.
You will benefit from high dividends during the downturn and capital appreciation during the upturn.
Interpreting Buffett’s actions
Rather than blocking your money in loss-making stocks, buy defense stocks to make the most of the downturn. You can return to bank stocks when they start rallying again.
