Today I mitigated some risk in my corona crash investments.
Near the bottom of the crash, I invested in AZO, SBUX, AAPL, WFC, XOM, and BA. I sold AZO, SBUX, and AAPL with a 30, 33, and 25 percent gain, respectively.
What did I do with these gains? I reinvested them in WFC, XOM, and BA. The reinvestment helped lower my cost basis since these stocks are losers in my portfolio. I reinvested in them because I was optimistic that they would come back to their former glory.
But I have been reading recently, and I see troubling fundamental problems involving trends and financial strength ratios. For the upcoming discussion, the following definitions from the TD Ameritrade website are useful:[1]
The Quick Ratio:
“Current assets minus inventories divided by current liabilities. The Quick Ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. The higher the Quick Ratio, the better the company’s short-term financial strength.”
Total Debt / Total Capital:
“This is the debt divided by shareholder’s equity plus debt in a company’s most recent quarter. A higher ratio may mean that the cost of debt could weaken a company and increase its default risk.”
Interest coverage ratio:
“Ratio of earnings before interest and taxes for the trailing twelve months divided by the trailing twelve-month interest expense. A ratio below 1 means the company is not generating sufficient revenue to meet its interest obligations. Used to determine how easily a company can meet interest payments required on its debt. NOTE: This item is not meaningful for banks and insurance companies.”
These ratios are found by typing in the stock symbol in the search box, then clicking on the valuation tab, and then the financial strength link. How convenient!
BA–Boeing:
Boeing started with the 737-8 Max problem before the pandemic resulting in a grounded airplane. The grounded plane was a big financial hit and drove the stock price down. Then along came the COVID pandemic, which punished commercial aviation, causing a 90 percent decline.
A boost in commercial aviation is likely to happen when a vaccine comes out. When the 737-8 Max is allowed to fly, it will help Boeing as well. These events are likely to occur within a year or two. However, the work from home and stay local movement will linger and have a lasting impact, and I believe this means an even slower recovery for commercial aviation demand.
How long can Boeing survive with all this going on? I think the government will not let the company go under as it is one of America’s jewels. There is supposed to be money for it in one of those stimulus bills.
The ratios below help determine the financial strength of the company:
Quick Ratio: 0.5
Total Debt to Total Capital: 122.77%
Interest Coverage: -1.94
Summary:[2]
“BA has a Debt to Total Capital ratio of 122.77% and is among the most highly leveraged companies in the Aerospace & Defense industry. The company could face trouble servicing its debt as both its Interest Coverage and Quick ratios show that neither operating profits nor current assets alone are great enough to satisfy interest obligations.”
The premise going into this investment was the pandemic is temporary, and the recovery will take care of the shortfall. But when a company has a financial issue within a year, and the pandemic improvement for BA is one to two years, then my premise has problems.
XOM–Exxon Mobile:
In this case, less driving has led to a glut in the supply of oil and a price reduction. There have been moves to reduce the oil supply by the key players. But there is the work from home and stay local movement that will hamper demand for a long time. Additionally, there are disruptive technologies like electric cars, solar power, and wind farms that are a threat to the bottom line of oil-producing companies. Plastics will keep the oil industry afloat for sure. But it seems it will be a long time before demand comes back if it ever does.
Will XOM survive? I haven’t heard of any backup measures to rescue this company.
The ratios below help determine the financial strength of the company:
Quick Ratio: 0.6
Total Debt to Total Capital: 27.08%
Interest Coverage: -7.7
Summary:[3]
“XOM’s debt to total capital ratio, at 27.08%, is in-line with the Oil, Gas & Consumable Fuels industry’s norm despite its increase over the last year. The company could face trouble servicing its debt as both its Interest Coverage and Quick ratios show that neither operating profits nor current assets alone are great enough to satisfy interest obligations.
The premise going into this investment was the pandemic is temporary, and the recovery will take care of the shortfall. But when a company has a financial issue within a year, and the pandemic improvement for XOM is one to two years, then my premise has problems.
WFC–Wells Fargo:
Wells Fargo started with a checking and savings account scandal that led to fines. Additionally, the real estate market may turn over in the future due to record unemployment and the difficulty of making the rent or mortgage payment. There are programs to defer the mortgage payments, but in the end, the bill still has to be paid. The delay in the rent payment puts stress on landlords, and if there is not a program to catch them, some will have the risk of default due to the use of leverage and thin margins in their investment business. The loan defaults will hurt WFC’s financial picture because of their exposure to real estate loans. Additionally, the FED has reduced the interest rate, and this reduces the profit the banks can make.
However, WFC is a bank that is too big to fail, so there is a strong possibility it will get a rescue package.
Is WFC financially secure? A stress test can help determine that. The FED requires this for banks labeled too big to fail.[4] From the most recent stress test, WFC is above the minimum standards. One outcome of the stress test, however, is that WFC had to lower the dividend.
Overall, I think the industries discussed will recover, except I have some doubts about the oil industry due to the disruptive technology. At this point, the COVID reaction of the world has lasted longer than I expected. My original reason for investing in these stocks was that the recovery would be quick. It is proving to be quick because the S&P and NASDAQ have gone to new highs, and the DOW is not far behind. But BA, XOM, and WFC are lagging and still significantly down from their highs.
How long can the companies withstand this? For me, at this point, it is wise for me to invest in representative ETFs to add more diversification to the mix. Diversification minimizes the blow if one of the companies in my portfolio fails. It is more conservative.
To this end, I sold BA and XOM and divided the funds up into ITA (Aerospace ETF) and WFC. The main points here are that I believe is that the recovery for these stocks is taking longer than I expected and increasing the risk for bankruptcy. The industries will eventually come back. WFC has the too big to fail status and is OK based on the last stress test. Finally, the sale of losing positions helps me offset the capital gains from my three winners. The sale will help reduce my taxes.
In my book Crash Proof Your Investment, one protection method is to sell the position for a reason other than Price. In this case, I have found that my original reason for buying the stock does not seem to be valid anymore.
That is all for now,
Keep Safe,
Dr. Paul Keller
The Financial Master Series Books
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References
[1] https://www.tdameritrade.com/
[2] https://www.tdameritrade.com/
[3] https://www.tdameritrade.com/
[4] https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/stress-test-results/2020-annual-stress-test.pdf
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source https://drpaulkeller.com/risk-mitigation/
