Stock Talk #10: Why Megacap Tech Will Diverge From the Market (And New Podcast!)

Welcome to another week of trading, where the big news this AM is oil prices hitting a 21 year low. It appears the market underestimated weak demand for oil, as we had seen some large rallies on both news of a pending deal between oil producers and then the consummation of the actual deal. The energy industry can’t survive in its current form with oil at this price, and I expect this story to be one of many candidates that leads the market on its next leg down. I talk about this on my most recent podcast with my friend and options trader Sean “The Impervious” Busch on the third episode of stock talk (subscribe on Apple Podcasts or Spotify!)

I spent some of the weekend thinking more about what stocks will be insulated from Coronavirus and its effects, which may include a mortgage crisis and a full-blown economic crisis in China. I came up with three qualities I look for in Corona defensive stocks:

1. No BK risk (could mean low / no debt or no near-term debt maturities and high liquidity)
2. High operating leverage – costs don’t change much as sales go up
3. Customers consider product essential

Note that there is definitely a way to measure (1) and (2) (Net Debt / EBITDA, Change in EBIT / Change in Sales Revenue) and screen for stocks, whereas (3) is a judgment call.

As the subject of this post gives away, I think big cap tech (notably, Apple, Microsoft and Facebook) tends to excel at each of these three factors. The big tech companies often have little to no leverage and a ton of liquidity (ex. MSFT – for end of 2019, $134bn in cash, $63bn in long-term debt),  ability to scale sales without ramping up costs (selling Microsoft Office licenses) and products customers will think twice about cutting (losing Outlook, Powerpoint or Excel is not an option for most companies).

If selling right now is being driven by the amplifying effects of leverage in a downturn, fears of a slow recovery (for low operating leverage companies, it’s harder to scale sales back up fast) and the threat of cost cutting, I think the MSFTs of the world are going to be largely immune from this selling rationale.

Sure, these stocks likely don’t have as much upside as the ones that don’t score well on 1-3, but I’d argue in many cases the risk-reward is better. Many retail, travel, restaurant and Corona-prone stocks may be permanently impaired in value by COVID because in the worst case they’re forced to dilute equity or surrender the company to bondholders, and in the best case have to panic-sell assets and restructure to be much smaller companies than before.

If and when the next down leg occurs, I’ll be looking to buy tech again.

– Brostoff