Stock Talk #16: Birds and Bushes
“A bird in the hand is worth two in the bush.”
I found an incredible 10 minute clip the other day of Warren Buffett explaining this old adage as it relates to interest rates and return on investment. It’s worth watching for the investment wisdom. The TL;DR is this – interest rates and duration of holding determine if you’d prefer the one bird in hand (i.e. cash in hand) or two in the bush (the promise of cash at some later point in time).
This math will seem obvious to many, but I think it’s worth walking through. Let’s say a bird is worth $100 and the “bird holding period” is 20 years. You can see in the below how different interest rates change the decision as to whether you’d prefer one bird or two in the bush. As interest rates decrease, the bird in hand needs more years in holding period to be worth it:
At a 1.5% interest rate (about where we are now on the 30 year treasury), it takes about 48 years for you to double your money. In our example above, anything below a 3.6% interest rate or so means you should take the two birds in the bush in 20 years instead of the bird now.
Why does this matter today? Because interest rates are getting closer and closer to zero. I have a Goldman Sachs Marcus Savings Accounts that was a 2% year when I opened it last year; it’s down to 130 bps now. Whatever projections I make in this newsletter or on my podcast, one thing I can say I’m confident about for the next 2 years or so is that rates will stay low (in fact, this would’ve been an excellent prediction for the last decade plus).
Again, the consequence of lower rates is that “two in the bush” – anything that seems like it could double in some amount of time – becomes more attractive. Could this company double earnings in five years? Well, no, but how about ten years? Twenty? Given an infinite amount of time, I’m pretty sure almost any company could double earnings. I think this is one factor holding up the market right now.
Talking to readers of this newsletter, I’ve often heard shock that Corona-prone stocks in the retail, leisure, travel and restaurant sectors are rallying. I’m surprised that one of my largest Corona-prone holdings – Chef’s Warehouse – has rallied to close to post-Corona highs after diluting shareholders by 19%. One theory for junky stocks rallying is that if investors believe that companies can simply survive, they’re comfortable with longer and longer payback periods on their investment.
Taken to an extreme (negative interest rates), they should hypothetically be comfortable with an infinite payback period. If holding cash is costly, a small chance of a company paying dividends decades down the line becomes attractive.
Moreover, let’s be clear on COVID – even the worst estimates I’ve heard see this thing played out in three years. When interest rates are 1.5%, remember that three years on one dollar is $4.57. A ton of companies can equal or better this in dividends along. Apple’s dividend is 1% right now; MSFT is 1.1%; both companies have a history of growing earnings and returning more and more cash to shareholders (remember share buybacks also counts as a (non-taxable) return of capital). If you measure the market as SPY, there’s a 1.96% yield right there – if the market stays flat, it beats the 30 year treasury.
If you hate the stock market right now, I’d ask if you like cash more. And if you do, I’d ask if you really think there are no investments that can beat a 1.5% return over 30 years.
Before we wrap up, a few podcasts I recently recorded I think you’ll enjoy:
– CEO of GlideFast Consulting Mike Lombardo on entrepreneurship and ServiceNow – this was a great conversation on how Mike started GlideFast and the important of ServiceNow to the post-COVID future. I remain extremely bullish on NOW especially after they had an incredible print on first quarter earnings. Spotify link, Overcast link.
– The Impervious turns bearish – Frequent guest of the podcast Sean Busch gave a strong bear thesis on the market this Sunday. I think this analysis mostly applies to the next six months to a year, but it’s a good reminder as to why dollar cost averaging and being patient on big purchases makes a ton of sense. iTunes, Spotify, Overcast.
Happy trading,
Brostoff
