On one of the blackest days of the financial crisis in late 2008, I received a telephone call from a fellow investment manager. He is a person I respect very much and has built a great firm. He said he wanted to pick my brain on a matter that was urgent. He went on to explain that on that day he had $40 million in bonds coming due and the reinvestment options he was being given by his institutional brokers were all bad. Remarkably on that day he was being told that T-bills had a negative return. That is, he could put the money away in a safe place, but when it matured he would get back slightly less than he had put in. These were scary times.
The man in question is a "Cool Hand Luke" kind of a guy and his voice was as steady as a rock as he went down the list of how bad things had gotten. The commercial paper market had frozen up; the corporate bond market was in a free fall; and stocks were collapsing. He said ordinarily he would just negotiate an overnight rate with a bank, but he had no idea which of the banks he dealt with were safe. Indeed, he wasn't even sure if his custodial bank where the assets were held was safe.
His said he knew that I was a long-term investor and that I usually did not deal in the overnight market debt market, but he wanted to know what I felt "sure" about. What part of the financial system did I believe had the highest probability of making it through what looked like, at the time, an economy that was headed toward a 1929-type depression.
I asked him if he was talking about stocks or bonds. He said both, but bonds first. I said the bonds I had the most confidence in were high quality municipal bonds. I added that I would stay away from the areas of the country that were having the most problems with real estate delinquencies. I went on to explain that municipal bonds had fared well during the 1930s depression, and I had a lot of confidence they could make it through this economic collapse, as well. He knew this as well as I did and concurred with my thinking.
He asked about where I would invest in stocks. I think I surprised him when I said, "I believe one of the safest investments you can make in this market is what I will call "Gold Standard" common stocks. I told him that I thought there were approximately 100 companies in the world that might be safer than any government and would not only survive the crisis but would come out on the other side even stronger.
I told him these companies would survive and prosper because of seven reasons:
- They did business all over the world, so they were insulated from what was going on in the US or Europe.
- They had a low debt to equity ratios.
- They generated enough free cash flow to fund their working capital needs, so they did not need to be begging the banks for money. This free cash flow also gave them access to the capital markets.
- They sold products that we use every day, what I call "essential services" products.
- They were the undisputed leaders in their businesses, which allowed them to influence the competitive landscape for their whole business sector.
- They had been around long enough to establish a powerful brand, and they were extending their brands in the developing countries of the world.
- They treated their shareholders like owner-partners by paying a generous dividend.
I told my friend that these companies did not have the power to issue currency, nor field a standing army, but in an increasingly global economy, they had something better. They had created mutually beneficial relationships with billions of people the world over, who, on a daily basis, chose these "Gold Standard" companies' products and services more often than those of their competitors.
I concluded with the following. "I said I called these companies "Gold Standard" companies. I mean that literally in this way. Gold has long held the mystique, if not the reality, of being the ultimate store of value. Thus, in very difficult times when the financial system creaks and groans lots of money always goes into gold until the dust clears. But Gold's rate of return over very long periods of time has been poor, little better than inflation. The "Gold Standard" companies that I was thinking of had just as impressive a record of surviving the bad times, but had produced a compounded annual return that beat gold handily."
"Gold Standard" companies have been refined in the flames of countless tough economic times. Companies rise to the level of the "Gold Standard" not because they have survived for 25 to 50 years, but because they have grown for 25 to 50 years.
My conversation with my friend was now over a year ago, and while things have gotten better, there are still worries a plenty. But as I remind our clients often, "We are not investing in countries we are investing in companies. Companies that have been tested by time and have become more powerful because of the testing."
