Fearing a material decline in the markets as concern mounted about the health and economic impacts of the COVID-19 pandemic, activist investor Bill Ackman considered liquidating the entire portfolio of Pershing Square Holdings (PSH -3.91%). But instead of selling all the hedge fund's holdings for the first time in its history, Ackman made a big bet on a hedging strategy in late February that turned $27 million in premiums and commissions into $2.6 billion.
Instincts like this, and a history of controversial bets, have helped Ackman amass a fortune worth more than $1.6 billion. He's clearly an investor worth listening to, and some of his wise words in a recent letter to Pershing investors provide important guidance for those putting their money into the markets amid the turbulence of the coronavirus era. Here are three things Ackman told shareholders that every investor should think about.
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1. Avoid short-term thinking
It is important to be reminded that the value of a business is the present value of the cash it generates over its life.
Ackman is warning here against short-term thinking. In particular, he's advising investors not to employ the common practice of valuing a company using a price/earnings multiple based on what analysts estimate the company's earnings will be in the next year.
While he acknowledges this is a simple way to try to assign value, he doesn't believe it's an effective one in today's market, given the likelihood the coronavirus will interfere with operations for many businesses over the next 12 to 24 months.
Companies affected by the lockdown and by a coronavirus-related economic recession may perform dismally in the short term, but Ackman believes that even disastrous earnings shouldn't scare investors away if the business has good fundamentals like a strong balance sheet and a dominant position within its industry.
2. What investors should shoot for
We are fortunate to own businesses that are designed to withstand the test of time.
Here, Ackman is speaking of the investments made by Pershing, but his words should be something every investor shoots for.
Ackman's fund has a concentrated portfolio and the profits from his coronavirus gamble were used to add to its stake in several companies, including Lowe's (LOW -0.14%) and Restaurant Brands International (QSR -0.75%). And while hedge funds usually aren't in the business of holding stocks for ultra-long periods, Pershing has owned many of its key holdings since its inception in 2004.
Ackman identifies companies to buy into by looking for simple businesses with conservative financing that aren't overly impacted by extrinsic factors. And while you don't have to follow his specific methods of selecting your own investments, building the core of your portfolio around businesses you believe will do well over the long term has been shown time and again to be one of the most successful strategies for building wealth.
3. Take advantage of opportunities
We continue to expect that markets (and our performance) will remain volatile, and therefore, new opportunities may present themselves that are superior to investments we currently own.
Ackman's words again refer to Pershing's holdings, but teach a broader lesson as they speak of the importance of taking advantage of opportunities even, and perhaps especially, during turbulent times.
Volatile markets aren't something to be afraid of. They are a chance for smart investors to maximize long-term returns by buying shares of strong companies at discounted share prices. And building your core portfolio around businesses that stand the test of time doesn't mean being unwilling to branch out or change course when opportunities present themselves -- as long as you're willing to put in the work to make sure you're being true to your core principles.
Take these wise words to heart
Learning from great investors can help you to build a stronger portfolio. Whether you're following advice from Bill Ackman, Warren Buffett, or the other billionaires whose business acumen has made them household names, the collective wisdom they pass on can hopefully help you become a better investor so you can be successful during good times and bad ones.