Valuations are going to get a lot cheaper

After the huge market fluctuations over the past few months, investors are trying to decide on their next moves. Michelle Connell, president of Portia Capital Management, explained to Liz Skinner, special projects editor at InvestmentNews, which asset classes are likely to offer very wealthy investors the greatest opportunities. Connell also discussed what investors learned from the 2008 economic crisis and where they are — and are not — putting their cash to work.

Connell, a CFA and an adjunct professor of finance at the University of Texas in Dallas, manages equity, fixed-income and private investment portfolios for high-net-worth individuals and nonprofit institutions. Portia, which was named after the heroine in Shakespeare’s Merchant of Venice, manages about $80 million for clients.

Liz Skinner: What should wealthy investors be prepared for when it comes to real estate asset values?

Michelle Connell: If you are talking commercial real estate, obviously there could be a lot of distress coming down the pipeline, as we have retail organizations that are shuddering, and we’re expecting even more to go down that path. You’re even seeing some high-level hotels that you would think in the past would be fairly safe, there is concern there as well. But there are still a lot of opportunities in areas like multifamily because less people are owning homes and that statistic is probably going to get worse.

Any time you have a crisis, and/or a recession, typically the chasm between the have and the have-nots gets greater and it’s harder for the have-nots to buy. The bigger organizations in multifamily are looking at some distressed properties of smaller organizations, so the smaller players that have taken on too much debt are looking to be acquired by the larger players. I’m seeing a lot of people put together distressed debt funds for real estate lending and also distressed real estate for multifamily and for some other types of commercial real estate as well.

LS: What assets would you say are stretched beyond realistic economic expectations at this point?

MC: When you look at where we are currently with the public equity markets, it just doesn’t make sense. In the last few weeks, I’ve had analysts look at what has actually moved the S&P because it's obviously market-cap weighted. We broke down the first 50 stocks within the S&P, and it’s not just 20 or 10 names, it’s a handful of names. It’s almost like this stretched balloon and it feels very reminiscent to me of the tech bubble for those particular names. When I’m looking at the price-earning ratios or price-to-cash-flow situation for those organizations, I find it extremely interesting.

What has moved the most are some of the least profitable companies, versus the organizations that have stronger cash flows. There’s a lot of value names at a reasonable price, not necessarily energy-related or financial sectors. But there are a lot of good companies out there that are selling for  discounted multiples on a 20- to 25-year basis, then you have just a handful that are very stretched. People are chasing a few names and ignoring a lot of good healthy names that don’t have a lot of debt and do have strong cash flow.

LS: What industries should investors consider avoiding for now?

MC: I hate to say it because I’m in Texas. I have people saying all the time that they’re just going to buy oil stocks because they’re cheap. Well, you need to know what you’re looking at because so many of those companies in the energy sector have such heavy debt loads that they’re starting to sell pieces of the businesses that are smaller for them and just don’t make sense — or maybe with the lower prices for oil, are no longer are profitable. I have a few individual clients who have companies that go in and buy the pieces of those distressed energy companies. You need to be careful there.

Looking at some of the financials, you also have to be careful. There are obviously some really strong players in that area, like Goldman Sachs and JPMorgan, that are selling at very nice multiples. But then you have some regional banks that probably will have more difficulty than the larger players. It’s hard to paint a wide brush across sectors, you have to look at a more granular level and understand their cash flows.

There are expectations that in some areas of the economy, one out of four companies may go bankrupt. When you look at the leisure and travel sectors, that’s 20% of the economy. About half of those are not expected to be in existence in the next 12 to 18 months. A lot of that is not embedded in some of the prices of those stocks.

LS: What lessons were learned from the 2008 financial crisis that wealthy investors should be heeding now?

MC: A lot of wealthy people and a lot of private debt and private equity companies came into this with a lot of cash, so always building that cash before you get into a situation like this. Put the virus aside, things were getting very expensive here at the end of the year. If you look at surveys, wealthy people were sitting on a lot of cash even before the virus became an issue. At a lot of private equity companies, it was the same thing. It’s just having cash for when things go on sale. I think there’s going to be a lot of opportunity. I think it’s going to take another six to nine months to really see the distressed companies become more evident, and you’ll see the companies declaring bankruptcy or being put up for sale.

My friends who run private debt firms or mutual funds that are publicly trading debt, they’re waiting. They’re not doing a lot of buying. They think things are going to become a lot more stressed and they’re going to get things at a lot lower valuations, probably toward the end of the year. The system is not going to bounce back right away.

The Federal Reserve and our government can provide stimulus but [they] can’t create revenue. Sit on the sidelines because valuations are going to get a lot cheaper here. You have to be patient, you have to wait. Remember that about half of the companies in the S&P 500 were founded during recessions, depressions or financial crises.