Published July/August 2012
Those vexatious volatility trolls have returned again, bearing new worries.
Greece’s problems might push Spain and Italy over the edge, possibly even destroying the euro. The United States, facing a “fiscal cliff” at year’s end, certainly isn’t immune to the problems across the pond. We want to hold our investments for the long term (regardless of Keynes’ famous dictum), but we’d be foolish to ignore potentially devastating shorter-term economic and financial dangers.
Markets adjust quickly to these threats, however, and few are able to foretell the future. Nevertheless, markets, influenced by investor psychology, often over-react. It’s smarter to buy more of our favorite stocks when they go on sale due to these over-reactions than to fearfully dump them. However, adding at lower prices requires confidence – confidence in our ability to gauge a stock’s value, as well as the company’s future prospects and cash flows, especially under challenging macro-economic conditions. When we lack that confidence, a lethal combination of fear and uncertainty impels us to sell – often at market bottoms.
"Markets, influenced by investor psychology, often overreact."
This dilemma – whether to choose “fight” or “flight” in the investment world – is, fortunately, much more manageable in REITville. Consider Microsoft. Many smart investors believe its stock is cheap at less than 10 times its estimated 2013 earnings. But, as suggested by Dell’s disappointing commentary in late May, spending for desktop computers may be slowing significantly as more users go mobile with iPads and related devices.
How confident are we of Microsoft’s future earnings? Should we buy more on price declines, or is Mr. Market rightly discounting weaker prospects? Facebook, of course, is even more problematical. What can it earn? What is it really worth? Should we “fight” by buying more if the stock declines by another 20 percent, or should we take flight?
The valuation process in our world is less difficult. Net asset value (NAV) analysis can reasonably estimate a REIT stock’s value by looking at its properties and applying valuation metrics being used for similar properties in the vast private commercial real estate markets, then making adjustments for the REIT’s debt, any expected changes in property cap rates and for company-specific issues such as debt leverage, capital allocation skills and other factors. If we use a discounted cash flow or dividend growth model, we can apply an appropriate discount rate and make reasonable estimates of future long-term cash flows or dividend growth.
These are not easy tasks; the valuation of any stock is imprecise and is as much art as science. However, valuing REIT shares is made easier because so much of a REIT’s value is derived from the relatively transparent values of its owned properties and more stable and predictable cash flows (thanks, in most cases, to long-term leases). Furthermore, although recessions and global turmoil will affect demand for U.S. commercial space and the values of U.S. commercial properties, the volatility of that demand and of those values isn’t terribly high except in very unusual periods, such as 2008 through 2009.
Thus, it should be a less daunting task for most investors to buy more shares of their favorite REITs when they decline in price due to the worry du jour. And it is the wisdom and courage to buy when prices are down that provides the best odds of greater relative and absolute investment performance.
Would you commit more investment capital to Microsoft at $25, or to Facebook at $20? Or would you sell? Good luck with that. But would you buy more Simon Property Group (NYSE: SPG) shares at $110? I don’t know about you, but unless I was certain that Armageddon was just around the corner, I very confidently would! u
Ralph Block is the author of “Investing In REITs” and “The Essential REIT” blog.