As I write this, the Atlanta branch of the Federal Reserve System has just announced their forecast that second quarter gross domestic product is expected to plummet 53%; a harrowing statistic. Meanwhile, the S&P 500 Index sits at 3,055. That’s where it was on March 5 of this year, at which time, there were fewer than 50 coronavirus deaths in the entire country. On March 5, unemployment in the United States was 3.5%. At the end of April, it was 14.7% and Goldman Sachs just announced that they think we are currently over 21%.
So what gives? The best answer I have heard is that stock markets are always forward thinking. Investors seem optimistic that there will be a recovery, and a relatively strong one. However, if you represent a client who owns a restaurant, a retail store or even a school bus company, that client is looking at the various stock indices and shaking their head. The world has changed, and while we all hoped this would pass quickly, the coronavirus seems to be a guest who insists the visit must linger. The good news is that we are down to roughly 500 deaths per day in the U.S.. The bad news is that we were there a week ago and then the numbers spiked.
For those in the “break-up” business who do business valuations, this is an especially harrowing time. The 2019 year-end numbers are trickling in and for just about everyone except box retailers, 2019 was a fine year. But as you dump your data into the valuation calculator, you know that someone is going to assert that those numbers are ancient history and have “no relevance” given what has happened since March 1, 2020. Is that fair?
It isn’t, and for many different reasons. We have been down this road before. The stock market has seen us through banking crises in 1990 and 2008 as well as a tech bubble crash in 2000. This market is quite different. In 1990, 2000, and 2008 there were some real fundamental viruses in the economy. In two of the three corrections, the lending system got itself into real trouble. That required not just stimulus, but also some institutional correction. It took time to recover and the stock market history shows that. In February 2020, the S&P 500 was chugging toward 3,400, then utterly collapsed – falling by 1/3 in three weeks. Since then, the market got up, dusted itself off in April, and rose more than 7% in May. So we have a situation where the unemployment numbers and the gross domestic product numbers signal “depression,” while the stock market indices, (what people will pay to own shares in businesses) seems to think things are comparable to last November or early March (each with S&P at 3050).
I have read some articles and spoken with a colleague who values businesses for a living. He characterized the market issues in two ways: (a) episodic; and (b) systemic. If you owned a Wendy’s franchise and it was brought down by fire, flood or pestilence, there is no question that the flattening of the franchise affects its value. But if you have insurance, you rebuild and resume operations. Your problem was quite real but it was episodic. The value is still there, because once you re-build, people will resume eating at your trough. However, if the state highway department builds a spur that diverts traffic away from your franchise or the CDC announces that hamburgers cause COVID, you have a systemic problem. You may be able to adjust to compensate by changing your product line or offering free oil changes for customers at the drive through, but that’s the result of your genius and not the value of the business to Mr. Willing-Buyer. He might pay a healthy price for the business after you re-tool it for the new economic world and show him that sales and profits are back to the old days. But not now, thank you.
What this means for the domestic relations bar is that you have to pull your head out of the data and think about how COVID will affect the business you are valuing a year from now. Understand we are not done with COVID. Today it is like your crazy uncle who likes to roam around the house and cause destruction when visiting. As I write this, Uncle COVID has wandered into North Carolina, but we don’t know how long he stays or where he wanders next. Meanwhile, if you have a retail sit down food operation where you pay real rent expecting to seat 50 guests at a time, you may have a systemic problem; the kind where your genius is going to have to create value that otherwise has been crushed by six foot distancing. If you own a dance club or a stadium you are in worse shape, although those patrons may be willing to assume the risk if the authorities will allow it.
The stock market may actually be an indicator of what investor’s think of the business you are valuing. In the last recession I was involved in valuing a luxury goods wholesaler/retailer. So I watched Tiffany (TIF) and LVMH (LVMUY) to see what investors thought of the 2008 crash. They were slow to bounce and to some degree buoyed by a growing Chinese market that my client could not access. Today, you can see that any kind of box retailer is headed toward bankruptcy. The virus only hastened that process along. The cruise ship business has taken a slight bounce back, but if your client owns hotels in Port Miami, he has a systemic problem. Hotel operators in Cooperstown or Williamsport are in a different place. Sports will come back and so will the demand of parents to revel on the fields of dreams. Many businesses are cutting back and that may last a while. But, again, this is a physical virus and not an economic one. In addition, the market is telegraphing that most businesses will survive and thrive again. The second quarter does not decide the game.