July 02, 2020
As health concerns slowed our ability to shop and purchase items, the supply chain reduced goods available for purchase. People, concerned about the long-term impact of the shutdowns, slowed spending. At the same time, manufacturing closures limited the supply of in-demand goods. All of this combined has created a recession.
In a slowed economy, like the one we’re experiencing, the access to income generating strategies drops as well. It's in these times when you should lay the groundwork so you can be among those that will benefit the most in the post-recession economy.
While, sure, you can’t do much to change the current situation your business or wealth might face today, due to issues far outside your control, preparing your company, income, investments and overall financial strategies for a post-recessionary world can determine your future success. We’ve all heard tales of those that loaded up on underpriced assets and businesses during a recession only to come out of the downturn as newly-minted millionaires or even billionaires. You may not have the need to reach that level of wealth, but you ultimately do want to improve your own situation. Now’s the time to do so, using what I refer to as asymmetric information.
You may have heard of "asymmetric risk." In financial circles, it often describes a good investment versus a bad one. The idea is to find investments that offer better potential return, when compared with other investments, yet provide similar risk profiles. It’s that investment that offers a high return with only a medium level of risk. Or that stock that can see medium return, despite its low risk profile. Finding asymmetric risk is the hallmark of great investing. While it may sound simple, in practice it’s extremely difficult to uncover these opportunities.
During recessionary periods, however, it’s far easier to find asymmetric risk. Business sales drop, costs increase and investors worry about the future, leaving opportunities on the table. It presents a golden ticket to buy.
The question is how and what should you buy?
That’s where asymmetric information comes into play. This uses information either not available to the public or simply not available to the seller, to benefit your chances of investing success. In a negotiation, if you have equal information the discussions become more difficult, preventing you from that home-run purchase. The goal in focusing on asymmetric information is to gather data or knowledge about the purchase that the seller doesn’t know or understand, giving you the potential to buy an underpriced asset. Essentially, both parties feel as if they’re walking away with fair value, but you see the valuation differently based on your information.
It’s in these situations where you can then flip the investment for multiples on the dollar.
Asymmetric information comes up most often in insider trading, which is obviously illegal. There’s plenty of legal ways, though, that you can use this knowledge. This looks more like an out of town real estate agent selling a home for a client at the wrong price because they didn’t analyze the information properly or were not fully aware of the local economy. Or it’s purchasing a company at a low valuation, then pivoting its products to a new, more robust clientele. Having the perspective to change the way a business performs can provide a drastic increase in valuation (and income).
In a recession, the best way to find asymmetric risk is to focus on your area of expertise and uncover asymmetric information. Here’s how.
It’s extremely difficult to become an expert in one area, taking years to do so. If you have an expertise, then focusing on this knowledge will serve as your simplest path to finding asymmetric information. I’ve seen people make huge profits buying and selling vintage guitars, for example. You see the same in cars, electronics and other areas that most people view as simply niche hobbies. But that doesn’t mean all hobbies open this opportunity.
To determine whether or not your knowledge base can provide profitable expertise, first ask is it difficult for average buyers to determine a price? If so, then ask if the market is large enough to allow you to reliably earn income from it? If you can answer yes to both questions, then you’ve found an area where you can consistently and reliably purchase underpriced assets and sell them for more.
This sounds like a simple concept, but, in actuality, very difficult to accomplish. You need to see assets and businesses at their optimal valuation rather than as they’re priced in today’s market. That means you need to adjust an asset, change the business clientele or see the parts as more valuable than the whole.
Some hedge fund managers have become billionaires simply by purchasing conglomerates and then piecing off the individual brands for more than the cost of their acquisitions. That’s the extreme example of this. On a much lower scale, Ebay flippers buy large lots of goods and profit by selling them individually. Developers make money by purchasing swathes of land, rezoning it and selling new homes on the pieced out property. The opposite can also work, as developers purchase multiple properties in an area to then develop into a single high-rise apartment building, for example.
There are a million-and-one ways to see a problem, and even more solutions. Your goal: Use your knowledge of a market or industry and figure out how to see it in new light, increasing the value of your purchase. If you attempt to look at the problem the same way as everyone else, you will arrive at the consensus valuation. You need to find assets that deserve a higher valuation using your expertise and experience (or that of your partners) while paying a consensus value.
I’m always on the lookout for ways to use my asymmetric information, but to do that I need access to capital. That means growing money when you can, keeping some accessible and acting fast when the opportunity arises. This is the vital ground work needed that people often gloss over. Seeing opportunity is wonderful. Understanding where your expertise lies and how to use it is key. But having the funds available when the opportunity strikes is the difference between a no deal, a so-so deal and a great one.
The best opportunities often come-and-go in a flash. You must arrange your finances so you can comfortably take action when required. Sometimes this requires selling under performing assets - or even strong performing assets to take on a can’t miss opportunity. You’ll always be balancing increasing your capital and having accessible money for these investments. Your own risk tolerance and the markets you work in will dictate the balance required.
As we move into a potentially long recession, opportunities will present themselves to those that know how to look for the right deals. Understand what you know, your unique viewpoint, and prepare your money to deploy.
If you can put the pieces together, you can become one of those "lucky ones" who exit the recession with a huge win or two.
By Timm McLean, MBA |
CEO at WLTH