Corona Crisis: Conclusion

Corona Crisis: Conclusion

With this short series on possible economic scenarios I wanted to illustrate to you how I think about recent events. First of all it is important to think in terms of scenarios. This helps keeping an open mind and not focus on only one economic outcome. Further, one can assign probabilities to each scenario. Even though there is no way to calculate objective probabilities, assigning probabilities helps to put things into perspective even more. In my personal opinion I would give the scenarios of quick recovery and recession a probability of 45% each leaving a 10% chance to the scenario of a depression. Please note that a depression has by far the lowest probability, but still this scenario is being talked most about in the media.Talking about a depression raises the most attention and gets the most clicks, despite the fact that it is the least likely scenario. 

Implications on Investing

Furthermore I would like to briefly talk about the implications of these scenarios for investing. In my opinion it is prudent to build an investment strategy that takes into account each scenario. For example that means to hold at least 10% to 15% of the portfolio in gold. Gold acts as an insurance and can protect your wealth in a depression. To account for a recession it would normally be prudent to hold a portion of the portfolio in AAA rated government bonds that give you liquidity and have somewhat of a negative correlation to the stock market. However, 0% interest rates and high government debt make government bonds a less attractive investment. An alternative could be to hold some cash instead and/ or go into investment grade rated corporate bonds. At last, to thrive during a quick recovery, it is best to hold stocks. As most investors had stocks before the crash that means not to sell all stocks and also use low prices to buy and thereby lower the average entry price. The different probabilities of the scenarios show themselves in the weighting of each asset class. Because a depression has, in my opinion, the lowest probability I would only invest 10% to 15% into gold (someone who thinks a depression is more likely would invest more into gold). The rest of the portfolio would be distributed into stocks and bonds/ cash, where I would slightly overweight bonds/ cash, because of the higher volatility of stocks.

Finally it is paramount to maintain a positive outlook. Even the worst case of a depression would be mastered within a couple of years. In any case we will master this health crisis and likely enter a new era of prosperity and economic growth.

Economic Scenario 3: Depression

Economic Scenario 3: Depression

This third and last economic scenario is the one of an economic depression. Contrary to a recession, the timeline for a depression is at least several years. It takes this much time of continuous economic contraction until the lowest point is reached and the situation starts to get better. Furthermore a depression is characterized by high unemployment that can be as high as 25% and the passing of many new political programs. For example during the last depression in the US, Franklin D. Roosevelt passed a series of programs, summed up under the term New Deal.

How could a depression play out?

1. Deflation

During a Deflation prices are falling. In a deflationary environment consumers and businesses alike, anticipating prices falling further, bring their spending to a minimum. They prefer holding on to cash, because the same amount can buy more later on. The reason why Deflation is so dangerous is that it can quickly lead to a vicious cycle. Whereas the first decline in prices can be caused by an exogenous shock, consumers and businesses holding on to their cash cause further declining prices even though the shock is already absorbed. Now that prices declined further consumers and businesses will hold on to cash even more and so the vicious cycle ensues. Ultimately this behavior can bring the entire economy to a halt and it will be very difficult to get going again. The Great Depression of the 1930s is an example of an economic depression that was caused by deflation. During this crisis deflation was caused by a collapsing financial sector and bank failures, which ultimately resulted in a depression. 

2. Inflation

There are many examples in history, where economic depression goes hand in hand with (hyper-)inflation. Countries experiencing hyperinflation in present times that come to mind are Zimbabwe and Venezuela. The example I want to discuss further is Germany (Weimarer Republik) in 1923. After the end of World War 1 Germany had to pay massive reparations. Because the entire economy was destroyed and the state was completely broke, the central bank (Reichsbank) had to print large amounts of money. This increase in the supply of money, while at the same time the amount of goods produced was very low, caused one of the biggest hyperinflations ever recorded in a western nation. On June 9th 1923 1$ was equal to 100.000 Reichsmark. Six months later on December 2nd 1$ equaled 4.21 Trillion Reichsmark.¹ Finally there was a monetary reform and a new stabilized currency. The consequence was, that anything people owned in cash or cash equivalents became worthless. 

3. Deflation then Inflation

A further possibility is a depression, that is caused by a combination of deflation and inflation. In such a scenario an exogenous shock would lead to deflation and a collapsing economy. States intervening by printing money in order to stop deflation could then lead to massive inflation in the end. 


Economic Scenario 2: Recession

Economic Scenario 2: Recession

The second scenario that could possibly happen is an economic recession. A recession is characterized by a sustained economic decline, which manifests in two consecutive quarters of negative GDP (Gross Domestic Product) growth. Furthermore, the time line for a recession is usually between one and three years. An example of this is the last recession in 2007/ 2008. The high of the market was formed  in October 2007 and the lowest point of the decline was reached in March 2009. So the entire down move lasted for one and a half years. This falls exactly within the timeline we established earlier and if the corona virus was to start a recession we would expect a similar timeline.

There are a couple of aspects, that could prevent a quick recovery and aid the economy going into a recession. First of all, interest rates are already at, or very close to zero percent in the US and Europe. Because of this Central Banks have less options within the realm of monetary policy. They can’t lower interest rates as they did in 2007/ 2008. Before the start of the recent decline in the markets the FED, contrary to the ECB, had some room left to lower interest rates, but they immediately used this option at the beginning of the downturn. The only option left to central banks is the use of direct monetary stimulus. Among these options are the use of helicopter money as well as lending directly to companies in need. However, even the effect of these direct stimuli is highly controversial among economists, especially for high public debt ratios. Nickel and Tudyka find: “From a policy perspective, these results lend additional support to increased prudence at high public debt ratios because the effectiveness of fiscal stimuli to boost economic activity or resolve external imbalances may not be guaranteed.”* Ironically this paper was published by the ECB, the same institution that has been relying on the use of stimuli for years. 

Interest rates already being at zero and the possible ineffectiveness of stimuli in the context of high public debt ratios massively limit the effectiveness of the central banks. These are also factors favoring the scenario of a recession.

Another aspect to consider is the virus itself. If the corona virus was to appear in waves over a couple of years, as the spanish flu in 1918 did, it might be necessary to disrupt supply chains for much longer than we assume at the moment, thereby also sending the economy into recession. 


Economic Scenario 1: Quick Recovery

Economic Scenario 1: Quick Recovery

Quick Recovery

This scenario most people tend to forget. You only hear the media talking about the crash and companies that might experience difficulties because of the Corona Virus shock. However, a quick recovery, with a timeline of a couple of months, is definitely on the table. Most of the losses in the S&P 500 could be recouped, even though we probably won’t be at new all time highs soon. In this scenario the government provides aid to especially affected companies. Also, this scenario can be fueled by a decline in the number of infected people due to quarantine in many parts of the world. China is already reopening Hubei province and picks up production in their factories. 

Moreover the quick passing of a $2 Trillion stimulus bill by the US government could stabilize markets and initiate a recovery. The bill consists of a loan program for small businesses, an aid fund for cities and states and the use of helicopter money. Many Americans will receive checks directly from the government, thereby creating demand and stimulating the economy. However, only time will tell if this stimulus really has the effect politicians hope it will.

Finally we can conclude that an economic recovery over the course of the next months is a possibility. Also we should not get too pessimistic about the future. Even though the virus outbreak is a huge catastrophe this, too, shall pass.

Corona Crisis: Economic Scenarios

Corona Crisis: Economic Scenarios

Stock markets have dramatically gone down over the course of the past few weeks and investors are highly uncertain about the future. Long term investment strategies, like Compound Investing, can profit a great deal in volatile times. Using low prices to buy has a huge positive impact on the strategy’s return over the next years. However, times like these can also lead to bad decisions, because experiencing losses evokes a strong emotional response. In order to avoid such a response I will publish a series of posts on possible economic scenarios. Finally the goal is to provide the reader with a broad range of future scenarios. That will enable him to maintain an open mind and not freeze in light of his fear of an economic depression.    

Monster Beverage Summary

Monster Beverage Summary

Below you will find the summary of my analysis on Monster Beverage. What really stands out to me is the possibility to visually recognize a company that does a good job compounding their earnings. Just looking at the chart of earnings per share you can see the exponential growth. They were able to post higher earnings for each year with a compound annual growth rate of 17.69% over the last ten years.

Please note: Because of the big stock market movements in light of the recent corona virus crisis I included a 20% margin of safety in the calculation of my entry price. So instead of 58$ I am now looking to buy at 46$. I am also aware of the fact that we could see a much bigger decline. Therefore I hold back some liquidity to be able to buy at lower prices. The second level at which I will be buying Monster Beverage is 31$ a share. 

Apple Summary

Apple Summary

I recently did a course to become a certified Financial Modeling and Valuation Analyst. One of the key takeaways was how to properly present financial analysis in excel. So I want to use what I have learnt and create a summary for each company that will be analyzed in this blog. Below you can find the summary of Apple. Just click on the picture to see it in full size.

Edit: The summary is now updated to include the data from the 2019 annual report as well as the recent drop in price.





Leverage & Wealth Creation


Leverage & Wealth Creation

How huge fortunes are made

This article will discuss the underlying theme of how most (all?) big fortunes were made. When I first discovered that there is something that most big and small fortunes have in common I was very amazed. Basically everyone that made a fortune used leverage in some form or the other. Leverage is commonly associated with risk, but when it is used consciously and prudently it is the most powerful tool available for wealth creation. What makes it even more important is the fact that leverage can be applied universally across all businesses, to investing in stocks and real estate, in your profession and even in day to day life. 

But what exactly is leverage? In finance leverage refers to the use of borrowed funds, which will result in a higher return on equity. But the concept of leverage can be understood more broadly. For example an entrepreneur can use leverage by employing people that work for him, which is actually why all of the richest men are entrepreneurs. Even with the highest paying job you could never earn as much, because without leverage you would have to put in all the hours by yourself. Leverage is also the reason why many people became rich by investing in real estate. In real estate it is easy to borrow money, because the property acts as security for the loan. Loan amounts of 80% are very common and can even be as high as 100% (or higher) were you only have to pay the closing costs. Another example of leverage from day to day life would be leveraging your time. This is achieved by hiring other people to do your less productive tasks, so that you free up time to focus on the more productive tasks yourself.  

Implications of Leverage for Investing

This article was meant to be a quick food for thought about leverage. It is really important to always keep this concept in mind, because it can be applied to so many different areas of life and business. In this last paragraph I want to briefly discuss what the implications of leverage are in the area of investing. Leverage can help you to drastically increase your returns. However it is important to be careful with it. When you invest in stocks you have to consider the high volatility and the high likelihood that the company you are buying is already levered. When the company has debt on its balance sheet they already use leverage so buying their stocks on margin can quickly increase leverage too much. The best piece of advice is to always protect the downside. Imagine the worst downside scenario and how your levered portfolio would react to it. If you keep in mind what could go wrong and rather use too little leverage than too much, it is a great tool to increase your returns. Even a small increase in returns can add up over time and make a huge difference when compounded. 


The Most Important Tool of Investing

The Most Important Tool of Investing


Today I want to talk to you about what in my opinion is the most important tool an investor can use to his advantage. This tool is diversification. It is the only tool that allows you to reduce the risk in your portfolio, while at the same time not lowering the returns. Even though most people have heard of diversification and you will frequently hear phrases like: “Don’t put all your eggs in one basket!”, there are a lot of misconceptions out there. The concept of diversification appeals to many investors, but especially new ones think buying a lot of different stocks will sufficiently reduce the risk in their portfolios. However diversification can quickly lead to diminishing returns without lowering the overall risk. The biggest reduction in risk comes from the first 10 different stocks. After that, risk is only marginally reduced, while at the same time costs go up drastically. Because many investors don’t understand that, to gain all the upside from diversification, they only need have around 10 stocks they will buy many more thinking they are further reducing their risk. This will lead to a diminishing risk adjusted return, because increasing costs, lowering the return, outpace the marginally reduced risk. This phenomenon is known as over diversification. 

As we have seen in this first paragraph, diversification, if over diversification is avoided, can be a great tool. But there is a whole different level of diversification. Most people focus too much on diversifying across different stocks, sectors or regions. However in this digital age all stock markets around the world a highly correlated. The true power of diversification can be harnessed when diversifying across assets that have a low correlation. This is why it is necessary to diversify across different asset classes that have a low correlation. Diversification in the form of Asset Allocation becomes the most important tool of the investor.

Asset Allocation

Investopedia defines asset allocation as: “… an investment strategy  that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals,  risk tolerance , and  investment horizon . The three main  asset classes  –  equities, fixed-income, and cash and equivalents – have different levels of risk and return, so each will behave differently over time.”. In our case the most important factor in determining the portfolio structure will be correlation. I will show you how different types of asset allocation have played out over the last decades and we will see the power of a well structured portfolio. The tool I will use for backtesting is which is a free service.

All Stocks versus Stocks and Bonds

This first section is meant to illustrate to you how big of an impact diversification can have. The portfolios shown are kept really simple to make a point and are for demonstrative purposes only. We will compare a portfolio that consists of US stocks only to one that has an equal mix of US stocks and long term treasury bonds. Long term treasury bonds are a good asset to diversify, because they have a correlation to US stocks of only 0.04 and are therefore almost independent of the stock market. In the table below you can see the comparison of the two portfolios for a period from 1978 to 2019. What you can see is that by allocating 50% of your portfolio to long term treasury bonds it was possible to massively reduce the risk and only giving up very little upside. The risk in terms of the maximum drawdown more than halved from -50.89% to -20.39%. Also the worst year delivered a performance of -7.26% compared to an all stocks portfolio with a worst year of -37.04%. Contrary to this development the return, measured as the compound annual growth rate, only went down by 0.95%. (As a side note: You can see the power of compounding, because even though the return only went down by 0.95% it makes up roughly one third of the end balance over this long period of time.) In the last row of the table you can see that it was possible to generate an annual alpha of 4.33% simply by adding bonds and without any stock picking. That means the portfolio that mixed stocks and bonds was able to generate a risk adjusted excess return of 4.33% per years compared to the broad US stock market over the same period of time.

Examples of Asset Allocations

The purpose of this section is to introduce you to different types of asset allocations to give you an idea of how professional investors use this concept to their advantage. Below you can find a table that compares these allocations to each other as well as to US stocks. For each allocation there will be also a pie chart to show you how they allocate their capital.

All Seasons Portfolio

This asset allocation goes back to Ray Dalio the founder of Bridgewater Associates (see sources). The goal of this allocation is to invest in asset classes that thrive in complementary environments. For example during inflation bonds would suffer losses, but gold would perform well and during an economic downturn stocks would suffer, but bonds would perform well. You can find the exact allocation in the pie chart in the slider below.   The only change I made is to allocate 15% to gold as the original portfolio allocates 7.5% to gold and 7.5% to other commodities. However it doesn’t make a big difference as it is the same asset class and there is a lot more data on gold. The reason behind the high weighting of treasuries is their low volatility compared to stocks. The goal is to have an equal influence of all asset classes, so bonds have to be given a higher weight. The compound annual growth rate of this portfolio is 9.46% for the period from 1978 to 2019. However the really special characteristic are its low drawdowns. The maximum drawdown was only -13.06% and the worst year only -4.46%. Contrary to that the best year, with a performance of 31.9%, came close to the performance of an all stocks portfolio. Dangers to this allocation in the future could be high government debt and low yields of treasuries. 


Equal Weight Portfolio

This portfolio has the same goal as the all seasons portfolio, but allocates its capital equally among the asset classes and also includes cash. Because cash doesn’t generate income and the risk portion (stocks) only makes up 25% compared to 30% in the all seasons portfolio, the return is lower. The advantage of a cash position is the liquidity that goes with it. This liquidity can be really helpful. You can either sit out downturns without having to sell assets or you could even use low prices to buy more assets. This allocation would also offer more protection against a systemic crash with 50% either being allocated to gold or cash. Which asset allocation you prefer comes down to your personal preferences and expectations.


Asset Allocation is the most important decision an investor has to make. Combining multiple asset classes that preferably have a low correlation will tremendously reduce risk and therefore enable the investor to achieve a superior risk adjusted return. Inside the asset class of stocks further diversification can be obtained by selecting multiple companies to invest in. However it is imperative to limit oneself to roughly 10 stocks and thereby avoid over diversification. Further we have seen two examples of portfolios that both use asset allocation to massively reduce risk. These portfolios are an orientation for the reader and meant to give him a feeling for how an asset allocation could look like and what to expect from it. I hope I could provide some interesting insights and you enjoyed reading.




Ray Dalio Interview in: Money: Master the Game by Tony Robbins

Apple Part 2

Apple Inc. (AAPL) Part 2

In this part of my analysis of Apple I want to show you how I projected Apple’s likely future earnings. I will also put the projected future earnings in relation to 1. the price Apple is trading at today and 2. the price I bought Apple stock at in december 2018. So we will be able to estimate the future returns and see, if Apple is worth buying.

Projection of Future Earnings + Price of the Stock

First of all we calculate the compound annual growth rate of per share equity for the period of 2009 to 2018, which is 16.19%. Using this growth rate we project the future per share equity ten years from now, by compounding the 2018 value for ten years by 16.19%. Per share equity in 2018 was 22.53$ therefore the projected future per share equity is: 22.53$ * (1+0.1619) ^ 10 = 101$. In order to get the projected future earnings per share we multiply the projected future per share equity by the average return on equity of the last ten years, which gives us: 101$ * 0.3555 = 35.90$. The last step is estimating the future price of the stock. The estimated future price is the projected future EPS * average P/E over the last ten years. That gives us a future price of 15.81 * 35.90$ = 567$.

Calculating the Return  

Based on the estimated future price of the stock (future value) and the price at which Apple trades today (present value) we can calculate the return we will likely get if we buy the stock today. At the time of writing (early dec ’19) Apple trades at 264$, which will be the input for present value. The compound annual growth rate is defined as: {(future value / present value) ^ (1/n)} – 1 which in our case will be: {(567 / 264) ^ (1/10)} – 1 = 0.079 = 7.9%. That means if we buy Apple stock today at 264$ our return for the next ten years is likely to be 7.9% p.a.. I bought Apple for my portfolio in december 2018 for 149$ a share. Using the same formula for CAGR with 149$ as input for the present value we will get a result of 14.2% p.a..


Using these simple steps to estimate the likely return of an investment can help a lot with determining the right time to buy and with managing expectations. We have seen that buying Apple at todays prices would only give us a return of 7.9% which is not very attractive. Therefore we can conclude that even if we think Apple is a great business that we would like to own, it is necessary to wait for lower prices. In my personal case these calculations help me with managing my expectations. Apple stock went up tremendously in 2019, but I only expect 14.2% p.a. over ten years. So I know that if a large part of that movement happened early on that I might have to sit trough some sideways action. These calculations help me forming realistic expectations, thereby not getting discouraged over the lifespan of the investment. As I am happy with my expected 14.2% return I will stick with my investment in Apple, however I would not recommend buying Apple at these high prices.