Make a Shopping List for Stocks
Identifying candidates to buy before a market sell-off can help you execute a buy-the-dip plan.
Did you ever go to the grocery store without a list and end up spending more than you wanted, buying junk food you'd vowed to avoid or succumbing to an impulse purchase just because something was on sale?
Well, failing to compile a shopping list of stocks to buy when the next big market drop occurs – and shares go on sale – can also be costly. It's harder to execute a buy-the-dip plan when markets plunge and fear spikes if you haven't prepared in advance.
"The windows of opportunity don't last very long," says Justin White, manager of T. Rowe Price All-Cap Opportunities. Having a list helps take the emotion out of your decision and allows you to "act quicker and buy with greater confidence when the time comes to strike."
Stock prices don't go up forever – even in bull markets. There are inevitable downdrafts along the way.
Since World War II, pullbacks, or drops of 5% to 9.99% for the S&P 500 stock index, have occurred every 15 months, on average, according to CFRA Research. Corrections, or declines of 10% to 19.99%, strike about every three years, and bear-market downdrafts of 20% or more (such as the 34% slide in 2020) occur roughly every six years.
Savvy investors take advantage of those unpleasant market downturns to fill their shopping carts with stocks they covet at more-attractive prices. Such bargain-hunting frequently pays off because the broad market goes up more than it goes down.
The S&P 500 has been in bull-market mode 82% of the time since the end of 1945, CFRA data show. Hence, a good way to boost long-term returns is to buy when stocks are temporarily depressed. "History reminds us that investors should focus more on when to buy than when to bail," says CFRA chief strategist Sam Stovall.
Here are some strategies to help you pinpoint stocks to buy on weakness because they have the potential to rebound in a big way.
Seek Out the Best of Breed
High-quality stocks don't often sell at bargain prices. In good times, the stocks that appreciate the most and command higher price-earnings ratios tend to be leaders in their respective industries and have business models with staying power. They possess such bullish traits as a competitive advantage over rivals, strong management teams, products and services whose sales will benefit from long-term trends, and a track record of generating lots of free cash flow (cash profits left after investing to maintain the business).
A great company doesn't become a lousy one just because Wall Street suffers a steep correction or bear market. "These best-of-breed companies are what you want to own long term," says Thomas Plumb, manager of Plumb Balanced.
Plumb, for example, is bullish on the long-term prospects of financial companies that are well positioned to profit from the ongoing shift toward digital and contactless payment systems, including established heavyweights such as Mastercard (MA) and Visa (V), as well as upstart PayPal Holdings (PYPL).
After sell-offs, buying industry leaders such as these, or dominant companies such as e-commerce giant Amazon.com (AMZN), is a good way to boost the quality of your portfolio and enhance returns, says Plumb.
Head for the Hardest Hit
Consider adding the most bombed-out stocks in a market rout to your shopping list.
In the 25-year period ending in 2020, the three sectors and 10 subindustries in the S&P 500 that fell the most during market declines of 10% or more posted larger returns than the broad market gauge during the ensuing rebound, CFRA data show.
The S&P 500 was up 25.2%, on average, six months after such declines, compared with an average 30.6% for the three lagging sectors and 42.7% for their 10 subindustries. "The groups hit the hardest tended to rise higher from the ashes," Stovall says.
But there's a major caveat when buying distressed shares: Often, stocks that "explode off the bottom" are financially strained firms that investors take a flier on, says Plumb.
"The perception of the company just has to go from terrible to bad" for the stock to make a big move, he says. He cites the bust-and-boom shares of General Electric (GE) as a prime example. GE shares lost more than half of their value, dropping below $6 each. The shares, which he doesn’t own, have since doubled. But Plumb notes that companies with long-term issues to fix often stall after their initial rebound.
GE is still challenged by a heavy debt load, poor cash flow, ongoing weakness in its lending unit and a jet-engine business hurt by the pandemic. "At the end of the day, you don't want to own companies with structural problems," Plumb says.
Depend on Pillars of Strength
Set your sights on companies that have enough working in their favor to withstand temporary market setbacks. T. Rowe Price's White uses a scoring system that looks at four key aspects of a company, which he dubs pillars: Is it a high-quality company? Is it poised to top or beat investor expectations on earnings, revenues and other yardsticks? Is the business outlook getting better or worse? Is the stock selling at an attractive valuation?
"The more things tilted in your favor, the better," White says. But don't be scared off if not all four pillars are bullish, he adds. For example, Euronet Worldwide (EEFT), a money-transfer and e-payments company that also operates ATMs, doesn't currently score well on the "getting better or worse" pillar because of weakness in Europe due to a slower reopening in the wake of the pandemic and fewer international travelers. But the stock is a buy in White's book because it scores highly on the other three metrics. "It could double in two to three years," he says.
Similarly, although Zoom Video Communications (ZM) has seen growth in its remote-meeting business decelerate as the economy reopens and people head back into their offices, it still has three of the four pillars working in its favor, White says. It's a top-notch company that will likely top sales and profit expectations next year. And the high valuation is more reasonable when you look out a few years. "If a stock scores well, I move in, and if it doesn't score well, I move out," he says.
Look for Investment Themes With Legs
Keep an eye on leaders in businesses with a bright growth outlook that are likely to generate sales and profits well into the future, says Daniel Milan, managing partner at Cornerstone Financial Services.
With a shopping list in hand, you'll view market downturns in a whole new light. Says Milan, "Getting in at opportunistic entry points is great."