Building a strong portfolio amid market meltdown is not only an art but science as well. In a bear market, a vast majority of quality and battered stocks both trades at a significant discount to their previous high price levels and valuations. Thus, it throws a sense of belief in the general investment community that everything which has fallen from their peak in a bear market will attain those high levels in some time again and one could have an easy road for stupendous wealth creation just by picking up any beaten-down stocks.
But there is no free lunch in the stock market as well, and one should always remember this. Coming across a good investment option requires an extensive research exercise in terms of financial position analysis, operation strength assessment, management quality analysis, credit quality assessment, valuation assessment, future growth catalyst and many more, including sector, industry, and macro analysis.
Portfolio building is a rigorous, tedious, slow, and sometimes even meandering process. As an investor builds a portfolio for a long-term per se, to achieve long-term goals and financial freedom, you should not be much worried about what is happening today or what's going to happen after 10-day or a month or a year time, because that can't help to build a strong portfolio. Of course, you should buy scrips in a bear market which are actually trading below their intrinsic value, but this decision should be based on proper rationale and not on the basis market buzz and hypes.
So here in this piece of work, we are explaining a few strategies to build a strong in a bear market kind situation.
- Search companies with a higher margin of safety
One of the best investors of all-time, Benjamin Graham, had discussed the concept of margin of safety in his bestselling book “the intelligent Investor”. Graham emphasises that no matter how much intelligent you are, one risk in stock market investing no one can negate is the risk of being wrong. To deal with this situation, he introduced the concept of margin of safety. A company which is generating positive free cash flow after meeting its entire capex, debt, and other business obligation. Higher the positive free cash a company has, a greater margin of safety it provides to its existing and potential shareholders. Because these free cash flows give a business a headroom for future expansion and to deal with any contingent liabilities. Companies with negative free cash flow will face difficulties in sustaining during the tough time or in an economic downturn.
- Buy Future Trends Today
Businesses which will be in fashion in the next decade or so must have started creating its root today, therefore identify those businesses and invest in these companies to buck the future trend. These companies create astronomical returns in future. As we saw in many cases in the past such as Apple which came up with an IPO in 1980, Google came up with an IPO in 2014, Netflix in 2002, Amazon in 1997, PayPal in 2015 and recently we have seen how one American Video Communication company "ZOOM" has emerged out as big winner, its shares skyrocketed amid bloodbath in the global financial market. Zoom went public in March 2019. All of the companies mentioned above were unique businesses, and those who had invested in these companies in the early days have bagged humungous return and created a large amount of wealth as well.
- Add Consistent Compounders
Consistent compounder stocks are those who hand out a positive price return only because of their stronger fundamentals against the peer group, in other sense, a high-quality franchise always outperform their low-quality peers in any efficient market. In a market downturn as well, consistent compounders sustain strongly against the blow and outperform the benchmark indices and peer group significantly. These stocks are robust and bounce back quickly into the fame of a bull trend. Consistent compounders are built upon strong competitive advantage in terms of prudent capital allocation, competitive edge on products or services they are offering, they are run by quality management, and more often they trade at premium valuation against the industry peers.
- Never Overpay – Value intelligently
On May 06th, 2020 during the mid-market hours, we did an analysis of the LSE listed stocks and found that there were around 777 stock listed and traded on the exchange, which has traded below their book value or a PBV ratio of less than 1x. Are they all value picks? Can we directly infer that every stock trading below PBV ratio of 1x is value investing play? Are all of them worth buying just because the price you pay for each one of their stocks are less than per share worth of the company?
The answer is NO! Every single stock which has traded below their per-share value are not good bets, though there are chances you can find few quality businesses at a discounted price, this would not be the case for every stock.
Only stocks which have positive Return on Equity (or Common Stocks) should trade above its book value or PBV ratio above 1x. Because a company with negative ROE are wealth destruction bets for a shareholder’s point of view, as each of their losses get adjusted from their book value and reduces book value per share or owner’s claim with the same proportion, so technically they should not trade above their book value, as they are reducing book value every year through accumulated losses from operations.
- Do not time the market.
Many people mix-up the concept of portfolio management with trading businesses. One must understand, investing and trading are two separate businesses, and those who try to mix both the things will end up at the dead-end. Timing the market is the business of traders, they are having formal training and use sophisticated tools to benefit from the momentary movement in the market, mostly it is capitalised through the use of algo trading and human intervention is very limited. As an investor, you should try to find businesses which are worth a Pound (£) but available for few pence (GBX). This will increase your investment yield, and you would not need to predict market movement in the short-term.