Markets are cyclical, so over time they move up and also down. Many investors live in fear of a stock market crash and seem to spend half their lives expecting one. That is why some people joke about investors who have predicted eight of the last two stock market crashes.
But a crash is a serious thing. It can be scary. It can also present incredible opportunities. Here are four ways I would seek to profit in a stock market crash, whenever it comes.
1. Buy quality on sale
One of the most attractive things to me about a stock market crash is that it lets me buy what I regard as high-quality, blue chip companies while their prices are unusually low. That gives me more bang for my buck.
Take a company like Legal & General, for example. I like its established business, its iconic brand, and the cash generative nature of its business. That enables it to pay out dividends with a yield of 5.9%.
But if I had bought the shares in March 2020, I could have bought them for 51% of what they trade at now, at the time of writing this article yesterday. So I could have got almost twice as many Legal & General shares for my portfolio then as the same money would buy me today.
Crashes often throw up very cheap prices for only a short amount of time. What if I wasn’t ready to buy when Legal & General crashed in March 2020? After all, an insurance company faces risks such as price competition and unexpected payouts due to novel situations. So maybe I wouldn’t have fancied Legal & General in March 2020 without researching the risks more fully.
Well, I could have bought it half a year later, in September 2020. The price was higher than it had been in March. But it was still only 58% of where it stands now. Crashes often work like that. Just like an earthquake, there are tremors beforehand and aftershocks later on. So even if I cannot get the shares I want at their cheapest point, a crash may still throw up a lot of good opportunities to buy them in the following months or years at a more attractive valuation than before.
But some crashes are very short. That is why I think it is helpful to make a shopping list beforehand of companies I think could be good additions to my portfolio. I will not have enough time to do that research properly in the heat of a crash.
2. A stock market crash can offer higher yields
There is something else I missed by not buying Legal & General at those March 2020 low prices. Not only did I miss out on a share price gain, I also lost the opportunity to get a double-digit yield.
While the 5.9% yield today attracts me, if I had bought back in March 2020, the same shares would be yielding 11.5% today based on my purchase price. That is because a dividend yield is a percentage of the price one pays to buy a share. So, the cheaper I can buy a share, the higher the yield will be if it pays a dividend in future.
There were other double-digit yield opportunities I missed in the crash too. For example, asset manager M&G yields 8.9%. But if I had bought it on 20 March 2020, the current yield would be a mouth-watering 16.6%.
3. Learn one’s own investing psychology
Something many people underestimate about investing is how much of it is about temperament. Indeed, legendary investor Warren Buffett says, “The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd“.
A lot of investors think they know their own temperament. But, as Rudyard Kipling’s poem If reminds us, it is easier to behave calmly and rationally when everyone else is doing the same thing. In a market meltdown, by contrast, behavioural cues can be confusing. Fear stalks many investors’ minds as they see the value of their portfolio fall rapidly and sometimes dramatically.
Anybody who invests for a long enough time will experience a market crash. I think that can be valuable in helping one understand one’s own psychology. What makes someone do well or badly in such a situation is not necessarily the crash itself. Rather, it is how they respond to it.
To understand one’s investing psychology and prepare better for future stock market crashes doesn’t just happen. It requires honest, disciplined analysis of what went well and what went badly.
4. Move into recovery themes
A crash can offer me another opportunity, which is to move into investment themes that I think could do well after a crash.
A lot of the economy is cyclical to some extent. That can mean that the economic factors that drive a crash can also lay the foundations for its recovery. Consider oil and gas as an example. In 2020, energy stocks plummeted. To cut costs, companies slashed their capital expenditure plans by tens of billions of pounds. But spending less on oil exploration today means there will be less oil available in future. That could drive up prices if demand stays the same while supply shrinks. So when Exxon slashed spending in the last crash, I took it as a buy signal for my portfolio. That has turned out well for me, but there are risks in buying companies whose plans have been thrown into doubt. Sometimes, their businesses never recover. Reduced capital expenditure could simply reflect reduced future customer demand.
It can be easy after an event to figure out what the investment theme was. After a while in lockdown, for example, a surge in home delivery seemed inevitable. But it can be hard to identify such themes before they happen. That is what I would seek to do, to buy possible post-crash winners when they are deeply discounted.
