When it comes to a stock market crash, it seems like everything goes out the window. Everybody is relentlessly sells as panic spreads like wildfire.
But as Warren Buffett once said:“be greedy when others are fearful”.
When pessimism begins to set in, it’s time to go to work.
There are three types of stock that I would buy in a stock market crash.
Resilient companies that everybody needs
There are many great companies on the stock market, but when the market is bullish this is already priced in. However, when prices fall because of a market crash, the prospects and cash flows of the companies don’t change. When merchandise is marked down 20% or 30%, it is still the same as when it was full price.
Companies such as Unilever will still be around in a bear market. It’s likely that you already use Unilever products without you knowing it. Are you likely to stop buying soap or dishwasher tablets in a recession? Probably not!
Postage and delivery companies will also still be around in a stock market recession. Life goes on, as it must, and many businesses that people and companies use everyday won’t skip a beat.
Companies that rely on whipping out the begging bowl every six months to fund a new project will struggle in a stock market recession. When cash and credit dry up, then those businesses that are left without cash injections to keep themselves going will see their share prices take a hammering.
In a stock market recession, those businesses that are able to fund themselves through their existing operations will survive and see their share prices react in a more stable manner than their unprofitable and cash burning counterparts.
Businesses with strong balance sheets
Cheap credit is everywhere in today’s market of low interest rates. Many companies are tempted to lever themselves with debt to take advantage of the tax shield but also as a mean of cheap expansionary capital.
While debt is not a bad thing if managed right, companies that over-lever run the risk of a serious situation if their trading turns south. Debt is essentially a call option on the assets of the business – if the bond or debt holder wishes to exercise their right to their claim on the assets of the business, then the business must deliver. If it is unable to do so without going into administration, then go into administration it must.
Many businesses have gone under due to the burden of debt on their balance sheet.
Companies with balance sheets that include plenty of cash and tangible assets (intangible assets can be worth anything) will survive a stormy stock market recession.
I will be keeping an eye out for these types of businesses when the recession inevitably arrives.
Views expressed in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.