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What should I buy in a declining market?

Warren Buffett, arguably the world’s number one investor, has lots of good advice for potential investors. It may surprise you to hear that one of his preferred times to buy equities is during a market downturn.

Fear causes people to panic sell, which is why a declining market is often a great time to buy.

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Going against the crowd is not an easy thing to do though. The trick is to be confident in what you’re buying. Do your due diligence, carefully research the companies you’re interested in and only buy shares in businesses that you wholeheartedly believe can go the distance.

Failing to plan is planning to fail

There’s no perfect time to buy and timing the market is difficult for even the most experienced of investors. If you’re confident that you’re buying shares in a quality company and are prepared to hold them for the long term, then the price you pay becomes somewhat irrelevant.

Inspect the company’s annual report. Look for signs of weakness, such as negative cash flow, when the company’s cash payments exceed its income. 

Look for an economic moat which would be a sustainable competitive advantage that will endure. 

Check if the dividend yield is long-established, and whether it has been increasing on a regular basis. Does it have sufficient cover so it’s not at risk of a cut?

Looking at the price-to-earnings ratio (P/E) can give you a sign of whether the share price is trading below fair value. Anything north of 15 could be considered high, while above 20 is probably overvalued. Popular stocks often end up with a high P/E because they’ve been overbought when little else is appealing. These stocks may still be worth picking up during a declining market. 

On the other hand, too low a P/E could be a warning sign. 

Sustainable sectors during a recession

Essential consumer goods such as food and drink tend to do well in a recession as they have longevity. People always need to eat and drink.

Information technology is at the heart of every business nowadays, and that’s only getting stronger. One firm I’ve been keeping an eye on is Meggitt (LSE:MGGT). This company leads the way globally in extreme environment engineering. It’s an innovator specialising in advanced technologies in aerospace, defence, and energy – three areas the world increasingly depends on but is progressively opposed to.

In recent times airlines have been at the mercy of price pressures, increased competition, and the fallout from the Boeing 737 MAX fiasco.

Meanwhile, oil stocks have been in sharp decline because of reduced demand and the economic effects of the coronavirus.

Political instability and the on-again, off-again US-China trade war have done plenty to warrant an increase in demand for defence stocks, but these are also out of favour with climate change activists.

While none of these sectors feature highly among ethical investors portfolios, they are all necessary components of our modern world. Therefore, I think the strong will survive and my favourites in these sectors are Ryanair, BP, and Meggitt.

Meggitt has a £5bn market cap, P/E of 35, earnings per share of 18 and a 2.5% forward dividend yield. 

If you’ve chosen well when buying stocks in a declining market, then when sentiment improves, you’ll be holding on to a portfolio of prosperous stocks with strong share prices.

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Kirsteen has no position in any of the shares mentioned. The Motley Fool UK has recommended Meggitt. Views expressed on the companies mentioned 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.