The stock market crash shaved chunks off the share price of nearly all companies. A lot of panicking investors sold shares or index funds indiscriminately. As such, the share prices of quality companies suffered the same fate as poor ones. The good news is that shares in quality companies are now available at a discount.
Here are five pointers for finding stock market bargains when the markets are in panic mode.
Invest, don’t speculate
I make the distinction between investors and speculators as follows. A speculator thinks about what will happen to a stock price in the short term. An investor thinks about what will happen to a company in the long term.
Speculation may have paid off during the market crash. Shares in some companies, like content streamers and video conferencing software providers, rocketed for a quick profit. But how will these companies fare once things return to normal?
An investor will assess companies’ prospects during this crisis and for years beyond it. Companies with great long-term prospects happen to have had their share prices smashed by the market crash and are long-term investment bargains.
A company has a competitive advantage when it can protect its market share and profitability against competitors. High costs might present a barrier to entry into an industry. Strong brands might make it difficult for a competitor to tempt customers away. A company might be large enough to negotiate lower prices with its suppliers compared to smaller competitors, thereby keeping its costs down.
But not all competitive advantages are created equal. For example, the car making industry has significant barriers to entry but can boast only low, single-digit, below average operating margins. Utilities, on the other hand, can produce above-average operating margins.
Investors should look to buy shares in companies that have competitive advantages that help maintain above-average profitability for years to come.
Dividends for income
An investor looking for income needs to find companies with a track record of paying dividends for a number of years. Ideally, the dividends have been growing and are expected to grow further. Companies that have a clear dividend policy, like paying a percentage of profits as dividends, make it easier for investors to assess the likelihood of dividend growth.
Companies that pay dividends quarterly, as opposed to semi-annually or once a year are advantageous for income investors. During the current crisis, annual payers might be forced to cut dividends entirely. A quarterly dividend payer has the chance to assess the situation every three months.
Strong and stable
Having manageable debt is always an advantage. It is not so much the size of the debt, but the cost of servicing it that matters. If a company spends a fortune on interest payments, then a small drop in revenues can push the company into a loss.
But the size of the debt pile matters as well. Highly leveraged companies (having much more debt than equity) may struggle to secure additional lending in a pinch.
Investing everything in one stock is a recipe for disaster. What if management makes a single terrible decision that ruins the company. Backing multiple companies in the same industry is not much better as they will be affected by the same themes. It’s better to invest in various quality companies in different and vibrant industries.
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James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.