How to Buy Stocks in a Bad Market: Are there Any Safe Investments?

The other day, I reviewed Warren Buffett’s comments regarding moving 100% into U.S. stocks. Despite, or perhaps because of the widespread volatility and fear in the market, right now may be a great time to find some very solid stocks on the cheap. Who’s to argue with Buffett?

If the market downturn has you excited about finding bargain equities, you’re going to want to be very careful about what you choose to invest in. Let’s cover some rules to follow and metrics to look at given current economic, environmental, and global conditions.

8 Rules to Follow when Buying Stocks During a Tough Economy:

In a certain recession like this there are some general rules you must follow in order to avoid being burned when purchasing stocks or other equities:

1. Look for equities that you can own for at least 3-5 years.

2. Unless you’re a professional day trader, don’t watch the ticker on a daily basis. You’ll go insane and you’ll be tempted to start making short-term trades. You don’t have the know-how, technology, and connections to compete with the pros, so don’t try.

3. When (not if) your equity dips in price, hold onto it if the fundamental reasons you bought it remain true.

4. Increase your position on dips and buy at a low cost through discount brokers, such as Zecco or TradeKing.

5. If your equity becomes overvalued, sell it. From time to time, you may see irrational rally’s of 20% or more. If this leads to an overpriced holding, take your profit, go, and return when it dips again.

6. Use limit orders only. For further guidance on how to make a stock trade, check out this post: How to Buy a Stock.

7. Don’t trade after hours, you will get burned by experts who know how to take advantage of inexperienced investors.

8. If you’re not willing to do the research, don’t buy stocks at all. Instead, choose ETF’s and low cost index funds from beaten down and undervalued market sectors.

6 Metrics to Look at when Buying Equities During a Recession:

1. Revenue Growth rate versus its P/E (price to earnings ratio). If revenue growth rate is higher, you may have found a good value.

2. Cash is King. How much cash does the company have on hand? If total cash holdings are higher than the company’s market valuation, you may have found a company that is built to survive and thrive during a credit crisis.

3. Market Leaders. What companies are the leaders within their industry? Those with a small and/or declining market share may not have the strength to get through a recession, while those who are gaining share are probably going to come out even stronger

4. High dividend yields. There are some very attractive dividends out there right now in the range of 5-7%. If you can find a company that has a high yield, an increase in income, and is not in serious financial trouble, you have a bargain. Also, companies with a long history of increasing their dividends do so because they are usually loaded with cash and want to reward investors. Be wary of declining companies that keep high dividends so as to not lose investors.

5. Price/Book ratio. Look for 1.5 or below.

6. EPS growth. It may be hard to find in this market, but look for companies with an EPS that has increased year over year over the last 5 years.

How Do I Find Stocks that Meet the Criteria that I’m Looking for?

Fortunately, there are a number of free stock screeners out there to help you find what you’re looking for:

• Google Stock Screener – quick and easy to use interface.
• MSN Pro Stock Screener – perhaps the most in-depth in terms of number of metrics to look at.
• Morningstar Stock Screener – also includes Morningstar ratings.