When markets sell off, sometimes quality names with solid fundamentals get placed in the bargain bin along with everything else. When that happens, make sure you have your wish list in place.
When there’s a tough stretch in the stock market, sometimes premium-quality stuff gets placed into the bargain bin along with everything else. That’s why investors should consider making and keeping a wish list, so that when the market is in sell mode, you can look for bargains.
That doesn’t mean jumping in without a plan just because some high-flyer stock is suddenly trading at “only” 50,000- foot multiples instead of 300,000-foot ones. It does mean having a good sense of where you think a stock should be trading based on earnings, future growth potential, and fundamentals, and perhaps buying it not all at once but rather in increments that allow you to take advantage if prices get even lower.
The words “wish list” might remind you of those old wish book catalogs a lot of us drooled over around holiday time when we were kids. (Would this be the year we got that flashy bike, slot car track, or luxury dollhouse?) But a serious investor wish list is one that you need to sit down and research as well as approach with a lot of care. A stock that looks cheap might not actually be cheap, and just because a stock’s price has fallen doesn’t necessarily make it a bargain.
Instead, a “wish” stock is one that’s through no fault of its own gotten punished along with the rest of the market—the whole baby-and-bathwater thing—despite having great management, strong position in its industry, an outlook for sustained earnings growth, and a solid market for its products. While this article can’t recommend any particular stocks that fit this description, it can help you find these stocks and zero in on ways to find undervalued ones.
Let’s consider two theoretical companies in the same industry, operating in a tough macro climate where a fundamental challenge blows headwinds at everyone. Think of the 2020 coronavirus outbreak, for instance, or rising interest rates that helped push the market nearly into bear territory in late 2018. A lot of strong companies got bludgeoned along with everyone else at those times.
We’ll assume that both of the theoretical stocks are suffering in a market that’s in 10% correction mode and may ultimately fall further. Investors are behaving in “risk-off” fashion, diving into perceived safe-haven places like Utilities and bonds. Suppose both of the companies’ shares are down 10% from recent highs, and both might seem like enticing targets for investors to have on their wish lists.
How might an investor know which of the two is really worth a bid? We’re going to make this comparison tough. Neither company just got hit with a government investigation or lost its CEO in a scandal—things that would be obvious signs of a stock in which investors need to be wary. Neither is having any major fundamental supply or quality issues with its product lines, either.
Company A. The first company (Company A) has been in business for 100 years, has historically paid a solid dividend, and has an experienced management team. The customer base is global and diverse. It’s a mature company that’s well known and admired. Earnings have been growing in the mid-single digits but not much above or below that in any recent quarter.
Company B. While it’s in the same industry as Company A, the second company (Company B) has been growing faster and expanding its markets and customer base more quickly. Its products are fresher and more creative than Company A’s, and seem to be getting a foothold among more innovative customers. On the other hand, its cash flow isn’t as solid, and it’s had both positive and negative quarters recently on the earnings side. The positive quarters have been great, but negative ones sometimes come as a surprise and tend to knock down the stock.
We have the parameters down, but it’s still way too early to think about which company to buy.
First of all, no two wish lists are the same—much depends on each investor’s objectives, risk tolerance, and time horizon, among other factors. Your wish list depends on where you are in your investing journey. Both companies might be on different investors’ wish lists for different reasons that go beyond the fundamentals.
For instance, if you’re an older investor looking for yield, maybe you’ve been looking for a good chance to climb into shares of Company A and now seems like a good time with the stock down 10%.
Alternatively, if you’re a younger investor with a longer time frame and the ability to withstand some bumps and bruises along the way, Company B might look like a bargain and you want to take advantage.
Before you ever invest in anything, make sure to take time to ask yourself some big questions and put together an investing plan. If you have specific goals in mind like buying a home or sending your kids to college, your plan could look very different than if you want to eventually live off of yield from your investments. If you need your money in 10 years, that’s a very different looking wish list than if you can wait 40 years.
Let’s assume, just for now, that you’re a typical long-term investor who’s not particularly old or young, and that you might want to have some dividend payers and some more exciting growth names in your portfolio. How, then, can you decide between these two very worthy but very different companies?
First, look more closely at each firm’s fundamentals. As a TD Ameritrade client, you can conduct a whole host of fundamental analysis on the tdameritrade.com website. Simply login, type in a company name or symbol, and go to the Fundamentals tab (see figure 1). That’s where you can view each of the two companies’ stocks, check valuation ratios such as price-to-earnings, price-to-book, and more. You can also drill down further into valuation metrics, with an industry comparison, under the Valuation tab. Want to tap into 3rd-party professional analysis? You can find those under the Analyst Reports tab.
That last one is key, because you’re a smart investor (right?) and you don’t plan to buy right away. Instead, you’re going to monitor each company at least for a while, because it’s better to miss out on a potential bargain by waiting too long to buy it than it is to jump in without knowing enough and get hit by a falling knife (to use trader parlance).
Sounds like a lot to monitor, right? Let the platform do the monitoring for you, with customized Alerts, found under the Research & Ideas tab. For any security, you can use an alert to notify you of certain price targets, ratings changes, earnings consensus, end even news events.
It’s also a good idea to listen in to the next quarterly earnings call from the company on your list. If it's a crisis situation for the entire economy, listen closely to what the executives say about how they’re weathering the situation and if they’re perhaps finding ways to shield themselves—or even benefit from—the economic headwinds. Sometimes watching how a company handles trouble in the economy can tell you a lot about its future health and its ability to roll with the punches, so to speak. These are times when management often proves its mettle (or perhaps its incompetence).
Once you’ve gotten the hang of following the fundamentals, apply them to companies you’d like to own at a specific level. For example, suppose you say you’d like to own XYZ if its price were to drop about $20 from current levels, but only if it does so with no material change to its business environment. If that’s your view, you should monitor both prices and its valuation metrics.
But remember: The stock market is forward looking, and some fundamental data only considers the past. That’s why price alone shouldn’t necessarily be the determining factor. And if you think the market might have given you a short window in which to scoop up a bargain, but you’re not quite sure? You might consider picking up a smaller chunk—maybe one-third or one-half your target position, then watch and wait.
Easy? You wish.
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