The Nasdaq Composite Y Russell 2000 they are already in a bear market, which is a drop of 20% or more from a previous high. And after this week’s settlement, the S&P 500 it is also now just a few percentage points away from a bear market.
walt-disney, Amazon, Metaplatforms, starbucksY Adobe they are just a few names in the long list of companies whose share prices are down 40% or more from their all-time highs. Other once-beloved growth stocks like Shopify (NYSE: STORE) Y Netflix they have seen their share prices fall more than 75% from their peaks.
Bear markets can create life-changing wealth by providing investors with buying opportunities, but that doesn’t mean it’s time to dive headfirst into the abyss without a plan. Here are three mistakes worth avoiding during a bear market.
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Invest in companies you don’t understand
Probably the easiest way to lose money in a bear market is to invest in businesses you don’t understand. Several companies have seen their valuations soar to dizzying heights in recent years. Thrill-seeking investors looking for high-risk, high-reward stocks flocked to these names, many without understanding the fundamental business. The result was large swings to the upside followed by catastrophic losses to the downside.
During a bear market, things get very real very quickly. An investor who sees his portfolio go from forest green to scarlet in a matter of months without knowing why he is likely to lose his temper and run for the exits. If he doesn’t understand the companies he owns, it’s hard to know what decision to make and when.
Bear markets test fundamentals. Companies with good cash flows and healthy balance sheets tend to survive bear markets and grow over time. The ones that don’t tend to be eliminated.
Anchor all-time highs as a fair price or a price the stock will reach again
Another big mistake investors can make is thinking that a stock’s all-time high is a fair price or a price the stock will return to one day. After all, if a stock is down 80% from its peak and returns to that peak, that would be a 500% return. I’m sorry to say, but many stocks will never reach the all-time highs reached in 2020 and 2021. Or, if they do, it could take a long time.
As mentioned above, Shopify stock is down more than 80% from its all-time high. Despite compelling fundamentals, strong growth, a well-managed business, and e-commerce industry tailwinds, Shopify stock still isn’t cheap by any means. The company has a much more attractive risk/reward profile now that the share price has dropped so much. But that doesn’t mean Shopify needs to have a market cap of over $200 billion (which it did at its peak) until it proves it can maintain a high growth rate and achieve a consistent gross margin.
However, just as many growth stocks moved too far higher, others moved too far lower. Although Shopify is expensive, the risks are starting to look a lot less scary relative to the reward. Shopify has its problems, but at the end of the day, it’s an incredibly well-run company with a lot of potential for growth. Probably the worst part of Shopify is its rating. Since that issue is much less important now, it seems like a good time for investors to start looking at stocks like Shopify.
That said, entering a stock of this type assuming that it will earn a return of more than 400% in the short term is the wrong approach. Rather, depressed growth stocks with quality fundamentals are best approached as businesses you believe in and feel comfortable owning for at least a five-year period.
Bets on speculative stocks
Another big mistake is trying to catch a falling knife on a company that is down a lot simply because the stock is down a lot. This error is a combination of errors one and two and a common decision investors will make in a bear market. The temptation to see a stock that has been sold and try to buy the dip without knowing why can lead to painful losses. The percentages may surprise you.
let’s choose roku (NASDAQ: ROKU) Y Robinhood Markets (NASDAQ: BELL). As of January 1, both companies were already down 50% to 75% from their all-time highs. But since then, each stock is down an additional 50% to 65%.
The math sounds confusing at first, but it makes more sense with real numbers. Let’s say an investor bought a stock at $300 per share in 2021 and then opened in 2022 at $100 per share. That would be a 67% loss. Then four months later the stock was $50 a share. The reduction from the maximum is 83%. But even the investor who bought the stock 67% down at the beginning of the year would already be down 50%.
This exact scenario has played out with many growth stocks falling out of favor. Okay, that doesn’t mean they’re all bad. In fact, some seem like phenomenal buys now. It’s just to say that just because a stock is down a lot doesn’t mean it can’t upset investors trying to buy the dip.
Let time be your best friend
Instead of trying to be a hero and fight the fences during a bear market, the best course of action might be to simply save what you can, dollar cost averaging on the stock market (especially when stocks are on sale). and stick to quality companies with strong fundamentals and the best chance to persevere through this and future bear markets. This plan may not have the greatest benefits, but it certainly offers a risk/reward profile that makes sense to most investors.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of the board of directors of The Motley Fool. Daniel Foelber has positions at Shopify, Starbucks, and Walt Disney and has the following options: Long January 2024 $145 calls at Walt Disney Long January 2024 $80 calls at Starbucks Long July 2022 $145 calls at Walt Disney Long June 2022 $170 calls at Walt Disney, long June 2022 $400 calls at Adobe Inc., long September 2022 $600 calls at Shopify, short January 2023 $140 calls at Walt Disney, short January 2024 $100 calls at Starbucks, short January 2024 $150 calls at Walt Disney, short January 2024 $600 calls on Shopify, short July 2022 $150 calls on Walt Disney, short June 2022 $175 calls on Walt Disney, short June 2022 $425 calls on Adobe Inc., short November 2022 $120 calls on Walt Disney, short $135 October 2022 calls at Walt Disney, and $115 short calls from September 2022 at Walt Disney. The Motley Fool has positions and recommends Adobe Inc., Amazon, Meta Platforms, Inc., Netflix, Roku, Shopify, Starbucks, and Walt Disney. The Motley Fool recommends the following options: January 2023 Long Calls for $1,140 at Shopify, January 2024 Long Calls for $145 at Walt Disney, January 2024 Long Calls for $420 at Adobe Inc., January 2023 Short Calls for $1,160 on Shopify, January 2024 short calls for $155 on Walt Disney, and $430 January 2024 short calls on Adobe Inc. The Motley Fool has a disclosure policy.