Stock Market Crash: Want to pick stocks in a falling market? Remember these 5 golden rules

India plays the T20 World Cup later this year. Some of the leading and established players should not or should not be part of the team in its current form.

The dilemma here is whether to trust the oft-quoted saying in cricket “Form is temporary and class is permanent” and give them another chance or look elsewhere.

We would have to wait and see how this plays out on the cricket pitch and how the team is built. As investors, we too face a similar dilemma, especially when markets are in free fall.

What stocks should we support or choose? Those that have consistently performed and built wealth, but are currently stuck in a downward spiraling market or have passed their sell-by date?

Going back to the cricket analogy. History has shown that the team was always built or had an element of class or quality.

Whether one believes this or not in terms of cricket is up for debate.

When investing, what is not usually up for debate is that class or quality almost always comes back.

So what it essentially means is looking for quality when choosing stocks in these turbulent times. Here are some rules to follow:

1) Earning stability
Look for companies that have shown a trend in earnings growth with earnings improving regularly over a period.

This means that the company will have much greater financial and operational stability. When sentiments improve, shares of such companies quickly appear on investors’ radar. Markets and investors love stability and earnings visibility.

2) Feedback Matters
Invest in companies that are available at a decent valuation. Not all stocks with a high P/E ratio are bad, and not all stocks with a low P/E ratio are good.

There are many companies that don’t actually have a real business to justify their valuation.

Similarly, there are many good businesses run by good management that can be made available at attractive valuations.

As an investor, you must determine if the stock is worthy of that valuation.

In a down market, valuations become a buzzword and an important factor because it is a safe zone to stay in.

Avoid companies where valuations are excessive. But also beware of value traps, not all stocks available at low P/E are necessarily value buys.

3) Good management
This is a qualitative call. Good management with a proven track record will get a company out of tough times faster.

Good management keeps the company at the forefront in terms of products and technology. These stocks tend to have a faster recovery rate when confidence improves.

4) Avoid high debt
All companies have debt. It is an important indicator of the health of the business.

If a company has a high debt-to-equity ratio in a challenging business environment, it may find it difficult to meet its debt obligations.

A company with strained and stretched finances is a long shot. Valuations and sentiments are bound to plummet sooner rather than later.

5) Kindness to shareholders
One of the ways a company can be shareholder friendly is to reward stakeholders with regular dividend payments.

Stability and reasonable dividend payments over the years mean the company is fairly secure in its business. When capital appreciation is a challenge, dividends are another source of income.

When looking for stock picks in a falling market, a bottom-up approach to investing is preferred. Evaluate each company you want to invest in based on the general parameters mentioned above.

Compare them with their peers. Most importantly, maintain an asset allocation based on your risk profile and investment objective.

(The author is president of TradeSmart)

(Disclaimer: The recommendations, suggestions, points of view and opinions given by the experts are their own. These do not represent the views of the Economic Times)

Add Comment