Four Tips For Buying Stocks In A Recession

Four Tips For Buying Stocks In A Recession
by Glenn Curtis

Keep reading for some tips on how to invest in a troubled economy.

1. Think Resilience

During recessionary periods, individuals aren't able to spend as much money on high-tech gadgets or big-ticket items, such as cars or high end electronics; instead, people tend to put their dollars toward necessities, such as food or utilities. In addition, according to a McGraw-Hill study of advertising performance, companies that can afford to advertise will win consumers at the local markets, regardless of brand name recognition pre-recession, making them strong contenders for your portfolio.

2. Avoid Overpaying For A Stock

In recessionary periods or bear markets, doing your homework is extremely important because overpaying for a stock can have catastrophic consequences.

There are no hard-and-fast rules and certainly no guarantees to help you avoid overpaying. However, you can try to purchase shares in a (promising) company that trade below their tangible book value. Why? In an economic slowdown, earnings might decelerate or even be non-existent. When that happens, something tangible can protect the downside.

In a perfect world, when you purchase shares in a company that trade below tangible book value, even if the company breaks up and is sold off in pieces, you, as the shareholder, may still have a chance of being made whole again through asset sales.

3. Make Sure All the Air Is Out of the Balloon

If a company has been consistently reporting bad news and its stock has been in decline, a risky proposition would be to buy the shares in a recession. After all, who knows whether the worst is over and the stock has bottomed out? In short, the best advice might be to avoid a stock until the stream of bad news appears to have ended, or the market has turned enough to let you have a risk cushion.

But, how can one tell if the worst is over? It's not always easy and there are never any guarantees, but you should generally look for the following hints:

* Press releases or earnings calls indicate that management has become more upbeat. This is subjective, however, so you still have more homework to do if this occurs.
* The company or the sell side starts raising earnings estimates.
* New research coverage has been initiated. This is sometimes a positive sign that future growth or expansion can occur. However, if the company cannot round up the funds to support this section, this could be a negative for the company too.
* A company books large one-time charges in its fourth quarter as a means of lumping all the bad financial news into one time period and then painting a favorable picture for the upcoming year. (To learn more about company tricks,

4. Diversify Your Investments

Although this may go without saying, diversify your holdings when possible. This doesn't mean simply spreading holdings across a handful of stocks, but diversifying by industry and, if suitable, getting some overseas exposure too.

Let's take a look at some common diversification questions:

* Why is diversification so important during a bear market? Very simply, picking a bottom in a given stock, industry, or market is difficult or impossible. Therefore, limiting exposure to a particular security or group of securities makes more sense. You are more likely to stay afloat if you grab many life preservers, rather than just one (which may not keep your head above water in bad weather).
* How much should an investor diversify? Some investors believe that diversification can be obtained with approximately 10 to 20 stock holdings, while others believe in an even larger number of holdings and a variety of asset types.
* What other ways can I diversify? For one, consider mutual funds as a way of obtaining diversification. However, you can choose to explore certain asset allocation strategies and asset classes that best suit your risk tolerance instead.. Whatever way you diversity, and before you invest, it would be wise to consult an advisor. Discuss your unique situation with the advisor to make sure your investments are consistent with your risk tolerance and financial means. A properly diversified portfolio can help smooth returns and make the road to financial security less bumpy

Bottom Line

Risks are associated with buying equities in bear markets. However, with a little homework, you can mitigate some of that risk. Over time, stocks have proved to be a very resilient asset class, and they needn't be avoided if you know how to handle them.