Op-ed: After the latest market wreck, here's how we decide what stocks to buy now
- Stocks enjoyed a big rally last week, but there are plenty of names that are available at a discount – if you know where to look.
- Tech companies, which were high flying last year, were dominant among stocks that have fallen.
- If you’re digging through the bargain bin, focus on companies with earnings support and lower price-earnings multiples compared to prepandemic levels.
Bargains are addictive.
During my teenage years in Boston, my friends and I would frequent Filene's Basement, rummaging through tables piled high with designer clothes, scavenging for amazing items, marked down as much as 90% from their original price at Neiman Marcus or Saks Fifth Avenue. My most memorable purchase, about fifty years ago, was the peach Dior hot pants outfit I wore that night to a club that ignored the lack of my resemblance to the face on my license.
Since bargain hunting runs in my blood, a market that thrashes the Nasdaq Composite by 23% and causes the S&P 500 to plunge by 13% is one that gets me excited. Every professional investor has their criteria for screening the names that make the cut into the portfolio. The key is to narrow down the list according to the most desirable attributes.
Even though both the S&P 500 and the Nasdaq rallied hard last week, there are still legions of decimated stocks to consider as buy candidates. Their decline is understandable in light of the hyperventilating equities that crested in late 2021 from the weight of inflation, interest rate shocks, and an impending war in Ukraine.
They include the list of 153 stocks trading on both NYSE and Nasdaq with market capitalizations over $5 billion that are down 40% or more from their twelve-month high. Since many of these are years away from earning a profit, we also screened for equities having $10 billion or more in market value, whose price has fallen at least 30%, with 2022 earnings above the 2021 level, resulting in a 73-name cohort.
The dominant industry represented within the wreckage of those stockpiles is technology, which was clearly the group that became the most super-charged, momentum-driven sector during the pandemic and through much of 2021.
There are also other factors that make us comfortable with the belief that the market has been oversold. For example, Bespoke Investment Group published a report on March 14 showing that the Nasdaq's bear-market streak was three days away from achieving the status of the longest decline since 2008-2009 and the Great Financial Crisis.
One illustration of the recent extremes is the relative underperformance of growth versus value stocks. Year-to-date, the Russell Growth indices, for large cap, mid cap, and small cap, are 13% to 16% behind their peer Value composites.
Value investors might argue this disparity is justified, given the number of years during which growth has beaten value in the past decade. Still, the severity of this decline looks and feels like capitulation. When stocks fall in steep chunks for weeks on end, we eventually get to a point where every hedge fund, mutual fund, and trigger-happy, phone-app trading player with big margin calls, has dumped their shares.
So, if the set-up is right to buy, the decision-making is next. The easiest options are purchasing an S&P 500 index fund or, for a higher risk appetite, a fund comprising the 100 largest Nasdaq names contained in a QQQ ETF. Because of the huge bounce we just experienced, it might be wise to average into these purchases over the coming weeks.
The other approach is to add a few names that have been crushed but have earnings support and dramatically lower price-earnings multiples compared to pre-pandemic levels. For example, Adobe, Autodesk, PayPal, and Fidelity National will all grow earnings in 2022, command solid or dominant stakes in expanding addressable markets and generate strong cash flows
Finally, there are the former high-growth-but-no-profit darlings of 2020 and 2021 whose stocks are considered "un-analyzable" by many savants. These include Robinhood, Peloton, Teladoc, Twilio, Chewy , Cloudflare, and many others with real businesses but which have become excessively priced. At least 65 of these, with market values of over $5 billion, are down 60% or more from their twelve-month peak.
We would focus on those with five-year estimated sales growth of at least 20% per year whose operating cash flow margin should exceed 20% in three years, and where a discounted cash flow model justifies the high risk embedded in such investments through substantial upside potential.
None of these purchases should make you comfortable. But remember that most of the "comfortable" aggressive buys, made in concert with throngs of others back in 2021, have been pulverized.
Acting against the grain is often a good move in the investment world. Just tread carefully – keep your eye on the bargains that have wearing power.
Karen Firestone is chairperson, CEO, and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.