What to Buy When the Market Crashes?
Opportunities are abundant in a market crash, but what are the best choices?
Financial crises create opportunities as well as turmoil. When there are lots of cheap stocks, what’s the best stock to buy? There are many philosophies on this, but as an institutional money manager for many years I developed my own low risk/high return methodology.
Small and medium-sized companies get hit especially hard in a crash. While their business may be great, when the mutual fund portfolio manager at a large institution like Fidelity gets a notice that they have $40 million in redemptions that day, they need to sell immediately. They don’t have the luxury of waiting for a better price. This results in severely depressing the prices of small stocks which simply do not have enough buyers to match the selling pressure.
In the recent sell off, I bought excellent businesses whose market capitalization (number of shares x share price) was near the business’ net cash balance and the company was cash flow positive. In other words, I bought $100 in cash for roughly $100 as well as ownership in a valuable business. (Finance professionals would describe this as a company with a zero Enterprise Value – something rare, but it does happen.)
The risk in this strategy should be minimal - the cost of your capital. The upside can be very large. So, what are the challenges?
One needs to act quickly. These opportunities usually don’t last long, although some of these stocks in the recent crash stayed down in price for a few months.
Of course, some bargains aren’t really bargains. Companies with problems that are burning cash will not give good results. You need to verify the business is sound.
ABOUT THE AUTHOR: Martin Dirks
Martin Dirks is the founder of Investment Strategy & Analysis, LLC which provides consulting services in the areas of finance, investment and strategic planning. Clients include corporations, investors and attorneys, for whom expert witness services are also provided.
Martin Dirks is the former portfolio manager of a long/short public technology stock portfolio for Harvard University’s endowment. His portfolio grew from $110 million to $870 million in five and one-half years, an average unleveraged annual return on investment of 43% per year. In addition, he has been a portfolio manager with a $1 billion short-only hedge fund.
Mr. Dirks’ credentials include a Bachelor of Science in Physics and an MBA from Harvard Business School. He is an adjunct professor of finance for the MBA program at Golden Gate University in San Francisco.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.
