How to select stocks and survive during Stock Market crisis?

Here is an approach that can help you make the best of such falling markets.

Mar 25, 2020 09:03 IST India Infoline News Service

Buy Hold And Sell Dice Represents Stocks Strategy
In the last 25 years, investors have normally made money when they bought stocks after a steep correction. But that is easier said than done. When markets correct, most investors find themselves stuck at higher levels resulting in lower liquidity. You don’t have the heart to sell stocks at a loss and you do not have the liquidity to buy stocks at cheap valuations. This is called the classic Catch-22 situation. Here is an approach that can help you make the best of such falling markets.

Buy or even average value holders
What do we understand by value holders? If you look at the Nifty correction, there will be some stocks that have corrected less than the market. For example, if you look at the stock price movement from January 2020 onwards, stocks like Asian Paints, Hindustan Unilever, Nestle and Pidilite have held value better than others. These stocks have also corrected but the intensity is much lower. You may argue that these stocks are already expensive but the fact that they have held value in such tough markets shows the presence of buyers at every dip. If you don’t have an exposure, you can take an exposure to such stocks. Similarly, if you are already holding on to such stocks, you can add selectively to your positions.

Time to restructure your portfolio
This is the most important takeaway from any bear market correction. You normally accumulate a composite portfolio over time. Some may be cyclical, some may be stocks that triggered the rally and some too risky. This is the time to seriously restructure your portfolio. Don’t get too cagey about booking a loss on a bank with lower asset quality if you can allocate this money to buy a high quality bank with lower NPAs. Market crashes are the time to buy quality stocks that have corrected more than justified.

Buying the index is a good option
Buying stocks in a falling market can be quite confusing. However, in all the crashes in the past, the recovery over the next 2-3 years has been phenomenal. A 30% correction has normally led to a return of 70-120% in a time range of 6 months to 3 years. The best way to play this insight is to opt for an index ETF. Its low costs will ensure that you are able to track the index as closely as possible. Also, the index is automatically diversified and does not pose too many risks for the investor.

Focus on asset allocation and rule based investing
What exactly do we understand by asset allocation? Let us break up this question two parts. When the markets correct, it makes sense to increase your allocation to equity. The question is how you go about it. That brings us to the second part; which is rule based asset allocation. Normally, this is part of your financial plan. For example, if your allocation is 50% to equity, 30% to debt, 10% to gold and 10% to liquids, then in any market rally, you automatically move out of equity and into debt to keep the allocation intact. That ensures that liquidity is available when the market falls. This also ensures automatic buying of equities at lower levels to bring the balance back in the allocation.

Low debt could be a real winner
One big beneficiary in any market crash is the low debt stocks. These stocks may not avoid a crash but they would become a lot more attractive when the market bottoms out. One of the reasons IT stocks have been quick to bounce back is their low debt structures. If any market fall is followed by macroeconomic weakness, it is high debt stocks that are the worst hit. A classic case is the infrastructure and power stocks in the aftermath of the crash in 2008. They never recovered and eventually ended up at the NCLT.

Look at companies with a small capital base
If debt is bad then too much equity is equally bad, perhaps worse. A huge capital base would mean that the earnings get diluted and do not give valuation comfort to the market. On the other hand, stocks with low capital base also enjoy a higher EPS and also a higher ROE and this also supports higher P/E ratio.

Identifying stocks after the crash may be a reactive approach. A better option is to be proactive and focus on asset allocation. Once the percentages are defined for each asset class, just keep a margin of safety and churn it. This will automatically ensure that you are automatically defended against market crashes. You actually get the best of both worlds. You sell out at highs and buy in at lows! It is also a lot more practical and workable.

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