This year demonstrated the cruel realities of investing in stocks.
Year-to-date, the widely followed US stock market benchmark, the S&P 500, is down 14%. Meanwhile, the NASDAQ Composite, a tech-heavier benchmark for US stocks, has lost 22% of its value.
But that’s just the tip of the iceberg. Many fast-growing companies have had it worse. For instance, the ARK Innovation ETF, an exchange-traded fund that invests in high-growth tech companies, is down by more than 50%.
Multiple stocks that were big winners during the COVID-induced lockdowns have also since returned all their gains; some are even trading well below their pre-COVID prices.
In my nine years as an investor, I’ve never seen such sharp and steep drawdowns across such a wide array of companies. But this likely won’t be the last time either.
With this in mind, I’ve penned down a list of investing thoughts to prepare myself for future downturns.
Don’t celebrate when prices go up
Stock prices gyrate wildly. During the booming market of 2020, there were many investors who celebrated when prices went up. Today, many of the stocks that rose in 2020 have returned all those gains – and then some.
2022 has so far reinforced the fact that stock prices really don’t matter in the short run. If prices run up without fundamentals, they will come back down eventually. Similarly, if stock prices fall below intrinsic values, don’t panic. Prices will eventually return to their underlying values.
As a long-term investor, I have learned to ignore near-term price movements and focus on business fundamentals and valuations.
Cash matters!
When stock prices were rising, companies could raise capital easily by issuing new shares at inflated prices. This increased their cash balances with minimal dilution to existing shareholders.
But now that stock prices have fallen, this source of capital has evaporated. Debt has also become more expensive due to rising interest rates.
It is in times of crisis that companies with strong balance sheets survive, while those with weak financials struggle. Companies that are burning cash and have insufficient cash may end up in a liquidity crisis or end up having to raise more capital at depressed valuations, which could severely impact existing shareholders. If these companies are unable to raise money, their debt holders may end up taking over them, leaving equity holders with scraps.
Invest in strong managers!
With asset prices low, this is a time for companies with the financial muscle to double down on investing for their future. This is a time when prudent managers shine through.
If a company has a great capital allocator at the helm, the company can come out of this bear market stronger than before.
Berkshire, for instance, has started to become more aggressive with its investments in terms of both buybacks and acquiring stakes in other businesses. I believe Warren Buffett’s recent decisions will pay off handsomely for Berkshire shareholders in the future.
Diversify
When stock prices were going up, there was a lot of discussion about concentrating one’s portfolio into just a few stocks.
But this is a risky strategy. Every company has its own set of risks that could result in long-term underperformance of its stock. Companies that are still growing fast and burning cash bear even more risk.
When investing for the long run, we are placing a bet on a company performing well for many years. This doesn’t always pan out. In fact, most companies don’t do well over time and the strong performances of market indexes are driven by just a small handful of companies. When investing, we never deal with absolutes. We are always playing the probability game.
As a long-term investor, survival and long-term steady returns are more important to me than simply maximising earnings. While having a diversified portfolio might reduce my expected returns, it increases my odds of long-term survival and stable returns.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Jeremy Chia does not own shares in any of the companies mentioned.
