Covid-19: Diversify but Don't Reverse Your Stocks in this Market
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“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”—Warren Buffett
Warren Buffett’s golden words are true for bear markets which appear once in every decade. The last was the financial crisis of 2007-08 when Nifty fell over 50 per cent and the Great Depression of 1928 which caused markets to nosedive around 86 per cent through mid-1932. Currently, Indian bourses have corrected over 30 per cent from their peak and India VIX, the volatility index, is around higher levels which all indicate to 2020 being a bear market.
As an investor, your wealth would be in red by now and this fear of wealth erosion will further compel you to sell in this falling market. But history has time and again proved that bad news is your friend as it gives you a chance to buy stocks and be a part of India’s future.
But then the question is how, what and when to start buying? Well, diversification is at the very core behind investing in such markets. It is especially devised to protect you from risks at such times. The lower betas and uncorrelated nature of the diversified portfolio is the very core diversification is built on. Stocks with a lower beta tend to fall less than the overall market during a downturn while standalone highly leveraged companies and businesses in weaker competitive positions pose to be risky. A diversified portfolio will bring down the overall standard deviation of your portfolio, thus immunizing it from concentrated risks in a particular sector due to lockdowns.
Now that we have tackled how to buy, let’s figure what to buy. Since this pandemic is more of a health hazard than the previous crisis which had been more of a liquidity event, the uncertainty and fear this time is bound to create a change in consumer behavior itself. Hence, past performances of companies may not pan out as expected in the future. Picking companies which have higher free cashflows to sales, higher ROCEs, sufficient reserves, minimal debt, robust balance sheets and a dominant industry position are safer bets. The idea is to believe in a company’s long-term potential so you can ride out the storm and buy more of it at a discounted price only to collect dividends until the market finally turns around.
But in this process don’t blindly get into undervalued companies (mid- and small-caps) just because they are available at cheap valuations. Filter the quality and stronger men from the countless boys. These very men will turn out to be winners in the long run. Hence, cherry pick the fundamentally strong players and then ignore the earnings hiccups over a few quarters as these companies will be setting record profits 5-10 years down the line. Now addressing when to start buying, post a 30 per cent fall in the indices, risk-taking investors can start ramping up quality stocks in a SIP format. This incremental investing approach in a smaller yet diversified portfolio will enable you to create positions by improving your overall cost basis and inturn returns. Don’t wait to predict bottoms instead when you believe in a company start buying at lower valuations so you don’t miss the rally when markets turnaround.But this is better said than done. As majority of investors tend to overreact and go on a selling spree when they witness a stock market crash. Selling these stocks or funds would mean booking losses, however if you remain invested, you can recover the value of your investments over the next few months. Unless in dire need, selling in a deeply fallen market would be the worst strategy as what goes down usually comes up and vice versa. And markets are the best example. Profiting from investing in bear markets requires patience, discipline and enough wealth to be able to make opportunistic purchases. Hence, diversify should be the sole motto, but yes diversify ‘smartly’ to reap the best risk-adjusted returns.