A bear market shows investors which companies traded based more on promise than results.
In some cases, that can expose businesses which were better at hyping products than actually developing them.
It can also show where companies taking a risky journey might go wrong.
Often, the CEOs of stocks that drop for these reasons frame their problems as being part of the overall economic condition of the company, because no executive can admit their business model is faulty.
We saw this over the past few months with a number of companies.
- Stitch Fix (SFIX) has lost nearly 70% of its value not because of higher prices or inflation but because maybe people don't want clothes picked by a stylist they have never met (or an artificial intelligence) that they have to mail back if they don't like them or they don't.
- Peloton (PTON) did not lose 71% of its value this year because people went back to the gym or because they can't afford expensive bikes. It dropped because the market for expensive at-home exercise is only so big and a lot of potential customers already bought a bike from Peloton or a competitor.
- AMC Entertainment (AMC) shares haven't dropped by 57% this year because of the pandemic. They have fallen because people will go to the movies less often — generally only for blockbuster — because we all have a large amount of programming we can watch at home.
The challenge isn't in identifying companies with major structural flaws. It's in seeing ones that actually have a solid business drop by huge amounts.
As a long-term investor it's easy to say "I told you so" when a one-time high-flier crashes.
It's much harder to evaluate your holdings and decide whether a falling share price is market driven or actually due to how the company will perform.
Holding Good Companies Makes You Rich
Long-term investors don't buy shares solely for technical reasons.
They may use technical analysis to pick entry points, but when you buy a stock in order to hold it for years, maybe many years, you do so because you have an investing thesis.
A thesis is the "why" you own the company. Generally, when I research a stock I look for a number of key things:
- Management: Do I trust the leadership to focus on long-term priorities rather managing to earnings? Can the CEO adjust when something goes wrong or market conditions change.
- Opportunity: Is this company solving a problem? Does it do something that others can't?
- Moat: Are there barriers to entry that make it hard to compete with this company?
- Do I Like What It Does: This one is personal, many investors don't use this criteria, but I don't want to own shares in a company I'm not a fan of whose product(s) I don't use.
If nothing changes about any of those, I don't consider selling my shares. Even if something does change — like a CEO change — I step back and evaluate the new CEO before making a decision.
What I never do is sell shares because of stock price. The price of a stock does not always speak to its quality or its long-term prospects.
Bear Markets are a Buying Opportunity
Great companies like Apple AAPL, Microsoft (MSFT), Target (TGT), Costco (COST), and so many more have seen their share prices fall despite putting up good numbers,
It's important to remember that strength does not mean never facing adversity.
All of these companies may see lower profits due to higher prices and transportation costs that they can't fully pass on to customers.
But, their strength is that they have the resources and customer base to weather the storm.
Difficult economic conditions impact all companies, but in a bear market, companies with strong balance sheets that sell products or services people can't live without will still do well.
Companies can't stop using Office or Windows. People may not upgrade their iPhone as quickly, but they're not going to stop being Apple customers.
Target and Costco may see margin drop, but more customers will turn to them during tough economic times.
A bear market lets you buy the best brands out there at lower prices than they previously traded at.
That's an opportunity to embrace while everyone else panics.
Keep a long-term outlook and adjust your portfolio accordingly and a bear market is an opportunity, not a negative.
