This month brings the two-year anniversary of Cabot Small-Cap Confidential and in honor of that, I’m bringing you a multi-part series with Editor Thomas Garrity. Today Tom will explain how the economic climate factors into his stock picks and what he learned from last year’s bear market. I hope you enjoy it!
(You an read the previous issues here and here.)
Question: What would you say to an investor who has been scared off by last year’s bear market?
Answer: It’s OK for investors to be scared off by a bear market as long as they are using their time on the sidelines to look for bargain stocks that have been sold off undeservedly. Always have a Watch List, in both good times and bad, so that when your favorite stock goes on sale, you can make a purchase. If you don’t have an immediate need for your funds for retirement or another near-term obligation, you should put that sideline capital to work for you. Investing should closely approximate your risk and comfort level. If the stock market makes you feel uneasy, then putting your money in cash is a good choice. When you do decide to re-enter the market, stock selection will be even more critical than your timing was to get out of the market.
Question: How does the economic climate factor into your stock picks and outlook on the market?
Answer: As always, I’ll be sticking to finding companies that are leaders in their businesses. The only difference given the current market is that I may alter the selection criteria a little. The market has always operated with a here and now mentality when it comes to forecasting earnings. Analysts typically look out three to six months or 12 months and longer to determine a stock’s valuation. In the coming year, I’ll still base my target prices on earnings power, but my range of expectations for the future value of those potential earnings will be shorter. I’ll also be screening investment candidates for any debt, and favor those that have cash and liquid assets. I’ll continue to focus research efforts on industries that are less constrained by discretionary spending.
Investors’ patience has been tested this year and confidence in the stock market is limited. Therefore, there’s no reason for institutions to take on higher risks than are warranted. In light of this new paradigm, investors should revisit the old investment principles, when balance sheet risk and near-term profitability were in focus.
Question: What did you learn from last year’s bear market?
Answer: In the recent bear market, I learned what I failed to in the previous bear market: While it’s true that small-cap stocks generally trade outside the daily moves of the market, in market downturns, every investment can get punished. It doesn’t matter how well a company is operating, if the economy gets sick, the market makes it difficult to hold almost any security. All boats float and sink by the same tide. In the future, I’ll cut my holdings when the market takes a hit like it did last fall to help mitigate my losses.