Credit Sesame discusses upgrading your investments when the market is down.
Any way you slice it, 2022 has been a rough year for investments. The numbers aren’t pretty.
As of late September, the S&P 500 stock market index was down 20%. The Nasdaq composite, which holds more tech stocks, was down 28%.
Bonds, which are often viewed as a safe haven when the stock market is rocky, are poorly suited to 2022’s conditions. Rising interest rates are a big part of what has upset stocks. Those same rising rates also drive bond prices down, so the bond market has not been a safe place.
As for cryptocurrencies, which were touted as being immune to traditional market forces, they have had an even worse time in 2022. Bitcoin, the flagship cryptocurrency, has lost more than half its value so far this year.
It’s not just that investment markets are down. Stock prices can fluctuate, but of greater long-term concern is the performance of the underlying companies. With high inflation and the possibility of a recession threatening the operations of many businesses, this is a good time to be picky about your investments.
Upgrading your investments
Down markets can actually help. With investment prices down across the board, overpaying for good investments is less of a concern. Investments that are better suited to the economic environment may be available at reasonable prices.
In short, this is an ideal time to upgrade your portfolio. Below are six things to look for that can upgrade your investments for today’s conditions.
1. Positive cash flow and earnings
One of the most basic things you can look for from a company is that it’s making money.
The amount of money a publicly-traded company makes is expressed as earnings-per-share. Generally speaking, a company with positive earnings-per-share is one that’s profitable.
Since accounting treatments can affect earnings, another way of looking at whether a company’s business model is profitable is if it has positive cash flow.
You may be surprised to find that many companies on the stock market have negative earnings or cash flow. These can still be good investments if they’re on track to eventually be profitable.
However, if a company isn’t growing and doesn’t have positive earnings or cash flow, this is a good time to consider replacing it in your portfolio.
After all, the economy has largely bounced back from the worst of the pandemic shutdowns. If a company isn’t making money now, how will it fare if the economy slips into a recession?
Looking for companies with strong positive earnings or cash flow can be a way to upgrade your holdings in preparation for a worsening economy.
2. Low debt
Higher interest rates make it more expensive for companies to borrow new debt and service existing debt. So, a good characteristic for in this environment is a manageable amount of debt.
One way to look at this is as the amount of debt a company has relative to its liquid and marketable securities. A more practical measure might be a company’s debt-service coverage ratio.
The debt-service coverage ratio is the amount of operating income a company generates divided by the value of its debt payments. Look for companies that generate at least twice as much operating income as the amount of money they need to make their debt payments.
3. Reliable supply sources
Problems such as supply-chain snarls and raw material scarcity have created kinks ion the supply chain for some companies. For other businesses, you can add a shortage of qualified labor to these problems.
Steer clear of businesses that are being constrained by these shortages. Supply problems may limit a company’s sales. They also make it more vulnerable to inflation. Thus, companies experiencing these shortages are hit on both the top line and the expense line.
The best situation is if a company controls its own supply chain, or has well-diversified sources of supplies. Less labor-intensive businesses are not as sensitive to the workforce shortage.
4. Dividends for stability
With stock prices sinking, dividends can be a valuable thing to look for in stocks. A regular cash dividend can give you some source of return even when prices aren’t rising.
For many years, dividends have been somewhat out of fashion among investors. Technology-oriented growth stocks often don’t pay dividends but offer more in the way of future potential.
However, rising interest rates have changed this dynamic somewhat. The more interest investors can earn in low-risk alternatives today, the more it diminishes the value of future growth. Thus stocks with reliable dividends may be more stable alternatives for this environment.
5. Rebalance asset allocation
Investors often hold a mix of stocks, bonds and other investments. These broad categories of investments are called asset classes, and the proportion of each type of asset an investor holds is called asset allocation.
Asset allocation is based on the risk-reward characteristics of different investments. When interest rates were near zero, bonds and other fixed income securities offered very little reward. As rates have risen, the yields on these securities have increased. That means they now offer more competitive rewards.
Thus, as bond yields climb it’s a good idea to revisit your asset allocation, and perhaps upgrading your investments by shifting more towards bonds.
6. Fixed income quality
While bonds are generally viewed as lower-risk securities, they actually represent a wide range of risk levels.
For example, Treasury securities have virtually no default risk. At the other extreme, debt securities issued by companies that are teetering on the edge of bankruptcy or foreign governments with shaky debt-payment histories may carry a large amount of default risk.
While higher-risk bonds generally offer much higher yields, they may not be the right choice if you’re investing in bonds to cushion against the risk of the stock portion of your portfolio. To some degree, these high-risk bonds might simply duplicate the risks of stocks. That wouldn’t provide the diversification you may be looking for by holding different asset classes.
So, if you’re looking to bonds as a cushion against volatility or the risk of loss, high-quality bonds may be a better choice.
Upgrading your investments should be made in the context of your investment objectives and the details of each individual security.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.
