How to stay invested and pick up good quality companies—on the cheap

I’m sad to say there is no magic answer. It comes down to doing your homework and focusing on setting yourself up for the future. This is what will allow you to stay strong—and stay invested—in the face of all the challenges the world is facing right now. Even though markets are taking a hit, there is still no better alternative to being invested.

Ironically, while rising interest rates are a big reason so many people are pulling their money out of the markets, those same rates are not being applied to “safe” investments such as bonds, guaranteed investment certificates (GICs) and so-called “high-interest” savings accounts. These returns are still well below inflation, which is sitting at nearly 7% in Canada and more than 8% in the U.S.

For example, at the time of writing, the average yield for a 10-year bond was 3.35%, the highest five-year GIC rate is 4.85% and the best high interest savings account (HISA) is paying 1.85%. You cannot afford to sell and sit in cash because inflation will eat away at your money. This is true even though the markets are taking a hit. 

At the end of June 2022, the S&P 500 was down more than 20% from a record high at the start of 2022 and entered bear market territory. There is nowhere to hide. What I recommend is to take your pain today to set yourself up for the future. Use this opportunity to restructure and better the quality of your portfolio. 

Prepare for short-term pain and a better future

The goal is to buy companies that are leaders in their sectors, with good topline and bottom line growth, and that pay dividends, so you get paid while you wait for stock prices to rally. The leaders will snap back the quickest. 

History has shown us that markets go up over time as societies, economies and the standard of living improve. In 1970, the Dow Jones Industrial Average Index was nearly 1,000 points. Today, it’s more than 30,000 points.

That said, it’s not a straight line up. If you are buying good quality companies cheaply, you will still see down days, but you will also be positioned to fully take advantage of the next rally. And there will be a next rally. 

Why even good quality companies are taking a hit

The Bank of Canada and Federal Reserve are increasing interest rates to try and curb inflation. Gas prices are through the roof. The war in Ukraine rages on. It should come as no surprise that consumer sentiment is at an all-time low. Investors and economists are worried we’re heading into recession. That fear is driving the sell-offs we’re seeing in the markets. 

Tech stocks, in particular, have been hardest hit. Many of these are proven companies that are growing earnings. Yet, right now, a lot of investors are throwing the baby out with the bathwater. It’s up to investors to separate quality companies from the pretenders, the high-flying memes and short-term-gain companies from six months ago. 

How to spot a quality investment

Good quality investments are in every sector, but you’re going to have to do your homework to find them. If you are working with an advisor, especially one with a good understanding of economics and how the markets work, tap into their expertise. If you are going to do your own research as well, here’s how to get started: 

• Adopt a commonsense approach
  This means interpreting past the negative headlines, removing fact from noise, being objective and focusing on companies that make sense in the context of what’s happening in the world today. Take emotions out of the picture.

• Identify the leaders
  Look toward the leaders in the industries you’re interested in and delve into the numbers. Are they growing? Do they have a secured dividend? What is their future outlook? Are they increasing or decreasing earnings estimates for the coming quarters? Your answers will help give you that common-sense approach you need to make investment decisions.
• Be analytical about their forecasts
  If a good company’s forecast is not as positive as it has been, think about why. For example, Microsoft’s stock price is dropping even though its cloud business grew 46% this quarter. So why is the stock price taking a hit? One of the biggest reasons is a strong U.S. dollar, which eats into profitability when they convert sales in foreign currencies. This is a problem that comes up on a regular basis for multinational companies and not a fundamental issue. Microsoft is in all the right places for growth: cloud, virtual collaboration (i.e., its Teams offering), software, hardware. How do you not buy it? You’ll make your money when the markets rebound. You just have to be patient.  

My final thoughts

The biggest problem I see right now is time. Everybody says they’re a long-term investor until they see three months of poor performance. If you are going to buy good quality names, which I think you should, prepare for stocks to go lower before they go higher. 

Some of the best days in the market can happen after the worst. We know if you miss the best five or 10 days in a year, your returns will be substantially lower than if you are there for those temporary bounce backs. 

We also know that when markets begin to recover, investors who stay invested are rewarded. We saw it after the tech bust, the financial collapse and most recently with the COVID lockdowns. In times like these, I focus on finding good quality companies and I wait. 

Allan Small is the senior investment advisor at the Allan Small Financial Group with iA Private Wealth (allansmall.com) and he is the author of How To Profit When Investors Are Scared. He can be reached at [email protected].

Read more from Allan Small:

• What fast-rising interest, inflation and bond rates mean for investors
• Hedging against inflation with dividend-paying stocks
• The meaning of market swings—and why you should care
• A contrarian approach to inflation, interest rates and the markets

About Allan Small, FMA, FCSI

Allan Small is the Senior Investment Advisor at the Allan Small Financial Group with iA Private Wealth and host of The Allan Small Financial Show. He is also the author of How To Profit When Investors Are Scared. He can be reached at [email protected].

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