A plummeting stock market can offer a great opportunity to pick up good investments at bargain prices. But investors often fail to take advantage of this.
Panic can take over, leaving investors worrying about falls in their existing portfolio, instead of considering what new opportunities have opened up.
But in the heat of the moment, when markets are falling and fear sets in, it is rarely a good time to start planning a new investment strategy and deciding what to buy or sell.
Decisions made in this mindset are often reactive and rushed rather than well thought through.
Fast forward: A plummeting stock market can offer a great opportunity to pick up good investments at bargain prices
That’s where a ‘crash shopping list’ can prove useful. This is a list of companies or funds that you have researched, believe show potential, and would be willing to buy at the right price. With a plan in place, it is easier to get to business.
Markets are rocky at the moment. With inflation rising, Russia’s invasion of Ukraine and the energy crisis, there are a number of factors causing market volatility. None of us knows what could tip us into the next market downturn or when it could happen. But it pays to be prepared.
Why a crash creates bargains
When bad news hits markets, investors quickly get spooked and can start selling indiscriminately. They sell companies directly affected by the bad news, but also those unlikely to be affected. They often do this out of fear, to bank profits while they can or to shift money to safer assets.
Laith Khalaf, financial analyst at wealth manager AJ Bell, says the reaction of markets to the first Covid lockdowns is a perfect example.
He says: ‘It is understandable that the share prices of travel and hospitality companies fell, as they were set to suffer badly in lockdowns.
But technology companies, which benefited from lockdowns, also saw sharp share price falls – the likes of Ocado, Apple and Google’s parent company Alphabet.
Companies were all tarred with the same brush, but with hindsight it is easy to see that this does not make sense.’
How to build a list of funds to target
As you compile your portfolio, keep a number of companies or funds on the sidelines that you would be interested in buying at a later date at the right price.
Jamie Ross, manager of £272million investment trust Henderson EuroTrust, is a keen rugby fan. He thinks of his crash list as a subs bench, where a host of good players are ready to join the action at a second’s notice.
He says: ‘I keep a list of good quality companies that I am ready to add or sub into my portfolio when the timing is right.’
Ross adds that having ready replacements also keeps his portfolio optimal, saying: ‘It removes complacency, because if one of my existing holdings is not performing how I would like, I have another, high quality one ready to replace it in an instant.’
His approach is to search for high quality firms whose share price has fallen so that they are trading at a more palatable valuation.
For example, for many years he had kept his eye on Universal Music, a company whose shares are listed in the Netherlands. It owns the royalties to about a third of recorded music in the world.
When its share price fell 13 per cent in the turbulence of a few weeks ago, he pounced. It is since up 25 per cent to €23.81. ‘Its shares fell in the short term, but we hope to hold it for years,’ he says. ‘We expect it to be cash generative for years as it receives royalties every time a song it owns is played.’
What to do before you buy
Once you have your shopping list of funds and companies, you are ready to go if markets fall. But it is not as simple as just hitting ‘buy, buy, buy’ and scooping them up. There is more work to do.
First, research your companies or funds again to check that no new information has come to light that makes them less desirable than when you put them on your list.
For example, watch out for changes in a company’s strategy, its management team and for new financial results that reveal a company is not as robust as it seemed.
Next, consider why the share price has fallen – not all companies will simply have been swept up in the wave of panic-selling.
Independent investment commentator Adrian Lowcock says: ‘Before acting on your ideas, review the cause of the market crash and consider how the stock may be affected. Some may have seen their share price fall for a good reason.’
Lowcock sold some holdings in technology stocks in January so was ready to buy when the opportunity arose.
He bought shares in mining company Rio Tinto and housebuilder Persimmon as both were on his shopping list and he says they have long-term potential.
Third, do not try to time the market. It’s almost impossible and holding out to buy until prices are at their lowest can mean you miss out if you time it wrong. Instead, decide what price you are willing to buy at, and stick to it. You could even add target buy prices to your shopping list to remind you.
Finally, once you have a plan, do not go rogue in the heat of the moment. As most shoppers will have experienced, it is easy to buy something that looks like a bargain, only to get home to realise you don’t need or like it – you only bought it for the discount.
Lowcock says: ‘Avoid the temptation to go off-list. If companies that don’t appear on your list come on to your radar, do a lot of extra work to evaluate whether they are a good buy.’
Other ways to profit from a fall
Sometimes a market correction catches investors by surprise, and they do not have an up-to-date shopping list. However, rather than scrabbling around to put one together in a hurry, AJ Bell’s Khalaf suggests buying a fund that tracks overall stock market rises and falls.
‘Consider using exchange traded funds (ETFs) to gain quick exposure to markets as a placeholder to benefit from any rapid rebound in markets while you assess where the best opportunities are,’ he says. ETFs invest in hundreds or thousands of companies at low cost and are easy to trade throughout the day.
Another option is to buy more of what you already own. These should be companies or funds that have already made the grade, so it can make sense to buy even more at a lower price.
However, Phil Webster, manager of BMO UK High Income Trust, warns against doubling down too much on a few holdings. He says: ‘I worry that many individual investors who invest in shares often only hold a handful. New investors in particular may have bought companies where there was a buzz and then have not looked to diversify.
‘No fund manager would risk holding just five or six companies. If markets do fall, it may be a good time to add your shopping list to your portfolio to reduce reliance on a small number of companies.’
If you have a penchant for a particular type of company, a falling market may be a good time to add to areas where you have little or no exposure.
For example, Khalaf suggests if you sat on the sidelines of the US tech boom because you worried share prices had peaked despite good long-term prospects, you might consider going for it in the event of a market correction.
Look five or more years ahead
When turbulence hits markets, it can be hard to look beyond the next few months. But if you are investing for the long-term you need to consider how companies you like will be faring in many years’ time.
BMO’s Webster has recently added to his holding in online fashion company Asos on this basis. He says: ‘Its share price has been hit by the recent volatility as well as supply chain issues. But, it is still forecasting growth at ten to 15 per cent a year.’
Henderson’s Ross has a similar long-term approach. He says that while oil prices have risen sharply since Russia’s invasion of Ukraine, the bigger story is the impact on renewable energy firms. He says: ‘You can’t build a windfarm in a month to reduce reliance on Russian gas, but it really helps in the long term.
‘We see a much more interesting long-term outlook for renewable energy firms today than six months ago – and even six months ago the outlook was pretty positive.’
He has invested in Danish wind power firm Orsted for this reason.
Start with these six shares
Russ Mould, investment director at wealth platform AJ Bell, believes that when markets fall it is durable companies that investors should seek out.
He says: ‘If there is real panic, firms with strong competitive positions, sound business models, good management and robust finances could fall as much as stuff that maybe deserves to be sold. These quality names might be ones to focus on. They don’t need to be knock-down cheap, just reasonably valued.’
Here are six companies that Mould suggests it may be worth keeping an eye on for a share price drop.
1. B&M European Retail
What it does: B&M sells everything from baked beans to vacuum cleaners to toys in its 681 stores – all at low prices.
Why Mould likes it: This value-driven proposition could really chime with consumers in a time of inflation.
Why it could offer good value: Its shares are hardly expensive now and have a dividend yield of 3.5 per cent. A steep sell-off could leave them on an even more tempting valuation.
Current share price: £5.44.
What it does: It is one of the world’s biggest producers of beer and spirits, including Smirnoff, Baileys and Johnnie Walker.
Why Mould likes it: Diageo has an enviable collection of brands and consumers often stick with a brand, even if prices rise.
Why it could offer good value: This so-called ‘pricing power’ – an ability to pass on costs – means it generates excellent margins, returns on capital and cash flow.
Current share price: £40.21.
What it does: Halma owns small and medium sized firms creating life-saving technologies to tackle problems such as water pollution and chronic illness.
Why Mould likes it: Any firm that has increased its annual dividend by at least 5 per cent for 42 years running is doing something right.
Why it could offer good value: Halma has a competitive edge because of its ongoing investment and tight regulation around many of its products, protecting it from new market entrants.
Current share price: £25.32.
What it does: Harworth is a land regeneration and property development specialist, with about 100 sites in the North of England and the Midlands.
Why Mould likes it: Its shares are already cheaper than the total value of the assets it owns.
Why it could offer good value: Any share slide would open up that discount further and make the valuation more tempting.
Current share price: £1.73.
5. Smith & Nephew
What it does: It is a manufacturer of medical equipment.
Why Mould likes it: Smith & Nephew has been hit by Covid as elective surgery is postponed. But, as the impact of Covid fades, the company should benefit.
Why it could offer good value: It has also developed a promising pipeline in orthopaedics and a strong position in sports medicine and wound care, so sales could rise strongly. The shares already trade at a substantial discount to those of US and global peers.
Current share price: £12.33.
What it does: It is a utility provider and energy company.
Why Mould likes it: SSE is well placed to spearhead and benefit from the shift to renewable energy. It plans to fund an investment drive in renewables by selling assets and cutting its dividend for the year to March 2024. But, even with a dividend cut, the annual yield is still 3.7 per cent.
Why it could offer good value: A share price fall would increase the dividend yield, making it even more enticing for income-minded investors.
Current share price: £18.17.