As often happens when there’s heightened volatility, investors seek refuge in what are deemed “recession-proof” industries. This strategy of reducing exposure to high-risk holdings is entirely rational, and is one of the key ways that people mitigate the downside associated with declining markets.
However, this outlook can be overly conservative, and isn’t always guaranteed to bring you the results you might otherwise crave. For example, not all companies in the so-called “safe” sectors perform particularly well during an economic contraction – nor, likewise, do all cyclical stocks perform especially poorly either.
Moreover, adopting a defensive philosophy like this might lead you to miss out on many lucrative opportunities over time.
Indeed, a better way to go about your stock picking endeavors is to concentrate on the underlying foundations of a company. This approach doesn’t require you to second-guess the economic cycle, and you don’t have to constantly rotate your stock choices on a season-by-season basis.
In fact, this method helps you recognize what stocks are going up, regardless of whether it’s a bull market or a bear.
Focus On The Fundamentals
A company’s share price can be influenced by a multitude of factors. The interplay between supply and demand, investor sentiment, and broader macroeconomic events all play their part in determining the level at which a stock just happens to be traded.
That said, when you look for the primary causes that really shift the needle, it’s the fundamentals that ultimately count.
In this sense, you can define the intrinsic value of a security by assessing two things: its earnings and its valuation. These two metrics are crucial, and not least because they have the greatest bearing on how a stock will perform over the long term.
For instance, according to the theory of residual equity, common shareholders have a claim on the earnings of a company and are entitled to receive any dividend payments that the business issues in the future. As such, the profits a firm generates govern its market price the most.
There are many ways to figure out the earnings power of a business. Popular methods include calculating a firm’s return on assets and its return on equity, as well as other measurements such as its earnings per share and its EBITDA margin too.
Alternatively, if the circumstances are more appropriate, investors will sometimes substitute cash flow as a stand-in for earnings. Commonly used formulas include operating cash flow growth, free cash flow per share, and levered free cash flow margin.
Furthermore, the rate at which these earnings grow is reflected in the valuation multiple too. The valuation ascribed to a stock lets you know by how much a company’s earnings base is expected to rise in the future, with a high valuation signifying investors are willing to pay a premium today for some degree of anticipated expansion tomorrow.
Should You Prioritize Growth Over Value?
Warren Buffett once stated that he would prefer to buy a good company at a bad price rather than a bad company at a good price.
The implication here is straightforward: it’s the inherent quality of a business that’s instrumental in delivering gains over the long haul – and not just simply whether you snap up a bargain at the outset of your investment or not.
Indeed, the beauty of focusing on fundamentals means that, like the Oracle of Omaha says, you don’t have to worry too much about timing the market.
Not only that, but the process can be applied to growth and value companies alike.
For example, a growth stock that diligently increases its revenue and cash flows every quarter will also see its share price rise accordingly.
Furthermore, with their consistent profits and low valuations, value-oriented firms will also deliver strong returns, either in robust price momentum, dividend payouts – or a combination of the two.
When assessing a business’s ability to grow its earnings, it’s essential to identify ways in which it can maintain a marketplace advantage so that it can generate earnings year after year.
In fact, one of the best predictors of whether a company can protect its profits is the presence of an economic moat.
An economic moat is a term given to anything that affords a firm a competitive edge over its rivals.
Companies can create moats for themselves in many different ways. Some businesses, like Apple
, offer products that come with high switching costs for their customers. This means the process of swapping brands is laden with negative consequences and expense, disincentivizing users from migrating to other competitors.
While economic moats don’t necessarily help produce revenues in the first instance, they can be instrumental in creating meaningful profits through undercutting rivals or improving unit costs.
There’s no doubt that wider macroeconomic trends have some impact on the fortunes of a company, whether for better or for worse.
For instance, inflationary pressures drive up the price of services and goods which businesses need to procure to keep on operating. This leads to firms paying higher fares, which can adversely affect their balance sheet.
Similarly, rising interest rates threaten the earnings potential of even the best-performing enterprises, as the repayment of company debt becomes more onerous.
Although these variables are neither controllable nor entirely predictable, investors should nevertheless be cognizant of how they might affect share prices going forward.
What Stock Will Go Up In The Future: The Bottom Line
Appraising the fundamental properties of a company is the best indicator of long-term share price performance.
Earnings and valuation multiples help in this respect, giving a quantitative measure by which to judge the health of a business.
Other factors play a role in scrutinizing prospective stock picks too, including economic trends like inflation and interest rates, as well as the various economic moats that a firm might enjoy.