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Thus far this month, investors have really taken it on the chin. A recent flurry of negative economic news prompted the S&P 500 (a broad market measure) to decrease in each of the trading days thus far in June, tallying a cumulative decrease nearing 4.5%. The dejecting news came in a number of forms, including:
- The World Bank revised its projected U.S. economic growth rate for this year from 2.8% down to 2.6%.
- U.S. unemployment remained bleak.
- U.S. job openings also declined in April (the most recent month reported).
Combine this stream of bad news with growing pessimism about the European debt crisis, continuing uncertainty stemming from the Japanese disaster, and ongoing social unrest in the Middle East, and investor anxiety suddenly makes a lot of sense. However, Foolish investors start licking their chops when such situations arise.
While all this news does sound terrible, don't let the grim tidings overwhelm you. In stock investing, one man's trash truly can become another man's treasure. When the broader market's mood sours, investors often dump their holdings for fear of the temporary pain that occurs when your portfolio declines. That's where the hardened Fool steps in. Such events provide enterprising investors the opportunity to buy shares in attractive companies at lower prices.
Preparing for what lies (or might lie) ahead
In an effort to prepare for a potentially bleaker future for the market, I searched for large, solid companies that could make for compelling buys if they get slightly cheaper.
I started by taking large companies selling for slightly more than the average price-to-earnings ratio of the S&P 500 (currently 15.8). I then sought companies that also exhibited above-average operating results (high returns on equity, robust margins, strong past growth) to find quality businesses that I might consider buying if market sentiment declines further. Here's what my search uncovered:
Price / LTM Normalized Earnings
LTM Return on Equity (%)
Earnings from Continuing Ops. Margin
5-Year Average EBIT growth
|Mattel (Nasdaq: MAT )||17.4||26.5%||11.4%||7.93%|
|McDonald's (NYSE: MCD )||19.5||35.5%||20.6%||12.6%|
|Analog Devices (NYSE: ADI )||17.7||27.3%||29.3%||29.3%|
|3M (NYSE: MMM )||17.9||28.1%||15.6%||4.41%|
|Xilinx (Nasdaq: XLNX )||18.7||28.3%||27.1%||17.5%|
|Baxter International (NYSE: BAX )||18.2||30.3%||15.6%||11.0%|
To make them even more attractive as prospective investments (at the right price), each of these companies has a dividend yield in excess of 2%, and a debt-to-equity ratio of less than 100%. This means these companies actively return a portion of their earnings to shareholders and have minimal financial risk.
While this alone doesn't necessarily make these companies outright buys if their P/E drops below, say, 15, great investors tend to perform their research before opportunities arise. Overpaying for stocks can kill your returns over time. If you want to invest on your own, you need to make sure you only pay fair value or less for a stock. Prepare yourself for what could lie ahead, and act ahead of the curve. Your portfolio will thank you later.
If you feel especially bearish on the market, The Motley Fool's video "Watch This Before the Market Crashes," details how to prepare your portfolio. It also contains a stock pick our analysts love. To get the report, just click here – it's free!