How to Buy Stocks in a Bear Market

It's hard to predict where the stock market will go in 2014, so it is critical for investors to maintain a disciplined investing strategy. My strategy requires a lot of cash, discipline to buy incrementally on down days without acting on emotion, and a focus on defensive stocks that tend to hold up better than the general market in a correction.

I like consumer non-cyclical stocks like Colgate-Palmolive (CL 0.78%), Church & Dwight (CHD 0.36%), Hershey (HSY -0.55%), and J.M. Smucker (SJM 2.15%).  These companies sell household and food products that are consumed daily. They also pay steady dividends. And the best thing going for conservative investors who hate big swings in the market is that these stocks all share low betas, meaning their volatility is less than the general market.

The following chart illustrates important metrics recorded on Feb. 5: 

Volatility
In general, stocks with high betas like 3D Systems are considered higher risk because they deviate more than the general market, while stocks with low betas tend to carry less risk because they deviate less than the general market.

The chart shows Hershey holds the lowest beta and indeed was the only one with a positive return, albeit a small one, for 2014. Church & Dwight and Colgate-Palmolive also carry low betas with lower volatility. 

As a conservative investor I favor stocks that hold their value in the marketplace while delivering ever-increasing cash dividends to the owner. Viewing investments in the manner of Warren Buffett's intrinsic value, an investment should be measured by how much cash you can extract from it over time. Hershey, for example, has raised its dividend 51% over the past five years while the stock gained 198% compared with SPDR S&P 500 ETF dividend up 53% while the exchange-traded fund was up 137% in five years.

Dividend reinvestment
I rarely take advantage of automatic dividend-reinvestment plans for stocks. All dividends are to be paid in cash. The smart investor shall decide what's on sale at the time cash is delivered, and, if nothing is desired, then it is just fine to let cash sit. Inflation is tame right now, at around 1.5%, so while cash may lose some value to inflation, it is the best defense in a bear market.

The S&P 500 index rose 30% in 2013, topping off four years of successive growth in the S&P 500 since the bottom of March 2009. So far this year the S&P 500 was down -5.2% through Feb. 5. I am prepared for the market to operate in bearish territory or swing sideways for most of 2014.

Several pundits on CNBC have predicted a 10% correction. But what if there is no correction? What if we are experiencing the bottom now? No bell is going to ring saying, "This is the bottom, buy now."

As a result, I am picking off only tiny fractions of the total number of shares that I intend to buy over the next nine months. I may be catching a falling knife and getting stabbed, but I believe the wound is only temporary and over the long term these consumer stocks will rebound eventually.

A mathematician once told me to buy in fourths and fifths -- meaning if you want to own 100 shares -- you buy 20 shares at a time. I would argue that during a bear market, you may want to buy in ninths or tenths. This way you protect yourself when stocks fall rapidly in price; you may be losing money on your first two purchases, but you have the opportunity to catch the stock at a cheaper price with your future trades.

Final thoughts
Buying and selling in a bear market is a challenge. When most investors are running scared from the market, a smart investor with a clear, disciplined approach can use a correction as an opportunity to pick up shares. Consider buying in small increments over time to reduce risk.