Begin stocking soup and cut your own hair to save money! The economy is slowing and even Microsoft (Nasdaq: MSFT) and Time Warner (NYSE: TWX) are not immune.
Even worse, eToys (Nasdaq: ETYS) will fold by April without outside help. Could Buy.com (Nasdaq: BUYX) be next? Amazon's (Nasdaq: AMZN) own stock is likely to languish at least until the highly leveraged company proves it can be profitable. Amazon is still a Rule Breaker, however, which raises the question: Should we add a balance sheet criterion to our Rule Breaker principles?
Our First Mover criterion now includes the statement that a company must be in control of its own destiny. Majority-owned by AT&T (NYSE: T), Excite@Home (Nasdaq: ATHM) was not in charge. Amazon is, but the more debt it adds, arguably the less control it has. In contrast, eBay (Nasdaq: EBAY) continues to grow, profitably self-funded (it launched eBay Austria Monday).
Financial strength is essential to a stock's performance sooner rather than later. Young Rule Breakers are typically building products and market share the first few years, rather than financial strength, but if they're public, they usually need to start building financial strength in short order, too. Amazon knows this... now.
Whatever investing style you use, the financial strength of your companies is eventually the most important factor. Rule Maker investors demand strong working capital at their companies, as well as a strong balance sheet with low debt. The Drip Portfolio looks for companies with much more cash than debt, and when companies do have debt, Drip Port seeks "smart debt" -- debt used to grow the business profitably and at a higher rate of return than the debt's cost.
Sustaining a long downturn
Financial strength is especially necessary during extended market downturns. During slides, financially weak companies find it difficult and costly to raise money. By contrast, financially strong companies can buckle down and ride out a market swoon, even for years. Financially weak, unprofitable companies don't have this option.
What's an investor to do?
Depending on your tolerance for risk, you might always avoid companies that are not yet profitable and that risk running out of cash as a result. If you only buy strong profitable companies, you should have fewer concerns during an economic slowdown.
In another common investing approach, you might only portion a small part of your portfolio to risky, young, yet-unprofitable businesses such as Amazon. Our Breaker Port is much riskier than an average port. We own three companies that are not yet profitable: Amazon, Celera (NYSE: CRA), and Human Genome Sciences (Nasdaq: HGSI). We accept this risk because we like to buy Breakers young. We hope these companies will be profitable eventually and we'll be rewarded for buying "early."
But remember that this portfolio purposefully demonstrates just one investing strategy, rather than a hybrid strategy that most of us likely use. I own a few Breakers, a handful of Makers, and a few other Drip-chosen companies in my port. (Thinking about it now, I realize that I don't own any unprofitable companies, although I have in the past and will again -- Breakers.)
Much like strong companies, most long-term investors "buckle down" when the economy and stock market is weakening. The most successful investors do not sell past winners. Studies show that most millionaire investors are millionaires because they held a few great companies for decades. There are other reasons not to sell. You might not sell for tax reasons, as Brian talked about yesterday; or, you might not sell because you don't have a better place for the money; or, you hold your good companies even in a bad market because, hey, nobody can predict what'll happen next!
Steps you can take if you expect continued difficult times are:
1) Eliminate margin loans. Not only will you continue to pay interest on these loans for typically declining investments, but your risk is always higher (and arguably you're not in total control!) when you carry anything more than minimal margin.
2) Consider selling your weakest, money-losing investments. If you own a few companies that are unprofitable and whose business potential becomes more questionable the more questionable the economy becomes, consider selling. A better place for your money may be the S&P 500 Index -- the index, as a composite, is making money.
3) Consider dollar cost averaging. If we're facing a rough ride and you're a net investor (meaning you're adding more money to the stock market than you're taking out), think about dollar cost averaging more money into your favorite positions as the stock market declines, or even average into new positions. Drip users invest more money every month, usually free of charge. With commissions so low at leading discount brokers, you can also average into stocks without Drips if you wish. (Just try to keep commissions below 2% of your investment.)
4) If it suits your style, consider shorting the weak, money-losing companies! Shorting is always an option, but it can be especially lucrative in a slowing stock market or economy. The past year we considered shorting many companies that are now penny stocks. Argh! (This motivates us even more to spot our next Foolish short. We're lookin'!)
I believe Greenspan is likely to lower interest rates (we'll see if he does today at 2 p.m.), and that could benefit stocks momentarily. Either way, what happens over the long term is anyone's guess. So, the fifth thing to do, and that should always be done, is:
5) Be confident and knowledgeable. Know about all of your investments and write down, again or for the first time, why you own what you own. Also, write down what you expect your companies to achieve, so that you can grade them over time and sell any that fail to meet your requirements. We'll publicly do this for all our companies soon.
Fool on!
--Jeff Fischer, TMF Jeff on the boards.
