As the great lockdown comes to an end in much of America, many public health experts are warning that there could be a second wave of coronavirus cases. This, of course, is likely to cause further economic turmoil if it necessitates more stay-at-home orders.
If you're concerned further lockdowns will be necessary, either across the country or in hotspots, you may be thinking about buying stock in businesses that are likely to benefit, such as Netflix (NFLX -1.78%), Zoom Video Communications (ZM -1.18%), or Clorox (CLX -3.57%).
But before you buy these stocks in anticipation of a resurgence of COVID-19, there are three key things you need to do.
1. Investigate the fundamentals of any company you're considering
Buying a company solely because you think it will perform well because of COVID-19 is a risky move.
If everyone expects COVID-19 will lead to increased profit for particular businesses, this expected future success is likely already priced into the company's current share price, so you may not see big gains even if this prediction pans out. And, of course, you can't predict the future. If a second wave doesn't happen and the company doesn't get the windfall a COVID-19 resurgence would've caused, share prices could tumble.
Rather than trying to guess the effect the coronavirus will have on stocks, make sure you're buying shares of companies with a business model you believe is likely to lead to long-term success. To do that, look at the company's sustainable competitive advantages, the strength of the leadership team, and the company's value as measured by the price-to-earnings ratio and price-to-sales ratio.
If you don't have a sound basis for buying any stock beyond the fact you think it could benefit from another community lockdown, pass it by.
2. Determine how the stock fits into your portfolio
A sound investment strategy aims to build a diversified portfolio. Investing too heavily in any particular sector or buying too many shares of any one company exposes you to too much risk.
To make sure you aren't putting all your eggs in one basket, evaluate whether any coronavirus-related stock you're considering is too similar to current investments. If you own shares in streaming companies already, you may want to skip buying more Netflix stock. Otherwise, if it turns out everyone's too busy baking bread to binge-watch during the next great lockdown, you could see your portfolio take a huge hit.
3. Make sure you want to hold onto the company for the long term
If you buy into a diverse mix of carefully researched companies with sound business models, your investment portfolio is likely to perform well over time. But that doesn't mean you won't sustain some short-term losses -- especially as the full economic effect of COVID-19 won't be known for a long time.
If you buy and hold, you reduce the chances you'll end up with a losing investment, so aim to purchase shares in companies you'd be happy holding onto for many years. Buying into a business you don't want to own for decades solely because you think it will perform well over the next few months could be a recipe for disaster, since you don't have a crystal ball to tell you what those months will bring.
Don't make a decision you'll regret
It's tempting to try to make money during this unprecedented economic and public health crisis by buying stocks that you think will do well during it.
But you're likely to do far better in the long term if you stick to some fundamental principles of investing, including only buying shares of companies you believe will stand the test of time. If it just so happens those stocks are also likely to benefit from a second great lockdown, that's just additional security.