You should always be ready to put your money to work in the next bear market. Everybody knows that another crash will come eventually, but we don't know when. That's just a market reality, and stock markets have been setting themselves up for a large correction since the coronavirus rebound started. Share prices are generally rising even though many of the underlying businesses are in deep trouble. Stocks in the S&P 500 (^GSPC 0.97%) index are trading at an average of 44 times trailing earnings today. That's up from 28 times earnings a year ago and the highest readings we've seen since the market panic of 2008.
It's a good idea to keep some dry powder at hand so you can take action when the other shoe drops. Baron Rothschild said that you should "Buy when there's blood in the streets, even if it is your own." On that note, here is the first stock I will think of when the next big correction comes. If it goes down alongside a broad market drop, I'll just buy more at a bountiful discount.
It's Netflix, of course
Let's recall how Netflix (NFLX 2.42%) investors reacted to the COVID-19 pandemic.
- First, Netflix crashed alongside all the other stocks. The stock fell as much as 24% between mid-February and mid-March, 2020. By comparison, the S&P 500 lost 29% during the same period.
- The initial recovery was quick and strong. Netflix shares were setting fresh all-time highs again by the middle of April.
- It dawned on investors that lockdowns and stay-at-home orders are good news for companies who make a living from entertaining people at home. By July 10, the stock had soared 84% above the deepest, darkest trough of March. The S&P 500 had only gained 32% from the same March date.
- After that, basically, nothing happened. Netflix's stock has been trading in a fairly tight range since last summer and is currently down 11% from July 10. Meanwhile, the broader market index gained 30%.
Netflix is already trading at a discount to the market as a whole. At the same time, the business has been growing like wildfire. Netflix has 207 million paid subscribers now, up from 167 million when the pandemic started. Earnings and free cash flows are skyrocketing, supported by 16% higher revenues. It's a beautiful thing:
Planning for the next crash
Recent history has shown that Netflix shares can plunge at least as far down as the broader market in the next market crash. This is true even if the reasons behind the correction actually serve to increase Netflix's sales and profits. It's a fantastic company with a massive growth story left to tell, but Mr. Market refuses to consider Netflix's proven business strength when setting the stock price nowadays.
Netflix is a strong buy today. The opportunity only grows if you thrown in a misguided market-panic rebate on top of all that. Therefore, Netflix would be the first stock I'll look at if and when another broad market crash comes along. It's a simple recipe for enormous long-term returns.