The S&P 500 has dropped 10% or more 28 times since 1922, according to Yardeni Research. The market eventually recovered from 27 of these drops and went on to new highs. That last one is happening right now.
Yes, as of this writing, the S&P 500 is around 10% from its high, and many stocks are down far more than this. There are legitimate reasons for the sell-off. Nevertheless, I've decided to apply Motley Fool investing principles and use the rest of the cash in my retirement portfolio to buy more stocks. Here's why.
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Take a deep breath and buy
There are multiple things to keep in mind when investing. Among them: The stock market regularly pulls back every couple of years. This is normal.
Of course, the market could fall further. In fact, I'd guess the market will drop further. In the U.S., we're still combating supply chain disruptions and the highest rate of inflation in 40 years. Moreover, Russia's invasion of Ukraine has caused problems with energy prices and could exacerbate the semiconductor shortage (Ukraine supplies an outsized portion of certain, necessary raw materials). There also could be a broader fallout from the economic sanctions placed on Russia. Of course, these issues pale in comparison to the loss of human life in Ukraine, but they still suggest stocks may fall further.
However, I don't know stocks will drop further. No one does. The only thing I can confidently say is that a 10% drop is normal but infrequent. And in times past, a drop of 10% or more was a good buying opportunity for investors willing to hold for five to 10 years. That's indeed my time horizon. Therefore, it's important for me to take advantage of lower prices and invest despite ongoing market volatility.
But wait -- there's more
My retirement portfolio had a roughly 5% cash position. I'm still honing my opinions on how much cash to ideally keep on the sidelines. But I used all of this cash to buy stocks in recent weeks. This may sound crazy. After all, I just said my guess is stocks are headed lower in the near term.
The thing is, I add cash to my retirement account monthly -- adding new money regularly is another Foolish investing principle. So I'm out of cash to invest right now, but I'll add more next month and the month after that. If the market does drop further, I can simply take advantage of lower prices as they present themselves.
Here's what I'm buying
Another caveat to all of this is I believe stocks, in general, are still richly valued. Just consider the data. According to Yardeni Research, the price-to-earnings (P/E) ratio for the S&P 500 is currently about 22, compared to its historical average of 15. So even with the pullback, stocks are 46% more expensive than average on a P/E basis. That's concrete data that can't be ignored.
My point is, not every stock is a bargain right now simply because the market has pulled back. I believe you still need to be extremely selective in what you buy. You're looking for strong companies that can deliver strong returns from their current price.
The first stock I bought with my retirement cash was advertising technology company PubMatic (PUBM -2.27%). Looking at the big picture, the company serves digital ads, which are taking market share from traditional advertising. Its customers are spending more money over time, as evidenced by its net dollar-based retention rate of 149% in 2021, suggesting its customers like what PubMatic has to offer. Furthermore, the company is profitable and trades at an average P/E of 22. In short, there's lot to like about PubMatic right now.
The other stock I bought was MercadoLibre (MELI -0.45%), an e-commerce and digital payments giant in Latin America. Trading with a price-to-sales (P/S) ratio of almost eight, this is still a pricey stock. However, it has only traded with a cheaper P/S valuation once in the past decade. Revenue is roughly 20 times greater now than it was 10 years ago, and as Latin America continues to adopt MercadoLibre's digital solutions, I believe growth can continue at a robust pace, justifying today's valuation. Moreover, the company has built out valuable infrastructure that allows it to fulfills orders extremely fast, a real competitive advantage going forward.
To sum up: I understand if the stock market seems like a scary place right now, but volatility is a gift for long-term investors. We can buy stock in the best companies at reduced prices. Things can always drop further in the short term, but if we're patient, companies like PubMatic and MercadoLibre can create shareholder value and eventually deliver outsized returns.
