There's a saying among stock traders: Don't try to catch a falling knife. And with the S&P 500 down by more than 22% this year so far and more market turmoil expected in the near future by practically everyone, investors are right to wonder whether they should be continuing to buy stocks even when there's a crash.
There's more to being a shrewd investor than knowing pithy nuggets of wisdom, though. As it turns out, buying stocks when the market crashes can be an excellent strategy so long as you refrain from trying to trade in and out of a position at the "perfect" time.
Here's why it's better to keep buying
Let's use the recent coronavirus crash in March 2020 as an example of what can happen if you decide to sit out when the market is tumbling. Suppose it's early in February of 2020 and you are thinking about buying shares of a growth stock like STAAR Surgical, (STAA -0.81%) a company that makes implantable lenses for vision correction for people with myopia. Seeing the mounting pandemic wreak havoc on the financial markets, you opt to defer your purchase until the seas are calmer. When the crash happens in March, you pat yourself on the back for your farsighted choice. As it turns out, that would have been a big mistake.
Take a look at this chart:
As you can see, STAAR's stock plummeted during the crash, as did the wider market, but it bounced back to an even higher level quite dramatically. And since the depths of the crash in March 2020, STAAR grew like wildfire, with its shares now up by around 147%. So refraining from making a purchase either in the run-up to the crash or immediately after it would have left you without any of those gains.
The first principle to understand here is that the market values stocks based on the predicted future earnings of companies, among other things. The coronavirus crash occurred as a result of a general panic that many businesses would not be able to conduct operations as usual over the coming months, which obviously would lead to lower earnings. For a company like STAAR, which distributes its implantable lens products to ophthalmic surgeons and clinics, the total disruption of the early pandemic simply didn't last very long. Surgeons were still buying plenty of their lenses and implanting them into eligible patients, and there wasn't much reason to believe that further developments in the pandemic would cause much of a slowdown.
In other words, the stock's price may have crumbled, but nothing about STAAR's ability to compete was diminished as it was still profitable and growing. And that means the predictions about its future earnings recovered as soon as patients were allowed back into clinics, which in turn drove a rapid recovery of its share price shortly thereafter. The company's growth has proceeded at a steady clip since then with its trailing-12-month revenue rising by nearly 80% in the last three years.
The second principle to keep in mind is that market crashes drive down the share prices of companies whose operations and future earnings are exactly the same on the day before the crash as the day after it, along with the share prices of other companies whose prospects are genuinely harmed by the precipitating economic events which caused the crash. You can't predict much about a stock's future performance from the movement of its price alone, especially not during the intensity of a crash. And when you let your fear of future losses get the better of you, you end up leaving money on the table.
Consider your options carefully, not fearfully
Buying stocks during a market crash isn't for everyone, and you still need to be very selective in your purchases if you want to beat the market. There's no guarantee that every stock you buy is going to bounce back as quickly as STAAR Surgical, but it helps to focus on businesses that are profitable, growing, minimally indebted, and capably led -- which is much the same situation generally when it comes to investing. It's also important to recognize that crashes can be an opportunity to pick up shares at a steep bargain, but it isn't an obligation.
Put differently, if you have your eye on an attractive company and the market crashes, promptly finish doing your due diligence and decide whether to buy it or not. On the other hand, if buying right after a crash is going to give you anxiety, it might be better to wait so long as you understand that you might miss out as a result.
