5 Tips for Beating the Bear Market

On Aug. 1, U.K. Fool Stuart Watson -- from our sister site (fool.co.uk) -- provided an interesting take on defensive stocks. We thought you'd like to read it. The article has been updated and Americanized by Todd Wenning.

When shares are falling, it's easy to forget that investment is a long-term game. Your investing career is likely to last decades, and slumps, such as the one we are currently experiencing, are an inevitable, necessary, and even welcome part of the process.

So how can you beat the bear? Here are five tips for keeping your portfolio's performance on track.

1.  Keep your eyes peeled
Tough times are great for highlighting both good and bad businesses. Good businesses will be less affected by downturns, or will be able to adapt their business models accordingly. Companies that can continue to invest heavily through slumps are often worthy of close attention. When the recovery eventually comes, they'll be a step ahead of their competitors.

Equally, cracks in shaky business models are quickly exposed by falls in economic activity. To be frank, we're probably too late on this one and much of the damage will have been done to the share price already. Still, it's a good educational process to see what's fallen the most. It could help you avoid a similar mistake when the next downturn arrives.

2.  Be brutal
It's important not to get carried away by fancy forecasts about the potential of a business. Especially with smaller and younger companies, the rate of growth is difficult to predict and tends to be slower than brokers expect. Treat forecasts with even more disdain than usual during a downturn. Knock 10%, 20% or even 25% off the figures and consider whether you'd still buy or continue to hold any investment you examine.

I think it's also a good time to have a more concentrated portfolio. So consider selling out of what you think are the weakest companies you hold and invest the proceeds in those that you believe have the strongest prospects.

3.  Delve into debt
When looking at an investment these days, the first thing to examine is its cash position. Has it been generating or losing cash over the last few years? What level of debt does it have and when do debts have to be repaid or refinanced? If you want to investigate a company's financial health in even more detail, consider using the Altman Z-score, a ratio designed to predict which companies may go bankrupt.

Many U.K. businesses currently have too much debt, in my opinion. There has been pressure from institutions in recent years for companies to gear up their balance sheets to expand more quickly or buy back their shares. In calmer times, these higher levels of debt are manageable. At the moment, they're not looking too comfortable.

4.  Step back and switch off
As with all walks of life, there's a lot of nonsense written about the stock market and the economy. Sifting through the information that is both important and relevant to your investments is a skill that many people take years to learn.

We're flooded with bad news at the moment, as it makes for good headlines. Taking a step back from the furor of the financial press makes a lot of sense at times like this. It helps you ignore the short term, form your own opinions, and focus on the long term. Of course, reading the Motley Fool is the one exception you can make!

5.  Don't get emotional
It's important to keep emotions out of investing as much as possible. When share prices are gyrating wildly, it's especially vital. We make rash decisions when we're emotional, focusing on recent and trivial information at the expense of the bigger picture.

So, if you find yourself swearing at your computer screen every time you look at your portfolio or, even worse, letting off steam by insulting company managements on bulletin boards, then I think you'd need to question whether you're cut out to be an investor. Management is there to look after the business, not the share price and, on occasions such as this, the smaller and more speculative companies that many private investors tend to favor get hit especially hard, regardless of the progress they're making.

There's an old adage along the lines that if your investments keep you awake at night, then you're usually better off without them.

With all that said, here are seven highly rated value stocks identified by our 110,000-plus-member Motley Fool CAPS community:

*Source: Motley Fool CAPS as of Aug. 4, 2008.