When the economy tanks, conventional wisdom says to load up on "quality" -- the stocks of gigantic companies in critical businesses. To some extent, that makes sense. After all, no matter what the economy does, people will still buy food, medicine, and deodorant, and larger companies are more likely to have the financial wherewithal to survive a prolonged downswing.
As a result, companies like these are generally viewed as classic defensive investments for lousy economic times:
|
What people will do, no matter the economy |
Who'll maintain revenue |
|---|---|
|
Eat |
Kraft Foods |
|
Get medicine if they're sick |
Abbott Laboratories |
|
Plug in their refrigerators |
Exelon |
|
Buy basic necessities |
Wal-Mart |
The problem with conventional wisdom
Yes, when times are tough, companies that make what people need are likely to do better than ones that make what people merely want. It's also true that companies with strong financials can more easily absorb the shocks and stresses that come along with lousy economic conditions.
The problem with conventional wisdom, however, is that by virtue of it being conventional wisdom, everybody already knows its lesson. And if everybody already knows it, it's too late to profit from it.
Or is it? While conventional wisdom is pointing people to the biggest, most well-known companies, the kernel of truth buried in that wisdom suggests looking outside the blue chips for companies with strong fundamentals and an everyday niche.
There's a baby in that bathwater!
When everyone is fleeing to the supposedly safer environment of megacaps, they can leave quite a mess in their wake. Indiscriminate selling of the supposedly "unsafe" smaller companies means that some legitimate treasures are tossed out alongside the speculative trash.
And that's where you get your opportunity to win ... big.
When fear-driven selling dominates the market, you can pick up fantastic deals in strong, smaller companies. As always, look for the ones with strong balance sheets, solid business plans, and critically needed products and services. If you find them trading at an unreasonably discounted price, congratulations -- you've found the baby the market tossed out with the bathwater.
Take, for instance, these medical supply companies:
|
Company |
Market Cap |
Long-Term Debt |
Trailing |
|---|---|---|---|
|
ICU Medical |
$0.40 |
$0.0 |
19.6 |
|
Becton, Dickinson |
$21.30 |
$1.0 |
21.7 |
|
Baxter International |
$38.01 |
$2.7 |
23.0 |
The smallest one -- and thus the one most likely to be overlooked in this market -- is also the cheapest as defined by trailing earnings. It's also the only one without any long-term debt to worry about.
What this means to you
In normal circumstances, a smaller company with a pristine balance sheet can trade at a premium to its larger peers because it's either considered a potential takeover target or viewed as having more room to grow. Either way, when small companies trade at discounts to larger peers like we're seeing now, it's a sign that the market is well along its panicked flight to "quality."
At Motley Fool Hidden Gems, we love markets like these, because we have so many opportunities to buy small, strong companies on the cheap. One day the market will wake up to the high-quality companies it has thrown away, and we'll be poised to gain the full advantage of its short-sightedness.
If you're ready to take advantage of the market's panic sale, click here to join us today free for 30 days.
At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Wal-Mart is an Inside Value recommendation. Kraft is an Income Investor pick. The Fool has a disclosure policy.
