For the moment, the market seems to have settled. We're still down for the year, but the huge and seemingly arbitrary daily swings have quieted a bit.
Does that mean the worst is over? It's unclear. The housing market is still in freefall. Both traditional and investment banks are still taking billion-dollar write-downs and suffering falling earnings. According to a Financial Times report, Lehman Brothers (NYSE:LEH) is in talks to dump $40 billion in mortgage and real estate assets. The stock is down some 15% since Friday, bringing the damage up to 78% for the year.
And the malaise has hit credit cards -- concerns over increased credit losses have weighed on Discover Financial Services (NYSE:DFS) and Capital One (NYSE:COF).
Yet people say the market bottoms about six months before the economy recovers. Maybe that's what's happening here, maybe not. It's hard to draw a firm conclusion, but it doesn't really matter. There's money to be made regardless.
Hit the lobs
If you're a ghoulish value investor like I am, your first thought after the credit bust was probably something like "I'll bet some huge bargains exist in homebuilding and banking stocks." Those bargains exist, but so do dozens of others, because constant grinding negativity drove down so many great stocks.
Sure, you could make money if you identified the subprime winners, but why bother trying to separate the winners from the losers when great stocks that aren't involved in the bust are cheap right now? The subprime-stained stocks are still too ugly and risky for my dollars. In baseball terms: Don't swing at the fastballs. Aim for the lobs.
There's no reason to spend days figuring out whether Wachovia (NYSE:WB) will recover. That $53 share price is ancient history. Though the company will survive, it's had to cut its dividend, share value has been diluted by a $7 billion stock offering, and the business will be altered after it sheds billions in assets and more than 6,000 employees. Predicting this one is way too hard.
Similarly, steer clear of the investment banks. If one of them can collapse in a matter of days, who's to say another won't? Avoid them until you're confident that the worst is over.
And Lennar (NYSE:LEN) and the other homebuilders? I wouldn't go near them until there's actually some evidence that the housing market has bottomed.
Cheap and easy
Though the market isn't acting like it, the long-term prospects of most companies aren't significantly affected by the credit crisis. If we're in a recession, it will have a short-term impact on most businesses, but it won't last forever. So forget the lenders. Instead, go after the stocks that are also cheap, but don't have the same long-term risks.
For example, 3M (NYSE:MMM) is a giant conglomerate that produces everything from Post-it Notes to metered-dose drug inhalers to touch-screen monitors. A U.S. recession will slightly ding short-term earnings, but this is a company with more than 55,000 products and international sales of $15.5 billion.
Yet this stock has fallen about 25% from its highs and is trading at its lowest price-to-earnings multiple in more than a decade.
Health-care companies have been hit hard, too. UnitedHealth Group is trading at about 10 times earnings, even though it has a lot of cash on the balance sheet, high returns on equity, and good growth prospects. The market is worried about rising medical costs. Health care is a high-profile issue right now, too -- there are few topics that politicians love to complain about more during an election campaign (and do less about when actually elected) than our nation's medical system.
But I don't believe these are anything other than short-term problems. Health-care companies will reevaluate their models, adjust to any new regulations, and go back to printing money. Yet because of the market climate, this stock is more than 50% off its 52-week high.
Be careful, though
That said, you should still be cautious. The key to investing during a crisis is making sure that the stocks you're buying truly are isolated from the blow-up. One huge company has failed, others could follow, and challenging credit conditions may have far-reaching implications.
For instance, though interest rates are low, it will be much harder to roll over debt with the credit market at a standstill. Examine the balance sheet carefully, and make sure the company doesn't have significant debt that it needs to roll over in the next few years. When lenders get scared, it doesn't matter if you're a "good" credit risk -- you won't be getting money at attractive terms.
Another item to inspect is accounts receivable. Is the company doing business with people who will have a hard time paying their bills? In a credit crisis, you want to own businesses with rock-solid balance sheets and reliable customers.
The Foolish bottom line
Volatility is frustrating, but it has benefits, too. You rarely get the opportunity to buy excellent businesses at massive discounts to their fair value, but this is one of those times.
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This article was first published May 2, 2008. It has been updated.
Every now and then, Fool contributor Richard Gibbons gets a little bit terrified, and then he sees the look in Jim Cramer's eyes. He owns shares of UnitedHealth. 3M, Discover Financial Services, and UnitedHealth are Inside Value recommendations. UnitedHealth is also a Stock Advisor selection. The Fool disclosure policy is like a shadow on him all of the time.
