How Well Did You Time the Market?

The stock market tanked in 2008, only to stage a tremendous recovery that started in the spring of 2009. If you managed to sell at the top and buy in at the bottom, you're sitting really pretty right now. If, on the other hand, you joined the ranks of those who capitulated near the bottom and are only now thinking about getting back in ... well, let's just say things haven't quite worked out so nicely for folks who fall into that camp.

Truth be told, I'm not sure anybody really did time the market perfectly. I still heard many of the market bears who were close to recognizing the top gnashing their teeth when we were near the bottom. Likewise, the same bulls who appeared to nail the recovery were calling for the recovery throughout much of the drop. It's no big deal to be right once, if you're making the same call day after day after day.

Ignore the stopwatch
Timing the market is generally a futile endeavor. For one thing, personal sentiment tends to get in the way of rational thought, especially when your own real money is on the line. For another, at the extremes on either end, the market's driver's seat is occupied by an emotional herd mentality, not rational thought. If you're smart, you can't figure out where the market is going to go next, and if you're driven by your emotions, you can't separate yourself from the herd.

It's a can't-win scenario. The only way out is to stop trying to time the market and start paying attention to the companies available for purchase within that market. The beauty of the stock market is that it's a collection of individual stocks, each representing its own company. Not all companies are created equally, nor are they financed, led, or operated the same way. But when the market as a whole is driven to extremes, it moves all sorts of companies along with it.

Therein lies your edge. You can't time the market, but you can hold on through the swoons and even buy more of the strongest companies in your portfolio while they're on sale. Yet to be able to make such a decision as the market and economy appear to be crashing all around you, you need to know what companies you own and why they're really worth owning.

What makes a company strong?
Two things matter more than anything else in determining a company's strength:

• What it has.
• What it does.

The company's balance sheet describes what it has. It is an accounting of all its assets and liabilities, and it tells you how solid its financial foundation really is. A company with a strong balance sheet can survive a bad economy and position itself to take advantage of the carnage left in the wake of most economic meltdowns. On the flip side, a weak balance sheet makes it far more likely that the company will itself wind up as part of that carnage.

A basic description of the business will tell you more or less what it does, and its cash flow statement will tell you how well it does it. The cash flow statement shows how much money has been pouring into the business and how much cash it takes to support its operations. In many cases, in fact, the cash flows point to a truer picture of the company's health than does the profit number on its income statement.

When you find a company with both a solid balance sheet and great cash flows, then you have one worth owning, even during a market meltdown. And when such a meltdown takes a strong company down with it, then you have the opportunity to buy even more of that company at a better price. Look at these companies, for example:

(*) Defined as cash from operations, minus capital expenses.
Data from Capital IQ, a division of Standard and Poor's.

Strong free cash flows indicate that they're actively generating real cash, even as the economy struggles to recover. With a debt-to-equity ratio below 1, they have solid balance sheets capable of weathering most storms. And perhaps most importantly, given the continuing tightness in the debt market, they have more cash and equivalents on hand than they have current liabilities. That means they have enough cash to cover the bills that are coming due in the near future.

You can do it
When a company has a fundamentally strong profile like that, it's a lot easier to hold on -- and perhaps even buy more -- as the market takes down its stock. You can't time the market, but you can certainly hold on to strong companies that trade cheaply. At Motley Fool Inside Value, we were happy to hold on to our strongest companies throughout the market's 2008 crash. And now that the market has recovered much of its lost ground, we've been rewarded for our patience.

If you're ready to seek out the companies that are strong enough to hold through a market crash, then join us today. If you'd rather first see what companies were worth holding through the 2008 mess, click here to start your 30-day, no-obligation free trial and sneak a peek at our scorecard.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned no shares of any company mentioned in this article. Lincoln Electric and Markel are Inside Value selections. Adobe Systems is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Lincoln Electric and Markel and has a disclosure policy.