Jim Cramer on Sunday laid out five risks facing the stock market and argued they do not represent “the most dangerous time the world has seen in decades,” as JPMorgan CEO Jamie Dimon said earlier this month. The headwinds: A nuclear confrontation with Iran, along with rising U.S. tensions with Russia and China. The belief that the U.S. cannot fight in the Middle East, Ukraine and the Taiwan Strait all at once. U.S. debt is too high, which is bad for both stocks and bonds. A lack of faith in both Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen to respond to any and all challenges. The subtext of U.S. economic decline. These are all real worries for investors. But they don’t amount to another looming financial crisis on par with the Great Recession of 2007-2009, requiring investors to completely bail out of socks. They aren’t systemic risks, just challenges that can impact sales and earnings. So what should you do? For starters, don’t let your emotions — fear, in this case — control the decision-making process around buying and selling stocks. Here are five things we do to stay objective and clinical in a risky market. 1. Listen to CEOs and management teams. The September quarter earnings season is ramping up for the stocks in our portfolio. This means updated financials and — arguably more important — forward guidance and commentary from company leaders. While earnings results and other macroeconomic data is backward-looking, calls with investors are about what’s happening now and in the future. 2. Identify winners using metrics. Armed with quarterly updates, we can determine the best names in each sector and industry. We always focus on quality, but it’s even more fine-tuned when risks are mounting. That’s because the higher-quality names will better weather any volatility or downturns. They are also generally the first to rebound when investors enter back into the market. What do we mean by “high quality?” Stocks with strong cash flow generation, especially free cash flow. The greater the percentage of profits is back by cash, the higher the quality of those earnings. We also look for a solid balance sheet with a close eye on the net debt (preferably net cash) level. Net debt is simply total debt minus cash and cash equivalents. If it is a negative number, that’s a net cash position. This provides us a good starting point for thinking about liquidity in the event sales do take a hit. Obviously the more cash a firm has on hand, the better able it is to ride out a lull in sales. Having a net debt position isn’t a deal breaker, but we do need to ensure there are no large debts coming due on the horizon. The mega-cap tech names screen well here with Apple (AAPL), Meta Platforms (META), Microsoft (MSFT) and Alphabet (GOOGL) all sporting net cash positive positions. Amazon (AMZN) is expected to have gone from a net debt position to a net cash position during the third-quarter. Consider leverage metrics. Corporations take on debt to fund investments. As investors, we want profitable companies to lever up, to an extent, because strong management teams can make good use of that debt to provide stronger long-term returns. But with high borrowing rates, it’s expensive to take on debt, which means a company needs to justify the use of debt with strong returns on investments. A good debt metric is net debt-to-EBITDA, which helps us determine appropriate debt levels given a company’s EBITDA generation. The lower the number the better, as it indicates a company can cover its debt with the money it generates from operations. We generally like to see a ratio of less than 3 times. Above that requires persuasive explanation from management. 3. Think qualitatively, too. How much pricing power does the company have? How elastic, or preferably inelastic, is the demand for what the company sells. Can buyers afford to go without the product if prices increases or disposable income declines? Or are they going to sacrifice purchases elsewhere? Companies like Procter & Gamble (PG), Eli Lilly (LLY), Humana (HUM) and Costco (COST) all sell items we simply can’t live without: food, staples and health care. 4. Look for buying opportunities. No need to rush this last step. Money market funds and other bank deposit alternatives are yielding 5% or more at the moment. So keep some cash at the ready and “circle the wagons,” meaning stay focused on your best ideas. Pick your levels and opportunistically increase your exposure — keeping diversification in mind — as those levels are reached. 5. Make every buy count. Always consider your cost basis to make sure you are buying shares at a good price point. You can use technical indicators, but we prefer to focus on things such as price-to-earnings or cash flow levels or dividend yields. We recently added to our position in Morgan Stanley last week noting that the recent sell-off pushed the firm’s dividend yield to just north of 4.5%, an attractive return even in this environment. That’s because dividends can grow overtime — in addition to any price appreciation in the stock price — unlike bond yields which are locked in at the moment of purchase. Bottom line When the marker gets riskier, the goal isn’t to hit home runs but to get on base. On-base percentage is going to be far more meaningful in this environment than slugging percentage. This means forgetting high-fliers trading on price-to-sales multiple that don’t make money now but promise to in the future. Opt instead for best-of-breed companies in different sectors that boast real earnings and cash flow. They will survive the turbulence and soar after the dust settles. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., October 20, 2023.
Brendan Mcdermid | Reuters
Jim Cramer on Sunday laid out five risks facing the stock market and argued they do not represent “the most dangerous time the world has seen in decades,” as JPMorgan CEO Jamie Dimon said earlier this month. The headwinds:
- A nuclear confrontation with Iran, along with rising U.S. tensions with Russia and China.
- The belief that the U.S. cannot fight in the Middle East, Ukraine and the Taiwan Strait all at once.
- U.S. debt is too high, which is bad for both stocks and bonds.
- A lack of faith in both Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen to respond to any and all challenges.
- The subtext of U.S. economic decline.
These are all real worries for investors. But they don’t amount to another looming financial crisis on par with the Great Recession of 2007-2009, requiring investors to completely bail out of socks. They aren’t systemic risks, just challenges that can impact sales and earnings.
So what should you do? For starters, don’t let your emotions — fear, in this case — control the decision-making process around buying and selling stocks. Here are five things we do to stay objective and clinical in a risky market.
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