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What to Do If the Stock Market Falls 20% Next MonthBy
Wednesday, June 20, 2012
If the Dow Industrials fell 20% next month, 99% of American investors would freak out.
They'd act like amateurs... which means they would sell all their stocks... and swear off investing forever.
But if you see stocks like rich people see stocks, you'd be very comfortable... and probably very excited. You might listen to the fear hype on CNBC and shake your head... then you'd keep collecting huge dividends... and look to buy more.
That's the kind of stance you take toward stocks – the rich, sophisticated investor's stance – when you adopt the investment strategy of buying the world's best, safest, most cash-generating businesses... the types of businesses I call "World Dominating Dividend Growers."
For anyone who is worried about Europe, unemployment, the election... or anyone who simply wants to earn very safe, very consistent returns... this is the ultimate investment idea for you.
Here's what I mean...
Two months ago, I urged my readers to buy retail giant Wal-Mart (NYSE: WMT).
The stock has been on my recommended list since 2006. But in April, a scandal broke about the company bribing Mexican officials. The stock fell nearly 8% in three trading sessions. And I wrote, "This is EXACTLY the sort of thing that makes a World Dominator a great buy... It is a 'huge but solvable, one-time problem,' to use Warren Buffett's phrase."
Simply put... to do well in the stock market, you need to learn how to value a business.
If you know what a business is worth and the market suddenly values it for a lot less... you can make some money buying it and waiting until the market proves you right.
Was Wal-Mart's business suddenly worth 8% less in April? Of course not. Wal-Mart earned more than $43 million in profit per day last year. Will the bribery scandal cost even half that much? Maybe... and let's say it'll cost a whole lot more. Let's say it'll cost $8 billion, half a year's net profit. It would hurt, but it wouldn't dramatically change the value of the business.
I can imagine the feedback already: "Wait a minute, Ferris! Are you telling me Wal-Mart could light 50% of its annual profit on fire and not dramatically change the value of the business?"
Yes, I am... Or at least, it wouldn't change Wal-Mart's value much over the long term.
Wal-Mart is highly valuable because it fends off competition. That's why it doesn't really change much from year to year, except by selling more, making more profit, and raising its dividends. "Boring" businesses like Wal-Mart just keep gushing cash. And the source of a business' value is cash profits.
As Ben Inker, who heads the asset allocation group for the value-oriented money-management firm GMO, has pointed out... roughly two-thirds of all corporate value lies 20 years or more in the future.
Most people can't think past the next 20 minutes (or beyond the next CNBC commercial break). So they fare poorly and have no perspective on the value of a fantastic, World Dominating business like Wal-Mart.
In essence... you value a business by estimating all the cash profit you'll be able to take out of it over its life. We expect Wal-Mart to be around for decades to come. So you have to ask, if you think the Mexican bribery scandal will cost Wal-Mart $8 billion in fines (and I doubt it'll be that much), what's half a year's profit compared to decades and decades of slow but steady growth?
So it's no surprise that Buffett bought more Wal-Mart shares during the darkest few hours of the Mexican bribery scandal. He's become a billionaire simply by knowing what businesses are worth... and paying a lot less than that.
Were you buying Wal-Mart when the headlines were screaming about the scandal and the share price was falling almost 8% in three days? If you had bought then, you'd have gotten the stock for less than $60 a share. It's trading around $68 today, a big move in a short time for a giant company like Wal-Mart.
Once you learn about how to value a business, you start looking around for highly valuable businesses, like Wal-Mart, so you can buy them when their share prices are down.
That's why if the Dow suddenly falls 20% next month, I'll be thrilled. I'll be ready to buy the world's best businesses at a big discount. Will you?
Good investing,
Dan
Further Reading:
Wal-Mart is a prime candidate for what Editor in Chief Brian Hunt calls the "dividend momentum" trade – big dividend-payers holding steady, or even rising, as risker stocks struggle. These stocks are much better than everything else, Brian writes. "They're better than bonds… better than an index fund… even better than gold."
And as Dan explains in an interview with our sister site The Daily Crux, when you buy these high-quality dividend-payers, you are "assured all the income you need for the rest of your life."
Market NotesA NEW BUY SIGNAL FOR OIL STOCKS The oil sector looks like death.
The AMEX oil index is down 10% in the past month and almost 20% since March. Many oil companies, including oil-services giants Halliburton (HAL) and Baker Hughes (BHI), are trading at less than 10 times earnings. It's hard to find any analyst, anywhere, who'll say something good about the sector.
And the bullish percent index for the oil sector (BPENER) has just whipsawed into, out of, and back into a buy signal.
A bullish percent index (or "BPI") measures the percentage of stocks in a sector that are trading in a bullish pattern. A BPI is typically overbought when it rallies above 80, and it's oversold when it drops below 30. Buy signals occur when the BPI turns up from oversold levels.
The blue circles on the chart below represent buy signals. As you can see, BPENER triggered a buy signal in late May. But that signal reversed, and the BPI dropped to a lower low.
We got a second buy signal last week.
Oil stocks are brutally oversold. They're dirt-cheap. Sentiment toward the sector is bearish. And we just got a rare "double buy" signal from the BPENER.
– Jeff Clark
P.S. I just recommended my favorite oil trade to my S&A Short Report subscribers. If its bullish chart pattern plays out as I expect, it could return 167% gains over the next few weeks… To find out more about subscribing to my newsletter – and learn how to get access to this trade – click here.
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