The financial markets worldwide have been facing uncertainties due to various factors such as sticky inflation, high bond rates, and a struggling stock market. Despite this, some well-known investors are buying into the market while others are selling. This begs the question, what is the strategy of successful investors during economic downturns?
One investor who has stood the test of time is Warren Buffett. He has made a name for himself as a successful investor by buying stocks during economic downturns and coming out on top. Monish Pabrai, a disciple of Buffett, shared different strategies that investors can follow to be successful during economic uncertainties.
The First Strategy
The first strategy is to look for companies with a durable competitive advantage or a “moat.” A business with a competitive advantage should have something that sets it apart from competitors and cannot be easily duplicated. This could be a brand, proprietary technology, or network effects. For investors, businesses with strong moats are the best to invest in because they can withstand economic downturns and continue to generate profits.
Brand moats, or companies with desirable labels, are some of the most powerful moats. For example, Coca-Cola has been a successful company for over 100 years because it has built a strong brand and loyal customer base. Even during economic downturns, people still buy Coca-Cola products because of the company’s brand recognition.
The Second Strategy
The second strategy is to invest in businesses with excellent management teams that can adapt to changing market conditions. During an economic downturn, businesses need to be able to adapt to survive. Companies with good management teams can make quick decisions and changes to keep their businesses running.
One example of a company with a strong management team is Amazon. Amazon has been successful because of its ability to adapt to changing market conditions. When the company started, it sold books online. Now, it is a leading provider of e-commerce, cloud computing, digital streaming, and artificial intelligence services. Amazon’s management team has been able to pivot the company’s business model to keep up with changing market conditions.
The Third Strategy
The third strategy is to invest in companies that have high returns on invested capital (ROIC) and can reinvest those returns back into the business for growth. ROIC is a metric that measures how much profit a company generates for every dollar invested in the business. Companies with high ROICs are able to generate profits and reinvest those profits back into the business for growth.
One example of a company with a high ROIC is Apple. Apple has a history of generating high profits and reinvesting those profits back into the business. For example, Apple invests heavily in research and development to create new products and services. This has allowed Apple to remain a leader in the technology industry and continue to generate profits even during economic downturns.
The Fourth Strategy
The fourth strategy is to look for companies that have a history of paying and increasing dividends. Dividends are a distribution of a company’s profits to its shareholders. Companies that pay dividends are often stable and mature, which can make them more resilient during economic downturns. Furthermore, companies that have a history of increasing their dividends may signal that they are confident in their future earnings potential.
One example of a company with a history of paying and increasing dividends is Johnson & Johnson. Johnson & Johnson is a multinational medical devices, pharmaceutical, and consumer goods company that has been in business for over 135 years. The company has paid dividends for over 50 consecutive years and has a track record of increasing its dividend payout each year. During the 2008 financial crisis, Johnson & Johnson was one of the few companies that increased its dividend payout, demonstrating its strength and resilience.
The Fifth Strategy
The fifth strategy is to diversify your investments across different asset classes, sectors, and geographies. Diversification is the practice of spreading your investments across a variety of assets to reduce risk. By diversifying your investments, you can minimize your exposure to any single investment or market downturn.
One example of a diversified investment approach is the use of exchange-traded funds (ETFs). ETFs are investment funds that trade on stock exchanges like individual stocks. ETFs hold a basket of assets that track an index, commodity, or sector. Investors can use ETFs to invest in a diversified portfolio of assets with lower fees and greater flexibility than traditional mutual funds.
For example, the Vanguard Total Stock Market ETF (VTI) holds a diversified portfolio of over 3,600 U.S. stocks across various sectors and market capitalizations. The ETF provides exposure to the broad U.S. equity market, which can help to reduce risk and increase returns over the long-term.
WisdomSpoon finds these 5 strategies very useful. Investors can find businesses that can withstand economic downturns and continue to generate profits.