When the stock market keeps falling, it’s a scary time to be invested. But history shows past market crashes have given us the opportunity to buy good assets at bargain prices. This has certainly been true for US billionaire Warren Buffett, whose investing career began in 1956.
Buffett has always been generous in sharing the lessons he’s learned from a lifetime in the stock market. One of his more memorable pieces of advice is: “You only learn who has been swimming naked when the tide goes out.”
What did Buffett mean?
The swimming naked quote came from Buffett’s 2008 letter to shareholders, written at the height of the financial crisis (you can read Buffett’s latest letter here).
In 2008, he was commenting on the problems facing major US banks, which were facing big losses from sub-prime mortgage loans. What he meant was that when times are good, the price of everything goes up. No one looks too hard for problems. But when things get tough and losses mount, all sorts of other problems start to appear.
I suspect that’s what we’re going to see over the coming months. Some companies will suffer serious financial problems that will leave shareholders with permanent losses. But some companies will be able to survive and recover as the coronavirus epidemic tails off.
There’s a lot of money to be made if you can buy good stocks now when all share prices are low. But how can you tell the difference between good and bad?
One key giveaway
In my experience, the best place to start is with debt. Too much borrowed money can destroy companies. And even if the business survives, shareholders are often wiped out.
The first sector where we’re seeing this is oil. Shares in Tullow Oil and Premier Oil are both down by about 85% so far in 2020. In my view, these heavily-indebted companies are both likely to breach their lending conditions over the next 12 months. This could lead to emergency refinancing, leaving shareholders facing further losses.
Oil is the first sector to run into problems, but I don’t think it will be the last. I’d also steer clear of heavily-indebted retailers, travel groups, and restaurant chains. And I’d avoid airlines for now.
Like Buffett, I’d steer clear of any business with too much debt. If there’s one simple thing you can do to avoid big losses when investing, it’s staying away from companies that are addicted to borrowed cash. The situation can look safe for years, but you never know when it will blow up in your face.
What I would buy
Buffett’s success is partly due to his ability to spot companies that can recover quickly after a period of difficulties.
As I explained last week, I think FTSE 100 firm Associated British Foods could be a good buy at the moment. I’ve also been buying more shares in insurance group Aviva for my portfolio. Pharmaceutical and tobacco stocks could also be a good choice, in my opinion.
Among smaller firms, scientific instrument makers Judges Scientific and Oxford Instruments both look good value to me. Both companies have plenty of cash on hand and are confident business will return to normal after coronavirus. I rate both as quality stocks.
