Amidst the stock market reaching record highs in 2024, some investors may experience unease. Persistent inflation and worries about a potential economic downturn, particularly if the Federal Reserve maintains high interest rates for an extended period, contribute to these concerns.
During challenging times, investors typically seek defensive stocks. Nevertheless, establishing a sustainable investment strategy is prudent irrespective of market conditions. Given the occasional volatility of stocks, incorporating safer investments into your portfolio can enhance its resilience during downturns.
How to find safer stocks to invest in
Identifying safer stocks for investment may appear daunting, yet it becomes more manageable when approached systematically. Once you understand what criteria to consider, the process becomes simpler. Moreover, leading online stock brokers typically offer stock screeners, facilitating the discovery of safer stocks effortlessly.
1. Consider companies with larger market caps
Bigger corporations often represent safer options for stock selection. Their extensive revenue sources, economies of scale, and substantial financial reserves enhance their stability.
For instance, they typically allocate more funds towards research, development, and advertising. Additionally, they attract top talent and boast superior distribution networks compared to smaller rivals.
While no company guarantees a risk-free investment, including large-cap entities, they generally demonstrate greater resilience due to their stronger business foundations and access to more affordable financing than their smaller counterparts.
2. Pay attention to valuation multiples
Valuation multiples serve as metrics aimed at assessing a company’s financial performance and its stock. Common ones include the price-to-earnings (P/E) ratio, price/book ratio, and dividend yield. Discrepancies in these figures relative to industry peers may signal either overvaluation or undervaluation of the stock.
For instance, a high P/E ratio indicates a stock’s elevated price compared to its earnings. However, it’s crucial to recognize that certain industries naturally have higher P/E ratios than others, necessitating comparisons with close competitors. This principle applies to other valuation multiples, such as dividend yield.
During challenging market conditions, investors often pivot towards value stocks over growth stocks.
3. Target non-cyclical businesses
Cyclical businesses typically face increased volatility during economic downturns due to consumer spending reductions. Industries such as entertainment and travel often encounter significant challenges during recessions. Similarly, companies in the consumer discretionary sector tend to suffer when consumers tighten their budgets.
Conversely, essential services like utilities and healthcare are less susceptible to economic fluctuations. Factors like the state of the economy have minimal impact on people’s essential expenses such as electricity bills or healthcare needs, categorizing these industries as non-cyclical.
4. Find companies with increasing dividends
A continuous rise in dividends serves as another indicator of a company’s positive financial trajectory. The most robust companies demonstrate the ability to boost dividends consistently, regardless of economic conditions, including recessions. Typically, these are companies operating in non-cyclical sectors like consumer staples and pharmaceuticals.
An excellent starting point for identifying resilient companies is the list of Dividend Aristocrats. These companies have a track record of maintaining and increasing dividends for at least 25 consecutive years. While this criterion alone doesn’t guarantee a buy, it provides a solid foundation for further research.
5. Look for companies with a sustainable competitive advantage
Competitive advantage, while less easily quantified compared to other factors, holds equal significance. Companies with robust brand loyalty or patented innovations distinguishing them from competitors exemplify this advantage. Consider iconic brands that shape entire industries—they typically possess a competitive edge. Apple serves as just one illustration of numerous companies in this category.
Risk factors to watch out for
Investors should be mindful of risks when seeking safe stocks.
- Penny stocks may seem enticing due to their low share prices, allowing for significant quantity with minimal investment. However, they often signify troubled companies at risk of insolvency or gradual decline.
- Unprofitable companies aren’t always unwise investments. Startups in burgeoning industries may incur losses before turning profitable. While successful ventures can yield substantial growth, the inherent volatility of new sectors makes them less suitable for risk-averse investors.
- High dividends can be alluring for consistent payouts but may also indicate instability. Companies paying out a substantial portion of earnings as dividends may struggle to maintain them, though exceptions exist for REITs mandated by the SEC to distribute substantial earnings to shareholders.
- Companies burdened with excessive debt may pose heightened risk, particularly in cyclical industries. Those with elevated debt-to-capital or debt-to-equity ratios may not be the safest investments, particularly in the short term.
In Conclusion
During periods of economic uncertainty, investors often seek safer stock options. Large-cap companies with favorable valuation metrics typically fit this criterion, as do those operating in non-cyclical sectors like consumer staples or utilities.
Nevertheless, indicators such as high debt burdens, unsustainable dividends, and lack of profitability may suggest that a company isn’t a secure investment. While no stock guarantees complete safety, focusing on firms with robust fundamentals while steering clear of warning signs can mitigate investment risk.