Make a Shopping List for Stocks

Did you ever go to the grocery store without a list and end up spending more than you wanted, buying junk food you’d vowed to avoid or succumbing to an impulse purchase just because something was on sale?

Well, failing to compile a shopping list of stocks to buy when the next big market drop occurs – and shares go on sale – can also be costly. It’s harder to execute a buy-the-dip plan when markets plunge and fear spikes if you haven’t prepared in advance.

Here are some strategies suggested by Adam Shell, Kiplinger’s Personal Finance, to help you pinpoint stocks to buy on weakness because they have the potential to rebound in a big way.

Seek out the best of breed. High-quality stocks don’t often sell at bargain prices. In good times, the stocks that appreciate the most and command higher price-earnings ratios tend to be leaders in their respective industries and have business models with staying power. They possess such bullish traits as a competitive advantage over rivals, strong management teams, products and services whose sales will benefit from long-term trends, and a track record of generating lots of free cash flow (cash profits left after investing to maintain the business).

Thomas Plumb, manager of Plumb Balanced, for example, is bullish on financial companies that are well positioned to profit from the ongoing shift toward digital and contactless payment systems, such as Mastercard (MA), Visa (V), PayPal Holdings (PYPL) and Amazon.com (AMZN).

Head for the hardest hit. Consider adding the most bombed-out stocks in a market rout to your shopping list. In the 25-year period ending in 2020, the three sectors and 10 subindustries in the S&P 500 that fell the most during market declines of 10% or more posted larger returns than the broad market gauge during the ensuing rebound, according to CFRA Research.

But there’s a major caveat when buying distressed shares: Often, stocks that "explode off the bottom" are financially strained firms that investors take a flier on, says Plumb.

"The perception of the company just has to go from terrible to bad" for the stock to make a big move, he says. He cites General Electric (GE) as a prime example.

Depend on pillars of strength. Set your sights on companies that have enough working in their favor to withstand temporary market setbacks. Justin White, manager of T. Rowe Price All-Cap Opportunities, uses a scoring system that looks at four key aspects of a company, which he dubs pillars: Is it a high-quality company? Is it poised to top or beat investor expectations on earnings, revenues and other yardsticks? Is the business outlook getting better or worse? Is the stock selling at an attractive valuation?

Look for investment themes with legs. Keep an eye on leaders in businesses with a bright growth outlook that are likely to generate sales and profits well into the future, says Daniel Milan, managing partner at Cornerstone Financial Services.

Themes to zero in on include e-commerce, cybersecurity, financial technology (think digital payment systems, for example) and electric vehicles.

Editor’s Note: Adam Shell is an associate editor for Kiplinger’s Personal Finance magazine, www.Kiplinger.com.