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Profit from a Stock Selloff

While debt jitters drive markets lower successful investors ask themselves how to profit from a stock selloff. The traditional way that long term investors profit from a stock selloff is to pick up bargains when a falling tide lowers all ships. This approach requires fundamental analysis of individual stocks prior to the day that the market sells off. An alternative approach is to anticipate a rebound after the market becomes over sold. This approach assumes that all stocks will rebound together and often relies upon technical analysis of overall market sentiment. Our view is that more information usually results in more profit, so we suggest that investors search out and learn about individual stocks that might result in a profit from a stock selloff.

For the investor interested in picking up growing companies, buying companies with strong balance sheets, or investing in companies with cash, there are lots of companies to pick from. If the investor wants profitable, growing, cash rich companies at great stock prices that is another matter. Investors pay a premium for value and great stocks commonly have high price to earnings ratios. Thus many successful investors keep a list of stocks that they have researched. This list includes stocks with two characteristics. One is intrinsic stock value, the growth and earning potential of the company. The other is margin of safety in the form of cash reserves, absence of debt, and unencumbered tangible material assets such as production facilities and real estate, patents, oil or mineral reserves, and other valuable assets not currently producing profit. Such stocks are commonly priced on the high end of the spectrum. These stocks become a much better deal as the market falls, when buying them becomes a way to profit from a stock selloff. Companies like Berkshire Hathaway are commonly in the news when they purchase huge blocks of stock, preferred stock, or whole companies as stock prices fall across the board. Their purchases are certainly not random. The targets of these purchases and takeovers are well researched stocks with intrinsic stock value and a margin of safety.

Successful long term investors know a lot about their stocks. They understand why a stock price has risen and they understand why a stock price falls. When the market falls due to general expectations of bad economic times the stock selloff often takes good stocks down with the bad. The sales and income of a company selling basic consumer products or groceries will commonly not drop off when a recession hits. No matter what the debt rating of the EU or the USA, people will buy hand soap, laundry soap, beans, rice and potatoes. A smart investor knows what his company makes and how its sales will be affected by a recession, how its expansion plans will be affected by a rise in interest rates, and if its research and development efforts are likely to be affected by a need to conserve cash. In order to profit from a stock selloff the successful investor always asks himself what is a good investment based on fundamentals. If a previously expensive but good stock is now very fairly priced it provides a means to profit from a stock selloff even while other investors are running for the door.

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