An article in USA Today Money states that that ‘investors don’t know when the next crash will come – they just know that it will.’ The article then goes on to talk about stocks that will do well when the market crashes.
There are nine stocks in the Standard & Poor’s 1500 index, including tech stock Digi International (DGII), Monarch Casino & Resort (MCRI) and apparel seller Christopher & Banks (CBK) that have many of the characteristics of stocks that tend to outperform – especially as the rest of the market overheats and peaks. Each of these stocks have small market values, $400 million or less, and trade for 50% valuation discounts to the average of other stocks in the index, according to a USA TODAY analysis of data from S&P Capital IQ.
Picking value stocks for when the market crashes is a twofold issue. Value stocks are ones that are priced below their intrinsic stock value. Finding and investing in these stocks is always a good idea as they tend to outperform the market. And, when the market in general gets overpriced and heads for a correction or outright crash, these stocks tend to maintain their value and then forge ahead as other stocks go down. Read the article for their stock picks.
The random walk hypothesis sheds light on the perils of picking stocks, even value stocks. Investopedia defines Random Walk Theory:
Random walk theory gained popularity in 1973 when Burton Malkiel wrote “A Random Walk Down Wall Street”, a book that is now regarded as an investment classic. Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement. Originally examined by Maurice Kendall in 1953, the theory states that stock price fluctuations are independent of each other and have the same probability distribution, but that over a period of time, prices maintain an upward trend.
The point is that, unless you have information that the market does not have, you will find it hard to beat the market without assuming excessive risk. What we do know about the market is that low cap stocks as a group tend to do better over the years than high cap stocks. These stocks have more room to grow and they are also more prone to failure. Thus, if you pick a single low cap or penny stock there is a strong chance that the company will go out of business and that you will lose your investment. On the other hand if you pick a lot of these stocks (40 according to a follow up on the Random Walk Book-The Random Walk Revisited) you will see better profits than from investing in a basket of large cap stocks. If you are going to buy value stocks for when the market crashes it may be a good idea to invest in a few shares of many companies.
What You Know and What the Market Does Not
Peter Lynch who built the Magellan Fund into a global powerhouse gave an example of when someone is smarter than the market. A truck driver had been making deliveries to a small company for years. One day he showed up and found that the company was breaking ground for a huge expansion. He asked someone what was going on and found out that the company was getting a lot more business, new products and customers and expected a huge growth spurt. This was a small company and no one on Wall Street was following it. The man invested $1,000 in stock of this company and was rewarded with one thousand fold growth over the next decade. The stock price started to go up and analysts followed the stock after profits were reported at which time the random walk asserted itself. But for a short time the trucker turned investor knew something that the market did not. If you have similar information you can reliably pick value stocks before the market crashes and become rich.