Bear Market Strategies Guide: How to Evaluate Stocks

Navigating the investing world is tough, especially when markets are going through a rough patch.   

When fear reigns, a lot of jargon gets thrown around, but two words have dominated conversations lately—bear market and bull market. While both refer to market phases, they are markedly different regarding the impact they can have on your portfolio. 

The Indian equity market has been correcting for the last five months, and one of the commonly asked questions is, ‘What are the best bear market stocks?’ Here’s a guide to help you evaluate and pick fundamentally strong stocks in a bear market. Read on to learn more about what to buy in a bear market.

How Evaluating a Stock in a Bear Market is Different from a Bull Market?

Bear and bull markets are two sides of the same coin. One cannot exist without the other, but navigating a bear market significantly differs from investing in a bull market. While a bull market is all about optimism, pessimism is the dominant feeling in a bear market.

The market sentiment during a correctionary phase or a bear market is low and is dominated by sell-offs at the slightest trigger. 

Stock evaluation and stock picking are best tested in a bear market. In a bull market, when the sentiment is high and momentum is in the favour of the market, many stocks tend to do well. A bull market might induce a false sense of security as all the stocks you pick are doing well in the short run. 

However, this fallacy is challenged in a bear market, when, at times, it is possible that anything you pick may perform subpar compared to your bull market returns.

A bear market is where many fundamentally strong stocks trade at a discount. This is an excellent opportunity to add quality stocks to your portfolio. Here are the parameters that you can use to find the best fundamentally strong stocks in a bear market. 

10 Factors to Evaluate Before Investing in a Stock in a Bear Market 

Making the most of a bear market differentiates an equity investor from a wealth creator. The Indian equity market witnessed a long bull run, but the current market phase dominated by more red days than blue ones might test your long-term investment convictions.

Whether this is a longer-than-usual correction or a bear market remains to be seen. But first-time investors who can wade through this market downturn without falling prey to fear and greed will likely emerge stronger in the coming months.

Another factor that marks investors from wealth creators is their ability to add great stocks to their portfolios at attractive valuations. Here is how investors can identify fundamentally strong stocks. 

1. Understanding How Global Economy and Geopolitics Impact the Indian Markets 

Global economy and geopolitical factors impact the performance of the Indian economy and Indian markets, directly or indirectly. Therefore, it is essential to understand the nuances of changing geopolitical and other factors in a world stitched together by trade. 

Foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) play an essential role in the Indian investment ecosystem. Typically, the Indian equity market reacts negatively when foreign investors sell shares en masse, as they get higher returns on investment in other markets.

The massive sell-off can trigger a market downturn. Such a downfall can present good buying opportunities as stocks have corrected, presenting shares with attractive valuations that can deliver positive returns once the tide turns. 

2. Understanding Investor Sentiment and Market Momentum 

Investor sentiment plays a vital role in determining the direction of market momentum. When times are good and investor euphoria is high, even the slightest positive development will lead the markets to rally. Investors tend to ignore adverse developments, and the markets recover from dips pretty fast. 

On the other hand, if negative sentiment dominates, even the slightest negative news can cause a market-wide selloff, leading to a market correction. Worse, markets will take a considerable time to recover. 

Negative market sentiment prevails when investors can benefit from market overreaction and accumulate blue-chip stocks at attractive valuations. Once the market stabilizes, these portfolio additions can yield high returns. 

3. Fundamental Analysis 

When negative sentiment prevails, Indian equity markets tend to react to unfavorable news, both domestic and international, leading to a significant downturn. This may be the time to buy the dip, but the question is how to shortlist and choose stocks.

Fundamental analysis helps you differentiate between speculative and investment stocks. Fundamental analysis enables you to assess a stock’s intrinsic value by examining financial statements, economic indicators, and industry conditions. 

Fundamental analysis is a funnel focused on three factors: 

• Economic analysis: Macroeconomic factors include unemployment rate, consumption level, inflation, and GDP growth.
• Sector or industry analysis: Industry-specific developments, trends that can support or hamper industry growth, competition in the industry, etc
• Company analysis: Analyzing the financial health of a company through ratios such as P/E (price to earnings), PEG (price/earnings to growth), and P/B (price to book value).

Economic analysis can help you identify sectors or industries with the potential to do well, such as pharma or the banking and financial services sector. 

Further research into identified sectors will help you spot the largest registered companies in the industry. 

Now, you need to identify the registered companies in the sector with a low P/E ratio compared to the industry PE ratio. To further validate your selection, you can also look at the PEG ratio and PB ratio. 

You will be left with a few companies after your fundamental analysis. 

4. Pick Stocks with Strong Financials 

If done correctly, fundamental analysis would help you find shares that are rightly priced. However, you can further narrow down your buying pool by studying the companies’ financials. 

A financially strong company will have consistent earnings growth, low debt levels, low income from other sources, and a strong product or USP that sets it apart from competitors. 

Companies with solid financials tend to have lower risk and provide sustained returns over time.  

5. Analyze Quarterly Results and The Company’s Outlook for The Year 

Past performance, it is known, does not guarantee future results. This is true for the financial strength of an organization as well.

As an investor, you should pay attention to the quarterly results of companies to learn about earnings growth, improvement or deterioration of margins, and net interest income growth in banking, financial services, and insurance (BFSI) sector companies. 

Some sectors and companies also publish commentary or earning guidance reports for the coming quarters. These reports can act as a guideline for share price performance in the near future.

Decoding companies’ earnings communication, a strong financial background, and favorable fundamentals can help you identify a good stock for investment. 

6. Invest in Defensive Sectors

Sectors that show resilience during an economic downturn are called defensive sectors. Including stocks from defensive sectors in your portfolio can help you stabilize your portfolio returns during a bear market. 

Traditionally, four sectors in India are considered defensive. 

1. FMCG: Fast-moving consumer goods that produce essential household items such as personal care or food products are largely immune to economic downturns. 
2. Pharmaceuticals: This sector caters to one of the most basic human needs–medicines, and thus can withstand an economic slump. 
3. Healthcare: Closely related to the pharma sector, the healthcare sector, which includes healthcare service providers, is likely to be insulated from economic weakness.
4. Utilities: Companies that provide services such as supply of gas, electricity, and fuel are also known to be resilient to market weakness as people use them irrespective of the state of the economy.

Defensive stocks can prove to be the best bear market stocks. Adding them to your portfolio can add stability as these stocks are not reactive. They can limit your portfolio losses during market fluctuations or bear markets. 

7. Pick Stocks with a High Dividend Yield

Risk aversion is one of the central themes of a bear market. One way to hedge risk while investing in stocks is to add stocks with high dividend yields to your portfolio. 

High dividend yield stocks mean you are investing in companies with high revenue and robust cash reserves. These companies tend to be less volatile vis-a-vis growth companies that pay low or no dividends. High dividend yield stocks can outperform low dividend paying stocks, thanks to strong company financials. 

Additionally, high-dividend-yield stocks can help investors create an alternative income stream, giving them a much-needed financial cushion when the markets slump. 

8. Look Out for Monopoly Stocks 

Markets are cyclical, and a bull market will invariably follow a bear market. Adding monopoly stocks to your portfolio will stand you in good stead. 

Monopoly stocks already have a strong business presence owing to low or no competition in the market. Railway stocks are traditionally seen as monopoly stocks in India as Indian Railways is a state-owned enterprise with no competitor. 

9. Identify Stocks in Sectors that did not Rally in The Last Bull Run

Bull runs rev up broader markets, but not all sectors will rally the same way. Some industries or subsectors may not have rallied in the recent bull run. Usually, these are the stocks that are available at attractive valuations.

As a long-term investor, you can look for sectors or stocks that held steady during the last bull run. If these stocks have strong financials and fundamentals, they can be valuable additions to your portfolio, as they tend to do well once the markets rebound. 

10. Work on Portfolio Diversification

One should invest with conviction. But there is only a thin line between conviction and overconfidence. While having confidence in your stock selection is good, you should avoid concentrating your investment on just one or a few stocks.

If you are a novice investor, you should avoid investing more than 10% of your portfolio in a single stock. Portfolio diversification is a very important part of the investment process.

A bear run is a good time to diversify your portfolio as it offers many stocks at reasonable valuations. 

If speculative stocks form a large percentage of your portfolio, you can take advantage of the bear market to increase the weight of blue-chip stocks. This will help you balance your investments and provide stability to your portfolio. 

Conclusion 

While no foolproof bear market strategies exist, you can follow the steps mentioned to identify fundamentally strong stocks in a bear market. Adding them to your holdings will set your portfolio for growth for the upcoming bull market. Happy investing!

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