The stock market has been in an upward trend for more than 10 years since the last recession. Since then, there had been three meaningful corrections of 21%, 21%, and 15%, respectively.
Here are three tips to better prepare your stock portfolio for future market corrections.
Stay in quality businesses
Quality businesses have staying power. They may have some or all of the following characteristics: stable and predictable earnings or cash flow, a strong balance sheet and a low beta stock.
As we’re late in the economic cycle, utilities like Fortis (TSX:FTS)(NYSE:FTS) and consumer staples like Hershey’s and Coca-Cola have run up to high valuations compared to their historical levels.
Their predictably stable and growing earnings leave little room for surprises, which is why investors have flocked to them for safety and income.
Fortis is one of the top dividend stocks in Canada for having increased its dividend for 45 consecutive years. It’s been able to do so because of its quality earnings and well-managed business. The utility’s payout ratio is sitting comfortably at about 75%, it has an A-grade balance sheet, and its recent beta was only 0.05.
So, whenever these types of stocks are attractively valued, buy and keep a good portion of them in your diversified portfolio, which will add stability to your overall portfolio.
Focus on cash flow
It doesn’t hurt to always focus on the cash inflow of your portfolio. In other words, focus on buying stocks that pay you good, consistent, or even better, growing dividends.
As mentioned earlier, Fortis has paid increasing dividends for more than four decades. If you had bought $10,000 worth of the stock in 2007, right before the last recession, you would have received more than 58% of your original investment in cumulative dividends.
What’s interesting is that you’ll eventually get your original investment back, but your stake in the company will stay the same (unless the company buys back shares or issues more common stock).
You can use those periodic dividends for paying the bills, your vacation, or buying more shares of quality companies during a market correction. It’s therefore very empowering to generate consistent or growing cash flow from your portfolio.
Build a bigger cash position
It’s so frustrating not to have the cash to buy quality stocks on sale when market corrections occur. As the market has been going up for most of the last decade, it makes sense to build a bigger cash position to prepare for that inevitable market correction of 15-21%.
Also keep in mind that in a market crash, stocks can fall about 50%. The cash flow generated from safe dividend stocks like Fortis can help you build a cash position or generate cash every month that can potentially go to investing in great businesses when they’re attractively valued.
