The equity markets have experienced a sustained selloff in the first five months of 2022. Most indices are trading significantly lower compared to all-time highs with growth stocks tailing off even further. Alternatively, investors should understand that stocks remain the best asset class to derive inflation-beating returns over the long term.
So, what do you do amid a stock market selloff?
Evaluate your savings
It’s very likely you will lose money if you liquidate investments in a stock market selloff. So, to limit portfolio losses, investors need to ensure there is enough savings in the bank that give you access to short-term liquidity. So, if you think there is not enough cash in your savings account, it’s time to deploy additional capital into an emergency fund.
Buy quality stocks at a lower valuation
Several technology ETFs or exchange-traded funds as well as stocks have entered the bear market territory in May. High-growth stocks such as Shopify (TSX:SHOP)(NYSE:SHOP), Lightspeed, and Nuvei, among several others, are trading at multi-year lows.
Right now, investors are worried about the prospects of lower earnings and decelerating revenue growth in an environment that is inflationary and uncertain. The prospect of multiple interest rate hikes and higher commodity prices will lower pricing power for companies and compress profit margins.
So, companies in hyper-growth mode will have to pay a higher cost of debt to fund expansion plans going forward. Further, the threat of an upcoming recession, geopolitical tensions, and supply chain disruptions will impact the demand and supply of products and services in the next year.
For example, Shopify’s revenue has risen at an annual rate of 63% in the last three years. The rapid expansion in the top line allowed the Canadian tech giant to report an operating income of US$268 million in 2021 compared to an operating loss of US$91.9 million in 2018.
In 2022, analysts expect Shopify to increase sales by 26%, while its earnings might decline by 81.6% year over year. SHOP stock is currently trading 80% below all-time highs, valuing the company at US$44.5 billion by market cap.
However, Shopify stock is also trading at a discount of 140% to average analyst price target estimates.
Avoid value traps
A challenging macro-environment provides investors a glimpse into the ability of a company to rise against the tide. There are several fundamentally weak companies trading on the TSX, such as Aurora Cannabis and Hexo, that remain high-risk bets, despite their depressed valuations.
Canadian cannabis stocks are perfect examples of a value trap, as they continue to report massive losses, lower profit margins, and less-than-impressive revenue growth.
Buying individual stocks is a risky proposition, and you need to spend enough time analyzing the businesses and their ability to derive generous returns. So, investors need to find companies that generate robust cash flows, which can be used to reinvest in expansion plans, lower debt, or even pay shareholders a dividend.
It’s also a good time to scrutinize your portfolio and reassess the risk appetite that will help you deliver steady gains once the global economy rebounds.
