The new year and the new decade ahead will give investors a chance to start fresh, or at least an opportunity to commit to investing resolutions. When it comes to stock wins and losses, investors who did not sell the latter group will not have any capital losses to write off. But after the S&P 500 (.SPX) returned close to 30% in the year alone, meaning risks are higher than normal that 2020 will have at least one correction.
The reasoning for a small correction is simple: Reversion to the mean is more likely.
Investors need not panic about a potential market drop, but they may minimize the damage by following seven basic investing resolutions for 2020.
Pay attention to valuations
For fundamental investors, valuations matter in general. Microsoft (MSFT) may sport a high price-to-earnings ratio, but that does not mean the stock will correct lower. Microsoft continues to report exceptionally strong software sales and growing cloud business. Subscription growth for Office 365 is unlikely to stall in 2020. So, Microsoft’s P/E of over 31 times is easily justified.
GameStop (GME) trades at just 0.6 times book and has a forward P/E just under 12. The stock is cheap, yet this does not imply the stock is a value holding. Digital game downloads from Electronic Arts (EA) and from Steam are hurting game sales at GameStop.
Whatever valuation investors choose, stick to a range that you find suitable and have the discipline to buy and sell. If, for example, Tesla (TSLA) at a forward P/E of over 75 times understates its future growth, then continue holding the stock. Conversely, if you believe Tesla’s capital cost requirements will grow so fast that the company will keep losing money, avoid the stock.
The bottom line here is that Tesla is an example of a stock that enjoyed a solid rally in the second half of 2019. And if market indexes fall on profit-taking, selling pressure on Tesla may accelerate. Microsoft stock may dip, too, but investors may average down in the stock. That strategy would pay off if the market rebounds and if Microsoft continues to report strong subscription growth throughout 2020.
Invest in out-of-favor sectors
Looking at out-of-favor sectors will pay off if the undervaluation compensates investors for the risks in betting on an eventual recovery. The technology sector was one of many shining areas of the market in the last year. As it rose, markets ignored the rebound in oil prices. Chances are good that the sector will rebound further in 2020.
Royal Dutch Shell (RDS/A, RDS/B) fell as low as $56 in the last few months but promptly rebounded back to $60. With the prospects of energy prices recovering with the support of stronger global growth, RDS is a stock to consider. It pays a dividend that yields over 6%. BP (BP) is also trading in a narrow range and pays a dividend that yields 6.5%.
The drug manufacturing sector is another beat-up sector that is out of favor. Teva Pharmaceuticals (TEVA) is starting to win its investors’ confidence. Management is stabilizing the business and applying much of its cash flow to pay down its debt. If the government allows for higher drug prices, Teva’s revenue may stop falling. And if generic competition on Teva’s Copaxone lessens, the stock could start at $10 as the bottom.
Avoid stocks at the peaks
Avoiding stocks that reached all-time highs in the last year may work if markets really peaked at the end of 2019. If profit-taking picks up at the start of 2020, investors buying Apple (AAPL) at all-time highs might face paper losses for a few years. In effect, investors are at the mercy of the markets trending higher. If that does not happen, and if Apple reports weak iPhone 11 sales, its stock may give up its 85% gains.
Even though I said Microsoft is a buy based on its relative valuation, the stock also ran up to all-time highs recently. Investors are getting no margin of safety, especially when the stock is widely held in many mutual funds and index exchange-traded funds.
Rite Aid’s (RAD) monstrous run-up to $24 is another example of a stock to avoid at the peak. With a short float of over 25%, a violent squeeze led to the stock’s pop after its earnings report. Fundamentals of this drugstore chain improved in the last quarter, surprising short sellers. So, after the drop from the peak, investors may want to consider Rite Aid stock at better levels. A better idea would be to wait for Rite Aid’s next earnings report. If it posts improving same-store sales again, then the stock is a compelling investment.
Avoid stocks you cannot explain
Peter Lynch once said that if you can’t explain why you’re investing in a company on a postcard, then don’t invest in it. The biotechnology sector is fraught with danger for investors who do not understand the difference between drug discovery and drug sales. A drug discovery company has no revenue and applies all of its funded cash to research and development.
Dermira (DERM) is an example of a company that reported positive clinical results for its atopic dermatitis research. Its shares nearly doubled from 52-week lows. XBiotech (XBIT) also reported positive clinical data in the last few quarters. On Dec. 7, it sold its antibody discovery program to Janssen.
Do you have the basic science background to follow clinical studies? Do you see a path to profitability for early-stage drug developers in the biotechnology space? If you do, then find and hold a basket of several drug stocks in this space for diversification.
For everyone else, hold drug manufacturing stocks that generate consistently strong cash flow. I picked Regeneron (REGN) throughout 2019 for that reason. AbbVie (ABBV), Pfizer (PFE) and Johnson & Johnson (JNJ) are examples of stocks that are easier to understand. Of course, with Pfizer and AbbVie at all-time highs, investors might want to wait for a pullback.
In the last decade, buying Fitbit (FIT), GoPro (GPRO) or Groupon (GRPN) would have led to disastrous losses. These companies timed their stock listing at the peak of their respective hype. And when the fad ended, so did the market’s euphoria for their stock.
For 2020, avoid fad stocks. Stocks that recently went public might happen to be fad stocks, with consumer demand for their products on the decline. Peloton (PTON) stock peaked at $36 in December 2019. Selling accelerated after a viral ad created a mixed but largely negative reaction. But fundamentals for Peloton could deteriorate if discretionary spending weakens in 2020. The Peloton exercise bike is a few thousand dollars and requires a monthly subscription. If owners cancel their service due to a lack of interest, Peloton’s revenue growth would plunge.
Canada Goose (GOOS) is a potential fad company whose product is facing weakening demand. Still, Hong Kong is an important region for the winter jacket maker. The company forecast weak performance ahead due to the unrest. Lululemon (LULU) looked like a fad stock a few years ago but as its highs indicate, that is not true. Lululemon continues to report strong earnings every year.
Technology stocks were star sectors in the last year. Most of the high-flying stocks like Alphabet (GOOG, GOOGL) or Facebook (FB) reinvested earnings back in the business or bought back stock. Yet if growth slows, investors end up holding underperforming shares. So, for 2020, investors should focus on holding stocks that pay dividends.
Dividend-paying stocks distribute earnings to investors instead of retaining them. This gives investors a stream of regular dividend income. And it becomes a core source of returns should stocks move nowhere or head lower. Disney (DIS), Lockheed Martin (LMT) and AbbVie are some dividend-paying stocks to consider. They have an even balance of dividend yield and stock appreciation potential.
The energy sector pays a richer dividend yield but due to its cyclical nature, it is riskier. If you happen to believe that the energy cycle is back to its growth phase, then Exxon (XOM) and ConocoPhillips (COP) are the big mega-capitalization names to look at in 2020.
Do not judge a stock for its age
Cable companies look stale and are operating in mature-phase markets. Newspapers, magazines and books are declining markets that investors should avoid. Dig deeper into companies that at first look like they are operating in a mature business. Then evaluate their overall growth potential as the business pivots.
Comcast (CMCSA) is not just a boring cable company. It has an internet business that is growing nicely, an amusement park and NBC. The company is pivoting its business into the new-age sectors. Very recently, rumors surfaced that Comcast will buy a free streaming service called Xumo. This would fit nicely ahead of its launch of Peacock, a free streaming service.
Comcast is dealing with the loss of traditional cable subscribers by looking at it from an NBC perspective. Big affiliate renewal deals will come up in 2021. Plus, Comcast is always looking at its contribution to profits.
Even after rising by over 30% in the last year, Comcast trades at a forward P/E of 13.5 times. If its streaming business takes off, markets may reward the stock with a higher valuation.
As of this writing, Chris Lau owns shares of BP.
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