American Consequences - June 2019

outstanding shares. This determination combines the stability of that company’s cash flows (which is necessary for a high credit rating and access to cheap capital) with its cash earnings power and a low share price. These are the three most critical factors for a successful bear market investment. STRATEGY NO. 3 OWN THESE TYPES OF ‘ANTI-FRAGILE’ STOCKS Wouldn’t it be great if some stocks were “crash proof ”? We’ve seen two bear markets in the last 20 years. The S&P 500 cratered 49% from March 2000 to October 2002. And it collapsed 57% from October 2007 to March 2009. Nearly every stock in the market fell during these periods... and many were obliterated. But not every stock. You can actually make money by staying invested in the face of a bear market... if you know where to look. Some stocks tend to go up during market downturns (or at least massively outperform the market). When most investors are selling during a bear market, not everyone is sitting on cash or investing in Treasury bonds. Many investors just swap out the types of stocks they own. They sell their risky growth stocks and invest in safer, all-weather stocks. You can easily see this by dividing the market into industry segments and studying which stocks perform best during economic downturns. The S&P 500 is made up of 11 industry segments.

What we’re sure you can see for yourself is that, almost without exception, these companies sell high-margin products in stable industries that are dominated by a handful of well-known brand names. Look at the top 10 names on this list – all of which produced 15%-plus annual returns. Our bet is that most of you have a number of these companies’ products in your house right now. (Crane – which makes industrial products – is probably an exception.) One of the reasons we’ve found it’s safe to buy capital-efficient companies during bear markets is that they can support their share price. We have recommended shares of Berkshire Hathaway (BRK-B) in the past as a great bear market stock. A primary reason is because we know that Berkshire will begin to buy back its own stock during times when economic conditions lower the valuation of the shares. Warren Buffett, the legendary investor who runs the firm, has publicly stated that he considers the stock (the class “A” shares) cheap at 1.2 times its book value, a key measure that we should watch as investors. Currently, the measure is 1.5 times. Capital-efficient companies can do the same because they’re producing so much cash with their operations. In fact, a great test of any capital-efficient company is whether it’s producing enough cash to buy back all its

In a bear market, you should focus on buying what we call capital- efficient stocks.

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