What I Will Do in Bear Markets

The U.S. stock market continues to decline. We are now in a market correction and, with high probability, may enter a bear market. Many investors are fearful and keep asking the same question: Should I sell my stocks?

Before answering, we must first understand what a stock truly represents. Is it a lottery ticket that we hope will generate massive returns in a short period? Is it merely something we buy with the intent to sell at a higher price? My answer to both questions is no.

To me, buying a stock is not about price appreciation—it is about ownership. A share of stock represents a piece of a company. When we buy a stock, we become partial owners of that company, entitling us to a share of the cash flow it generates annually.

Should We Sell Stocks in a Bear Market?

Given this perspective, should we sell our stocks when the market declines? The key question to ask is whether the companies we own will continue generating cash flow during a bear market—and whether that cash flow will remain stable or significantly decline. Additionally, we should assess whether these companies can recover their cash flow levels and growth rates once the bear market ends.

By passing this test, we can ensure that the businesses we own are high-quality and resilient. If a company’s cash flow remains strong and it can withstand economic downturns, then why sell during a bear market?

Evaluate Companies in the Hoperation Fund Portfolio

Of course, determining whether a company meets these criteria is not simple. However, there are a few key approaches we can take:

1. Review Financial Statements from Past Bear Markets (stress test) Examining a company’s financial reports during previous downturns, such as the bear market of 2022, can provide valuable insights. Did the company lose customers? Did it face financial difficulties? Was its cash flow significantly reduced? Answering these questions helps us gauge how well the business can endure challenging periods.

   
   

2. Analyze Key Fundamental Indicators Fundamental metrics further confirm whether a company has a high-quality business model.

   
   

Below is a summary comparing our Hoperation Fund investment portfolio to the S&P 500, based on some key fundamental indicators (cap-weighted).

From the data, we can see that the companies we own significantly outperform the average S&P 500 company in every fundamental category:

• Financial Stabilities: Our companies have an average Debt-to-Equity ratio of 0.04, compared to 1.5 for the S&P 500—indicating much lower financial leverage. This is one of critical metrics measured a company in bear markets.

• Capital Efficiency: The ROE (40.7%) and ROIC (45.4%) of our companies are far superior to those of the S&P 500 (ROE: 19.1%, ROIC: 9.8%).

• Profitability: Our companies’ gross margin (61.5%) and profit margin (29.8%) are more than double those of the S&P 500.

• Valuation Metrics: The free cash flow yield and PEG ratio of our companies are also better than those of the S&P 500 companies.

A Bear Market is an Opportunity

Admittedly, the valuation of our companies is not very cheap when assessed based on free cash flow yield, as most are growth stocks. As a result, we expect that our portfolio’s market value will decline during a bear market.

However, this presents a great opportunity!

Why? Because we can buy more shares of these high-quality companies at much lower prices. If you attended our March monthly meeting, you would know that our investment portfolio currently holds 16% cash (and in our market analysis we suggest people generally should keep 30%-40% cash now)—we are prepared to buy more shares of these strong businesses at discounted prices.

A bear market is not a time for fear—it is a time for strategic action.

If your companies have durable cash flows, strong balance sheet, prudent capital allocation, and a history of weathering downturns, selling in a bear market is irrational. Instead, view price declines as a chance to increase ownership in high-quality businesses at attractive valuations.

Stay disciplined, focus on fundamentals, and remember: bear markets are temporary, but the compounding power of great companies is enduring.

PS: This article was drafted during a flight and later refined from the fencing venue at the March North America Cup.