Did you miss the bear market bottom? If you snapped up stocks in March, with the S&P 500 Index ($INX) near 675, you're probably feeling pretty perky.
If not, you may have another chance. The rally stalled in mid-June, and a lot of experts are predicting a sizable pullback. Many stocks have already lost ground.
That leaves us to face vexing questions: Is a stock's drop a great buying opportunity or a sign of trouble ahead? Is the market regrouping, or is the real bottom still ahead?
How do you know the difference, anyway?
I posed these questions to several seasoned money managers with decades of market experience. The initial reaction was always the same: a knowing laugh that said, "That's the trickiest thing about investing. And if you find the answer, let me know."
"No one ever rings a bell at the bottom," says Insight newsletter writer Gary Shilling, who bought his first stock in 1961.
Still, these money managers helped me put together basic guidelines that point to about two dozen stocks as potential buys right now. In this group, I like these 10 the most: Berkshire Hathaway (BRK.B, news, msgs), Applied Materials (AMAT, news, msgs), KLA-Tencor (KLAC, news, msgs), Genzyme (GENZ, news, msgs), McMoRan Exploration (MMR, news, msgs), ConocoPhillips (COP, news, msgs), ViroPharma (VPHM, news, msgs), Gap (GPS, news, msgs), Walgreen (WAG, news, msgs) and BHP Billiton (BHP, news, msgs).
Question No. 1: Did anything change?
Whenever a stock has sold off, your basic challenge is to figure out whether anything has changed that permanently impairs the company's profit potential. Is the business fundamentally different?Your first stop is the news flow. You need to understand whether news developments have affected a company's competitive advantage, says Pat Dorsey, the director of stock analysis at Morningstar. "If a company can't raise prices anymore, but it could in the past, that's a big deal."
One shortcut here is to avoid one-trick companies with a hot product that could flame out. Stick with tried-and-true businesses that continue to profit from competitive advantages, such as solid brand names or mastery of their niches.
Morningstar calls these wide-moat companies. Their competitive advantages won't vanish quickly. So you can feel comfortable buying during pullbacks as long as you're an investor with a long-term horizon -- at least a couple of years.
If you don't want to mess with individual stocks, Morningstar has an investment vehicle that rebalances the cheapest of its wide-moat companies every quarter, called Elements Morningstar Wide Moat Focus (WMW, news, msgs), an exchange-traded note. It's outperforming the market this year by about 17 percentage points.
When sizing up a sell-off, be careful of two traps. First, even with no news reports, there could be a company development that hasn't yet been made public. Check the trading volume. If one day's volume is a lot higher than the average for the past month, look out. Some people probably know something you don't.
Also, never be lulled by company comments that it "knows of no reason" for a sell-off. "That is not very reassuring," says Hugh Johnson of Johnson Illington Advisors. "They may not know of a reason. But other people may."
Question No. 2: Are insiders buying on the drop?
This is usually a good sign that it's safe for you to buy as well. You can check by using the insider trading page at MSN Money; just punch in a stock symbol.Here's a great example from earlier this month: Energy company McMoRan Exploration sold off in mid-June when it issued stock to raise capital. On the pullback, co-Chairman James Moffett purchased more than $5 million worth of shares, and the other co-chair, Richard Adkerson, bought $500,000 worth. Each paid $5.75 a share (the stock closed Tuesday at $5.96).
McMoRan has been reporting big losses. But the insiders say it also has big potential. "We have multiple high potential deep gas and ultradeep targets," Moffett said in April. And he and Adkerson are backing those words up with money.
Just remember that insiders are typically early. So when you follow them into a stock, be sure to have a time horizon of at least a year or two.
Question No. 3: Is stock below where smart investors purchased?
Certain investors have such great long-term records that it pays to tag along. Warren Buffett of Berkshire Hathaway is an obvious example. I also like two biotech investors, Julian and Felix Baker. Their Baker Bros. Advisors has a great record.You can track the buying of smart investors by searching for their "13D" or "13G" filings with the Securities and Exchange Commission. When any of their major holdings fall below the price at which they bought, that's a good indication a stock is a buy -- assuming they're not selling, too. (You can check their positions by stock using the "insider trading" data on MSN Money.)
ConocoPhillips is one Buffett stock that's currently trading well below the price where he purchased. He bought it last year in the low $80 range. It's now trading in the low $40s. Buffett bought Johnson & Johnson (JNJ, news, msgs) in the low $60 range; it recently sold for $56. At $25.50, Kraft Foods (KFT, news, msgs) sells below Buffett's entry of around $33. And around $18, US Bancorp (USB, news, msgs) is well below the $31 Buffett paid.
At $5.80 a share recently, the biotech company ViroPharma was trading below the $6 or so paid by the Baker Bros. back in May.
Question No. 3: Is stock below where smart investors purchased?
Certain investors have such great long-term records that it pays to tag along. Warren Buffett of Berkshire Hathaway is an obvious example. I also like two biotech investors, Julian and Felix Baker. Their Baker Bros. Advisors has a great record.You can track the buying of smart investors by searching for their "13D" or "13G" filings with the Securities and Exchange Commission. When any of their major holdings fall below the price at which they bought, that's a good indication a stock is a buy -- assuming they're not selling, too. (You can check their positions by stock using the "insider trading" data on MSN Money.)
ConocoPhillips is one Buffett stock that's currently trading well below the price where he purchased. He bought it last year in the low $80 range. It's now trading in the low $40s. Buffett bought Johnson & Johnson (JNJ, news, msgs) in the low $60 range; it recently sold for $56. At $25.50, Kraft Foods (KFT, news, msgs) sells below Buffett's entry of around $33. And around $18, US Bancorp (USB, news, msgs) is well below the $31 Buffett paid.
At $5.80 a share recently, the biotech company ViroPharma was trading below the $6 or so paid by the Baker Bros. back in May.
Gap, for example, looks buyable after its recent pullback, believes Tim Ghriskey of Solaris Asset Management. The clothing retailer goes for a P/E ratio of around 12, compared with the much higher P/E ratios of similar clothing retailers such as J. Crew Group (JCG, news, msgs) and Abercrombie & Fitch (ANF, news, msgs). Gap is in the midst of a restructuring that is bringing down costs, which will help profitability in the future, and it is improving its merchandising, Ghriskey says.
Value investor Todd Lowenstein, a co-portfolio manager of the HighMark Value Momentum Fund (HMVMX), thinks McGraw-Hill (MHP, news, msgs), Walgreen and Comcast (CMCSA, news, msgs) all look attractive because they have sold toward the low end of their historical valuation ranges. Yet their businesses all still have the fundamental strengths they had when their stocks traded at much higher levels. So they aren't "value traps," or value stocks that will stay down forever, Lowenstein believes.
Question No. 6: Is the company financially strong?
Especially these days when credit is still tight, it pays to check whether a company in a downtrend has the financial strength to survive whatever is pressuring the stock, says Jack Adamo of Insiders PLUS, a top investment newsletter, according to Hulbert Financial Digest.Shares of the mining company BHP Billiton have been in an uptrend for the past decade, a great long-term record. But it's currently in a pullback, probably because of concerns that commodity stocks have rallied more than is justified in this economy.
But Billiton has a solid balance sheet with minimal net debt for its size, which means it has the financial strength to wait out the recession. That's one reason Adamo is waiting for a pullback into the mid-$40 range, from around $55, to buy the stock.
I compiled my list of 10 from the many stocks these experts mentioned and my own research. Consider it a starting point for your own efforts. A lot of stocks have gone on sale, but the trick is finding the real bargains.