Stock Market Fall: Want to pick stocks in a falling market? Remember these 5 golden rules

India will play the T20 World Cup later this year. Some of the top and established players shouldn’t or can’t make the squad in their current form.

The dilemma here is whether to trust the oft-quoted saying in cricket “Form is temporary and class is permanent” and give them another run or look the other way.

We will have to wait and see how it goes on the cricket ground and how the team is built. As investors, we also face a similar dilemma, especially when markets are in free fall.

Which stocks should we support or choose – those that have been consistent performers and wealth creators but are currently struggling with a downward spiraling market or are past their sell-by date?

Let’s go back to the cricket analogy. History has shown that the team has always been built around or had an element of class or quality.

Whether or not it is believed in terms of cricket is a matter of debate.

In investing what is usually not a topic of debate is that class or quality almost always bounces back.

So that basically means looking for quality while picking stocks in these turbulent times. Here are some rules to follow:

1) Profit stability
Look for companies that have shown a trend of earnings growth with steadily improving earnings over time.

This means that the company will have much greater financial and operational stability. When sentiment improves, stocks of these companies quickly appear on investors’ radar. Markets and investors like stability and earnings visibility.

2) Ratings matter
Invest in companies that are available at a decent valuation. Not all stocks with a high price-to-earnings (P/E) ratio are bad, and not all stocks with a low P/E ratio are good.

There are many companies that do not really have a real activity justifying their valuation.

Similarly, there are many good companies run by good management that may be available at attractive valuations.

As an investor, you must determine whether the stock deserves this valuation.

In a falling market, valuations become a buzzword and an important factor as it is a safe zone to stay in.

Avoid companies with excessive valuations. But also watch out for value traps, not all stocks available at low P/E are necessarily value buys.

3) Good management
This is a qualitative call. Good management with a proven track record will get a business out of tough times faster.

Good management keeps the company ahead of the game in terms of products and technology. These actions tend to have a faster recovery rate when feelings improve.

4) Avoid high debt
All businesses have debt. It is an important indicator of the health of the company.

If a company has a high debt-to-equity ratio in a difficult business environment, it may struggle to service its debts.

A business with tight and stretched finances is a risky bet. Ratings and sentiments are bound to nose dive sooner rather than later.

5) Shareholder friendliness
One of the ways a company can be shareholder-friendly is by rewarding stakeholders with regular dividend payments.

Stability and reasonable dividend payouts over the years mean that the company is quite secure in its business. When capital appreciation is difficult, dividends are another source of income.

When looking for stock picks in a falling market, a bottom-up approach to investing is best. Evaluate each company you want to invest in based on the general parameters mentioned above.

Compare them with their peers. Most importantly, maintain an asset allocation based on your risk profile and investment objective.

(The author is President, TradeSmart)

(Disclaimer: The recommendations, suggestions, views and opinions given by the experts belong to them. These do not represent the views of Economic Times)