When the economy is in a downturn and volatile stock markets, it is not easy for small investors to know where to put their money.
Are you looking for recession-proof stocks? Where should you put your hard-earned money? Should you invest in value stocks, growth stocks or dividend-paying stocks? These terms may seem a little foreign if you are new to investing. But they’re all related to different kinds of investment strategies that you can make with your savings.
Value, growth, and dividend-paying stocks are the three main stock types that investors can buy. Each type has its pros and cons, so it’s essential to understand what makes each one unique before buying any stock.
What is a Value Stock? | Value investing during a recession
Value stocks have given tremendous returns over the decades despite six recessions. Stock value doubled after the stock market recovery from COVID-19 in 2020.
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Value stocks are those with solid fundamentals priced below their peers.
1. Generally, value stocks have low P/E, low P/B, low price/cash flow, and a high dividend yield.
2. A value stock trades at levels that are perceived to be below its intrinsic value.
3. A value stock will have a bargain price as investors see the company unfavourable in the marketplace.
Value stocks have a low price-to-earnings (PE) ratio. The PE ratio is the price of a company’s stock divided by its earnings per share. Value stocks are stocks whose PE ratio is lower than the average PE ratio of the total stock market. This means that their price is lower than their intrinsic value. But be cognizant that it is important to avoid value traps while investing in value stocks.
Investing in value stocks in a recession may be a good idea for investors because their price is primarily low, so you can purchase more shares for your money. You can then wait for the company’s business to improve and its stock price to rise, giving you a more significant return on your investment in the long run.
Pure Value Index fund during recessions
As of April 30, 2021, the S&P 500 Pure Value Index returned 25.92% yearly. Its one-year return was 72.32%, while its 10-year return was 11.65%, as per data published by Investopedia.
The top five companies listed on the index as of this date were as follows:
- Cigna Corporation from Healthcare
- Berkshire Hathaway B from Financials
- Valero Energy Corp from Energy
- Marathon Petroleum Corp. from Energy
- Allstate Corp from Financials
Related Article: Is S&P 500 Index Fund a good investment in 2022?
The S&P 500 Pure Value Index tracks the S&P 500’s strongest value stocks. Every year, the index rebalances and is denominated in U.S. dollars and South Korean won. It comprises 120 stocks, of which 30% are financial services companies.
What is Growth Stock? | Is Growth Stock during economic turmoil a better choice?
Growth stocks are stocks that are expected to experience high growth in their earnings.
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1. Growth stocks tend to have solid fundamentals, strong earnings growth and profitability. This makes them less likely to experience the type of financial distress that can occur during a recession.
2. Growth stocks tend to outperform the market during periods of economic expansion compared to other stocks.
3. Growth stocks have higher P/E, higher P/B and higher Price/Cash flow ratios than Value stocks.
Growth stocks during a recession often offer investors the opportunity to buy them at a discount. This is because the share price of growth stocks often falls harder when the market is down than other stocks. As a result, they can be an excellent bargain for investors willing to take on a little extra risk.
Growth stocks are stocks of companies that have high expectations for future earnings. Usually, these companies reinvest their earnings for business expansion.
Even though growth stocks are expected to deliver higher returns than value stocks, their prices are also more volatile. That means that even though the value of your investment could increase, it might fall sharply before it rises again.
While there are no guarantees, investing in growth stocks during a recession can be smart. They tend to be less impacted by economic downturns, outperform other types of stocks during periods of economic expansion, and are less expensive during a recession.
What is Dividend Paying Stock? | Investing in Dividend Paying Stocks in a recession
Dividend-paying stocks are those which pay regular dividends to the shareholders and tend to be less volatile during a recession
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1. Dividend Companies pay dividends out a portion of their earnings to shareholders annually.
2. Generally, companies that pay dividends have strong cash flows and stable financials.
3. The financial stability of these organizations protects against downside risk.
The past performance of dividend-paying stocks during the last two recessions disappointed dividend investors. However, these stocks tend to be less risky during market volatility because dividend payments can partially offset price declines, thereby preventing downside risk.
If you consider investing in ETFs, there is a performance trade-off when investing in high-yield funds, as these tend to offer the highest yields. Over extended periods, these funds have shown more volatility (based on standard deviation) and significant drawdowns in bear markets.
Dividend stocks are a better investment option for investors who are new to the stock market because these stocks are less risky than other types of stocks.
Dividend stocks tend to fall less during recessions than stocks that do not pay dividends, making them recession-proof stocks that can help you survive the economic storm.
Related Article: Stocks That Pay Dividends – Find Out Before You Invest
What about Dividend Growth stocks?
These companies are growth companies that also pay dividends periodically. When a company pays a dividend on a growth stock, it can signify a definite competitive advantage. A growth company that pays dividends generates higher revenue, profits, and cash flow than its sector peers. Finding dividend growth companies and investing in them is also a great choice during a bad economic time.
Final Words
Overall, it’s important to remember that no type of Stock is guaranteed to make you money. When you invest in stocks, you’re taking a risk on a company’s future success.
But if you thoroughly research and pick the right stocks for your portfolio, you can make money during both good economic times and bad. Selecting stocks from Consumer staples and Utility sectors can be a winning bet during the recession for long-term returns.
Frequently Asked Questions (FAQs):
Consumer staples, Utility and Energy sectors are worth considering during recessions.
Healthcare, Energy, and Consumer staples will be able to survive a recession due to its never-ending market demand.
It is a bad idea to invest without knowledge of the market condition. However, it depends on your time horizon and risk appetite. During recessions, it is advisable to invest in mutual funds or index funds which eliminates the decision-making part while investing. Let the experts handle your investments.
With mixed economic results, it’s still unclear what exactly will happen in the coming six months. However, experts predict a mild recession during the 1st half of 2023.
