The most recent three years is helpful, because key indicators will be relatively current.
An investor can then look forward for an idea about what the stock should be worth in the future.
In normal business cycles, this is a good method of evaluating stocks.
However, when the market is overall severely depressed, you may find it difficult to determine how much value to place on those outside influences.
Ask the QuestionAnother way to look at this is to ask yourself: Is the stock down because the whole market is down or because the company had a weakness that was exposed by market conditions.
In some cases, the answer may be “some of both.”
Given that it may be difficult to discern whether the stock is an innocent victim or is guilty of a management error, investors must make a judgement about what went wrong and where will be company be when the market begins returning to a more normal climate.
If the company is a true victim and the ailing market infected it along with all other companies, guilty or innocent, your job is deciding how the company will react to improving market (and/or economic) conditions.
Your goal is to find companies that will leverage their market position to grow in size, market share, profitability and so on, when the good times return.
However, that may not happen. One reason could be that the company’s main customers may be much slower in returning to normal operations after a downturn.
Sour EconomyIndeed, a sour economy may significantly change the company’s market by forcing consolidation in different sectors.
There is no simple way to determine how a company will recover from a down market and slow economy.
Most solid companies can weather bumps in the market and economy. A severe problem may change the landscape enough that companies must rethink their markets and opportunities.
When the dot.com bubble burst in 2000, not only did many Internet and technology companies fail or get bought out, but also those supporting industries.
For example, when there was money flowing into Silicon Valley, real estate prices skyrocketed, as did dealership in expensive automobiles, and so on.
Companies that provided infrastructure support (computers, networks, financial advisers, media companies, and so on) also faced difficult challenges.
Many of these companies had expanded to keep pace with the boom and suffered significant losses when their customers consolidated and others went out of business.
Companies that can come out of a market/economic retraction with minimal debt and a good cash position will be in better shape to adjust to new market realities.
The key to success following a downturn is the ability to be flexible and move quickly - little debt and a lot of cash provides that agility.