The Financial Seat Belt for Turbulent Markets

By Dan Ferris, editor, Extreme Value

You don't need to be 37,000 feet above Myanmar to experience turbulence – but it does give us a good example of how it works...

The National Transportation Safety Board identified 163 serious turbulence-related injuries on U.S. airlines from 2009 to 2022.

Some 129 of those victims were crew members, who represent the distinct minority of people on board a typical aircraft.

The likely reason? They spend more of their time on their feet... while passengers spend most of their time wearing their seat belts. That's the single most effective measure against turbulence.

As investors, we can – and should – also buckle our financial seat belts. And while air passengers have just one type of seat belt available, investors have many options...

The most obvious and frequently used method among Stansberry Research editors is the stop loss... the point where you decide in advance that you'll sell.

This could be a given share price or percentage below your entry point (a hard stop) or a percentage below its peak since you bought in (a trailing stop).

Stops remove emotions from decision-making and help you cut your losses before they become large and catastrophic. You accept a tolerable level of injury with each small loss to prevent yourself from market turbulence becoming financially deadly. You preserve capital and live to fight another day. It's not sexy, but it works.

Another way to wear your financial seat belt is through your criteria for choosing stocks...

When Corey McLaughlin and I interview stock-picking professionals on our weekly Stansberry Investor Hour podcast, virtually all of them prioritize limiting downside over maximizing returns. If you limit losses, the gains will take care of themselves.

One of the best ways to limit downside is to buy high-quality businesses and not pay too much for them.

High quality means they'll keep growing and generating enough profits to maintain and grow the business's intrinsic value over time. Not paying too much means you've invested at a price that will allow the business's stellar performance to benefit you. (If you pay way too much, a great business performance can't save you from losing money.)

The best way to understand the notion of quality is to study great tech businesses like Apple, Amazon, and Alphabet... great insurers like Berkshire Hathaway, Chubb, and W.R. Berkley... great oil companies like ExxonMobil, Chevron, and Occidental Petroleum... great software companies like Microsoft and Canada-based Constellation Software... and many other great companies in other industries.

There's no better way to understand not paying too much than reading chapter 20 of value-investing guru Benjamin Graham's classic 1949 book, The Intelligent Investor. The chapter is titled, "'Margin of Safety' as the Central Concept of Investment." I keep a reminder on my phone to reread this chapter once a month.

In the chapter, Graham writes:

The margin of safety idea becomes much more evident when we apply it to the field of undervalued or bargain securities. We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the safety margin. It is available for absorbing the effect of miscalculation or worse than average luck.

In other words, if you think a business is worth about $100 per share, paying $80 per share will give you a 20% margin of safety. If you're 20% wrong in your calculations, you'll achieve an acceptable result as long as the business continues to perform well enough.

How do you find stocks with a margin of safety today? It's not easy...

I've said the market has been hugely overvalued many times in the past three years. I usually cite the S&P 500 Index's cyclically adjusted price-to-earnings ratio (above 35 today) as among the most expensive moments in the U.S. stock market since February 1871.

Still, while the current conditions make stock picking harder, at any given moment, there are opportunities to buy undervalued stocks. Believe it or not, that includes right now.

In our May 28 episode of Stansberry Investor Hour, we interviewed Chris DeMuth Jr. of New Canaan, Connecticut-based Rangeley Capital. All the securities he buys come with some type of catalyst, usually in the near future, that will likely unlock substantial shareholder value.

We also talked with Chris about the disconnect between large-cap and small-cap stocks...

Small caps have failed to participate in the market rally of the past few years. That's beginning to change. But for now, you can still find more bargains among small caps than among large caps.

You can find our interview with Chris on the Stanberry Investor Hour website, and you can sign up there to receive free e-mail updates when we post each new episode.

So if you want to find great ideas with a margin of safety – to make solid gains but also wear your safety belt – you might avoid large-cap stocks in favor of the smaller companies that folks have been ignoring over the past few years.

If it looks like I'm trying to talk you into becoming a small-cap value investor... that's partially true...

Whether you're buying large-, mid-, or small-cap stocks, it's a great idea to become a more value-oriented investor right now. That's the conclusion of research analyst Que Nguyen of Research Affiliates in her February 1 article, "Active Value Investing: Avoiding Value Traps."

Based on her analysis, Nguyen figures you can make an extra 2.4% to 5.2% per year by using various methods of picking value stocks. I also believe a value-oriented strategy will exhibit less turbulence and earn better returns over the next few years.

Nguyen also discusses adding momentum to the mix and avoiding low-quality "value traps"... cheap stocks that are doomed to stay cheap or get even cheaper.

Overvalued markets where everyone seems confident and bullish are generally followed by more turbulent conditions. Right now, then, you should expect great turbulence.

Stop losses can help prevent market turbulence from becoming financially deadly. Picking stocks with a margin of safety – value stocks – can do the same... and will likely outperform other strategies over the next few years.

Good investing,

Dan Ferris

Editor's note: On Tuesday, July 30, our founder Porter Stansberry is returning to share an urgent message. In this online presentation, he'll explain this year's market madness and what he believes is coming next. Most importantly, he'll reveal what he's doing with his own wealth to prepare for it... plus the No. 1 stock to avoid right now. Click here to reserve your spot for this event.

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