It’s been a rough few weeks for the stock market, Monday’s turnaround aside. The Dow Jones Industrial Average has fallen for four weeks in a row. The S&P 500 and Nasdaq Composite have fallen for three straight weeks. 

We're in the gauntlet of earnings season, with 25% of the S&P500 reporting this week. There’s a steady stream of Federal Reserve and inflation headlines. There’s a lot going on for investors to consider — and a lot of it has been overwhelmingly negative for the market. We're not letting the short-term ugly market decline cloud our judgment, because when we think longer term, there are a lot of high-quality companies with great long-term fundamentals being put on sale right now and we have plenty of cash to take advantage of such declines. 

With that mind, we want to first call attention to the four characteristics we think companies must have to be worthwhile investments in this environment. These have guided our buy/sell decision since late last year, when it became clear the Fed was getting serious about fighting inflation. 

1. Make actual, usable, sellable products

We’re looking for product-based companies that currently have goods and/or services for sale, not idea-based companies that are developing an idea and won't have anything in the market for the next few years. The idea applies to both physical and digital goods, as long as they are manufacturable and sellable products. It could be producing and selling physical products such as toothpaste, or it could be developing and selling software. The company just needs to be selling it to customers or clients now, so they are generating revenue and earnings now, unlike some startups with sale goals down the road.

2. At a profit

The Federal Reserve is reducing its fixed-income asset purchases and hiking interest rates in what’s known as a tightening cycle, after pumping easy money into the financial system in response to the Covid pandemic. We do not want to be invested in money-losing companies during a Fed tightening cycle. We want firms that are profitable and real earnings right now.

Obviously, speculative stocks that trade based on long-term narratives had their day in the sun during parts of 2020 and 2021. The party is over now, though, and broadly speaking the returns for those stocks have been dismal as of late.

When the Fed raises rates, it is effectively raising the price of money. Growth stocks — many of which are concentrated in the technology sector — tend to be the most vulnerable to selling pressure in times of rising rates. That’s because increased debt costs can weigh on their growth, and their future earnings can look less attractive. This is related to the idea of avoiding expensive stocks, which we’ll talk about later.

3. Return capital

One reason it’s important to invest in profitable, cash-flow positive companies right now is because the excess cash can be returned to investors in the forms of dividends, buy backs, or re-invest in the company for growth. Dividend-paying stocks, or companies that are buying back stocks, can offer some defense in times of uncertainty and volatility. These are characteristics we’re looking for in stocks to own right now.

• A number of companies our portfolio are doing this, such as Advanced Micro Devices (AMD), which in February authorized a new $8 billion share repurchase program on top of its existing $4 billion buyback program.

• Morgan Stanley (MS) has been buying back nearly $3 billion of stock per quarter. It has a 70 cent quarterly dividend, too, which at the current price amounts to about 3% dividend yield annually.

4. Not expensive

We’re looking for companies that trade at reasonable valuations. A key reason we’re looking to avoid expensive stocks is because long-term rates are rising, in addition to the short-end of yield curve influenced by Fed action. This can cause investors to rethink what they’re willing to pay for future earnings, which can translate to lower stock prices as multiples compress.

A stock multiple typically refers to its price-to-earnings ratio. Earlier this month, we wrote an in-depth look at how to value stocks using a multiples approach. For the purpose of this particular story, it’s important to understand that high-multiple stocks are more vulnerable to seeing their multiples contract in this current environment. That’s why we want to look to buying inexpensive stocks. For example, Meta (formerly Facebook) is trading at roughly 13x forward earnings estimates. Meanwhile, Snapchat (another social media company), is trading at ~33x forward earnings estimates. Adding a reference point, the S&P 500 is trading at ~18x forward earnings estimates. So you see, Meta is clearly cheaper than Snap on the multiples comparison. We're not saying that Snap doesn't deserve the higher multiple, but we think that because of such comparison dynamics, investors are more likely to hit the sell button in Snap than Facebook.

What’s on our shopping list for Tuesday?

• We're looking to add to our position in Ford Motors (F) after the stock has made a round-trip back to the current 6.7x forward earnings estimates, a historically low level. Ford of today is clearly different, much better than Ford in history, therefore, it doesn't make sense for shares to trade at the same multiple.

• We’ll continue to look to add to our oil positions — Coterra Energy (CTRA), Devon Energy (DVN), Halliburton (HAL) and Chevron (CVX) — on weakness because of their large dividend yields and strength of the energy cycle.

• Disney’s (DIS): this latest slide just doesn't make sense to us, because the parks business is more profitable than it has ever been, and the stock price reflects a lot of negativity at 25 times next 12 months earnings.

• Morgan Stanley (MS) just reported a resilient quarter and the stock has come right back to before the earnings release. It still looks cheap at 11x earnings with a 3.3% dividend yield. We want to put Wells Fargo (WFC) in the penalty box for a little bit given the rather disappointing quarter.

• We think the post-earnings selloff in Danaher (DHR) is unjust for a company of this quality. The forward multiple at 25x hasn’t been this low in years and management is always looking for ways to create value through strategic actions.

• We are watching Advanced Micro Devices (AMD) recent massacre and will add to our position in the low 80$, with the belief that CEO Lisa Su will be buying alongside us.