How to invest like Warren Buffett during a recession

By Nicole Goodkind, CNN Business

Between 2020 and 2022, stocks shot toward the moon. This year, they’ve been jettisoned back to Earth.

The S&P 500 is down about 18% year-to-date, inflation rates are at 40-year highs, geopolitical chaos abounds and a recession is looming. The easy-money environment that many investors grew accustomed to over the past 13 years is in the rear view mirror.

Risky meme stock, SPAC and NFT bets have dried up, giving value stocks, with more stable near-term cash flows, the upper hand in today’s fear-driven market.

The S&P 500 Growth Index, which tracks stocks that have the best three-year growth in revenue and earnings per share, has fallen nearly 15% in the past year. The S&P 500 Value Index, which tracks stocks with the best valuations, dropped by just 4.8% over the same period.

“Wall Street makes money, one way or another, catching the crumbs that fall off the table of capitalism,” Warren Buffett warned investors at his annual Berkshire Hathaway shareholder meeting in April. “They don’t make money unless people do things, and they get a piece of them. They make a lot more money when people are gambling than when they are investing.”

The difference between gambling and investing, says the Oracle of Omaha, lies in understanding a company’s fundamentals.

Technical analysis is based largely on stock price and volume. Traders aren’t trying to predict the future of a company. They don’t look at the underlying business or the economy but instead use charts and identify patterns to predict where a stock is going.

Fundamental analysis occurs when an investor evaluates a company’s financial position, performance, competition and the economy to determine its value, then purchases that stock when it’s trading at a discount.

The casino is open

About 15% of all current US stock market investors say they began investing in 2020, according to a Schwab survey — and the majority who opened their first non-retirement investment account that year were under the age of 45 and had lower incomes than more seasoned investors.

Bolstered by an influx of pandemic stimulus money, about 20 million new investors poured their extra cash into the US stock market over the past two years, using Reddit and other online communities to promote narratives that sent shares of companies like GameStop soaring 100 times in price over a few months.

These stock rallies were largely based on technicals — a coordinated short squeeze — and not on whether companies were viable in the long-term. That indiscriminate buying helped turn Wall Street into a “gambling parlor,” Buffett said at his company’s April meeting.

Technical analysis is useful for short-term trading and for timing markets, while fundamental analysis is useful for long-term investing, which is less susceptible to the whims of the economy.

Over the long run, equities tend to outperform inflation and recover from downturns by a wide margin, but it’s a marathon — not a sprint. Buffett is known to say that his favorite stock holding period is forever.

Fundamental analysis doesn’t tell investors much about what will happen in the immediate future, but when it’s time to hunker down and get through the hard times, fundamental investing is the way to go, analysts say.

Trust yourself

Investors aren’t very good at predicting the future, said Steven Check, who runs the financial advisory firm Check Capital. They tend to overreact to immediate problems. “The market is irrational in the short term, but it’s always rational in the long term,” Check said. Bubbles grow and burst but if you consider how a business will do over the next decade and then stick with it “you’ll eventually end up being rewarded,” he said.

“The stock market is the only store where when things go on sale, everyone runs out the door. You don’t want to be one of those people,” added Shawn Cruz, head trading strategist at TD Ameritrade. It’s likely that companies with strong balance sheets, healthy cash balances and growing revenues are currently priced at a discount, he said. “So if you have a long term focus and some specific names you’re looking at, this is a good time to pick up some quality shares for your portfolio.”

You don’t have to be a stock picking guru, he added. Companies like Chase, Apple, Amazon and Microsoft are still trading below their recent highs.

Do the homework

The good news for the lazier (ahem, busier) investors amongst us: Plenty of experts have already done the research for you and — for a small fee — you can gain easy access to it. But if you’re going by Buffett’s rules, it’s important to do the work yourself and never invest in a business you don’t understand.

A good place to start is by reading up on a prospective company. Look at who’s managing the business, what it’s promoting and how. Do you understand the product and do you think it has a place in the future economy? Ask yourself if you’d rebuild this company from scratch if given the change, Check said.

Next, take a look at the company’s financial statements, which are typically available on their websites. Evaluate their balance sheet. Do their profit-loss statements, cash flow statements, operating cost, revenue and expenses seem healthy? Has net profit been increasing over the past few years? Does the company’s debt seem outlandish?

You’ll also want to take a look at the broader economy and see how a company stacks up against its competitors You want to invest in businesses that stand out and have room for growth, especially in a crowded sector.

Finally, keep up to date. Your investment in a company doesn’t end when a trade goes through. The economy evolves and your portfolio should as well.

Most importantly, don’t be afraid to stop actively investing. “In my view, for most people, the best thing to do is owning the S&P 500 index fund,” said Buffett at his 2020 shareholder meeting. “There are huge amounts of money people pay for advice they really don’t need.”

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