It’s best to check your growth stocks out of these three boxes during a bear market

Anyone can look smart in a bull market. We’ve seen it in 2020 and 2021 – you can pick any stock and make money. But now, every arrow seems to be falling, and the sun may never rise again. Don’t let market volatility discourage you.

Historically, the stock market has moved in cycles, up and down. This will likely be another course of many. However, bear markets can have real implications for startups, and growth stocks may face financial pressures from the recession.

No investor wants to buy a stock that drops dramatically and never recovers. If your growth stocks tick these three boxes, they are more likely to live to see another bull market.

Someone studying the data on the screen.

Image source: Getty Images.

1. Revenue growth

Long-term investors should look to invest in companies that can thrive in good times and bad. Revenue growth is the most direct way to measure it. Now, that doesn’t mean revenue growth can’t slow in a recession — companies rarely grow for years without a hitch.

But the company must demonstrate that its business model is solid, and that it is not a coincidence or a temporary fad. Fitness Equipment Brand peloton It saw its growth explode upwards during the height of COVID-19, but it has since exploded.

Chart showing Peloton revenue rising in mid-2020 and then declining thereafter.

Data by YCharts.

Whether it’s a poor business model or mismanagement by leadership (arguably both in the case of Peloton), execution must be consistent, or the company is unlikely to thrive over time, let alone survive a recession.

2. Positive cash flow

So why do so many growth stocks drop during a bear market? It is common for start-ups and growing companies to lose money. Companies can easily raise money when stock prices are rising in a bull market. They can sell shares at inflated prices, which prevents investors from seeing their current shares drop too much in value (dilution).

Let’s say a company needs $1 million and is trading at $100 per share. He can raise this money by issuing 10,000 shares of new stock. But let’s say the market crashes, and the stock price drops to $10. Now, the company must issue 100,000 shares to raise the same amount of money. That’s more than 10 times the equity, so existing shareholders are experiencing even greater dilution.

So what is the solution? A company may be unprofitable for several reasons, and stock-based compensation, a non-cash account, is one of them. Instead, look for companies that generate free cash flow because the cash profits go to the balance sheet.

A company that is burning a lot of cash (negative free cash flow) may need to raise money, and you don’t want that to happen when the stock price is at rock bottom or forcing the company to take on excessive debt.

3. Balance sheet health

Finally, you want a company with a good balance sheet. For growth stocks, that means two things. First, you want to see as little debt as possible. There are times when companies borrow to finance an acquisition, or the business model requires debt like what Open door It is used to purchase housing stock, but this is the exception rather than the rule.

You also want to see that there is a healthy cash balance. A company can be so small that it burns money, but if it has large IPO reserves, it helps.

For example, a cyber security company guard one A depletion of $105 million over the past year meanwhile, the stock has fallen from a high of around $79 to $24 since its June 2021 IPO.

The graph shows the level of SentinelOne's cash and short-term investments since 2021, and free cash flow rose sharply in mid-2021.

Data by YCharts.

You can see how she has nearly $1.7 billion in cash. That’s enough money to run the company for another four years based on its current cash burn rate, assuming the business isn’t growing or close to turning a profit.

You never know what a stock will do in the short term, especially during volatile markets. But you can see SentinelOne’s excellent balance sheet and know that it’s doubtful the business will go anywhere, allowing you to focus on what drives long-term returns like growth and business execution.

wrapping

Growth stocks that are flexible, generate cash and have a strong balance sheet have all the building blocks for becoming great investments. Focusing on the things that matter rather than the things that don’t (like short-term price action) will put you in a position to do well as an investor.

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