It’s not easy to ignore your emotions. But that’s exactly you need to do to profit in a bear market, says Lynn Carpenter in Investor’s Daily Edge.

So forget about sensational headlines about the mortgage crisis and high oil prices. And don’t dwell on whether earnings match market expectations. Analyzing the business – and not market sentiment – is always the right strategy for value investors.

And if you have to focus on one thing during earnings season, make it profit margin trends…

“Nothing personal, it’s just business…” From the mouth of some Gordon Gecko-ish “greed is good” lizard as he backstabs the competition, a Godfather character, or a Chainsaw Al Dunlap type as he cuts old mens’ jobs to save a corporate buck, that’s about the disinterested cruelty you’d expect. But “just business” has a bright side. A very bright side.

It’s how good stock analysts find great companies – by focusing on what’s “just business” and leaving the emotions of the latest market price to others.

Today, the ability to do that well will give you the kind of intellectual power that will seem almost magical as the bear market starts its end phase. Analyzing the business and not other people’s opinions of the moment—a.k.a. what they’re paying for the stock today—is always the right strategy for a value investor, but in this economy it almost assumes the shape of a secret weapon.

Bear Market Down, Bear Market Up—Two Different Psychologies

Here’s why: Bear markets have a distinct two-part pattern. First, whatever set them off overwhelms everything. This time, it was the mortgage crisis and oil prices that did the dirty work. Day after day, no matter what else happened, the deluge of bad news from those two issues dragged everything to the bottom with them. Everything. Even software, biotech, and gambling stocks… even REITs that specialize in storage lockers, though none of these industries have much to do with mortgage rates, and oil prices affect them only modestly. All cats are gray at night.

The only stocks that escaped the devastation were those tied to commodities like steel or coal because, like oil, their prices were rising at astounding rates.

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Eventually, this “buried in the flood” effect changes. The human mind can only be scared witless by the same thing so many times. The same old subjects begin to dull with familiarity. And the first part of the bear market begins to end.

The second part starts… and that’s when other matters like earnings, sales records, mergers, acquisitions, and product breakthroughs that used to get a bare moment’s notice amid the pressing bad news suddenly seem fresher and more interesting.

The trick to bear market part two is using the right bits of this good news to find not only the earliest stocks to emerge from the bear market while they’re still cheap, but more importantly those companies with strong legs.

The Winner’s Tattoo Draws a Heart Around Profit Margins

Headlines won’t help you much in this search because they will focus on the less important things too heavily. They will, as usual, dwell on whether earnings expectations were met or missed. They’ll linger over sales growth without examining its quality.

The numbers you want to dig for in those press releases are the ones the smart analysts will be watching—the profit margin trends. In particular, pay attention to profit margins to note whether they are getting better. Those will be the companies to examine well and think about buying.

With inflation at work, sales growth may be no more than price inflation driving up the dollars taken in… but profit growth still means something.

The S&P 500 has an average 1-year increase in sales of 8% at present.

On the surface, that sounds excellent, but it’s not. Of the nearly 3,000 stocks that match or beat that 8% sales growth, only 571 can brag about a 5% or better improvement in their 5-year average net profit margin.

Yes, many companies are selling more, collecting more dollars, but they are paying much more for materials and overhead. They are holding on, which is something admirable in itself. There are good stories among them, but it’s hard digging to properly analyze them deeply.

Instead, go the easier route, the one that surprisingly few people even consider. Look for companies that are improving their profit margins.

How do you find them? As this bear market ends, read a few more paragraphs into the earnings press releases that interest you. Read past the usual headline and top paragraph basics and get to the part about profit margins. It’s hard to increase profit margins in a recession. It’s hard to do it with inflation. And it is proving really hard now when businesses are facing both.

If you have to focus on one thing in the earnings reports coming your way this season, make it profit margins. That’s the secret the pros will be looking at, too.

Source: How Do You Find Tomorrow’s Champion Stocks As Bear Markets Wind Down?