Buying cheap stocks after the recent market crash may not seem all that appealing to many investors. After all, previous bear markets have often lasted for a prolonged period of time. With the potential for a second wave of coronavirus across many of the world's major economies, stock prices could come under further pressure in the coming months.
However, the past performance of the stock market shows that it has always been able to recover from bear markets to post new record highs. Therefore, buying cheap stocks that have solid financial positions today could provide you with the greatest scope to benefit from a turnaround for equities over the long run.
Recovery potential
While a stock market rally and a return to previous highs may not seem all that likely in the short run, over the long term it seems probable. The stock market has a strong track record of recovering from challenges such as the global financial crisis, the tech bubble and many other difficulties that have caused investor sentiment to weaken and cheap stocks to become more widely available.
Certainly, coronavirus is an unprecedented event for investors to overcome. It is still too soon to know how significant its impact will be on a wide range of sectors and economies. But previous downturns and bear markets have spawned the same uncertainties among investors. Yet, sentiment has always proceeded to improve after even the most severe declines in stock prices.
Buying cheap stocks
Many investors aim to buy stocks when they are low, and sell them when they are high. One of the main difficulties in implementing this strategy is that for a stock to be cheap, there often must be a significant risk ahead that prompts weaker financial performance or declining investor sentiment.
At the present time, many of the risks facing the world economy appear to have been priced in to stock valuations by investors. Therefore, it is possible to buy high-quality businesses while they are trading on low valuations. This could provide you with a more attractive risk/reward opportunity, since buying any asset at a lower price can provide greater scope for capital growth.
Although there is a risk that cheap stocks will continue to fall in price, over the long run many valuations on offer across the stock market suggest that a wide margin of safety may already be on offer.
Financial strength
Of course, for cheap stocks to deliver on their long-term recovery potential, they must survive a challenging short-term outlook. Therefore, it is vital that investors select companies that have attributes such as modest debt levels, dominant market positions and the right strategies to reduce costs if required in the short run.
Through buying the most appealing businesses while they trade on low valuations, you could boost your portfolio's long-term growth prospects and improve your financial circumstances in the coming years.
