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I’d use Warren Buffett’s tips to capitalise on a second stock market crash

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The potential for a second stock market crash is likely to remain in place over the coming months. It is currently unclear how the coronavirus pandemic will progress, while political risks such as Brexit and the US election could weigh on investor sentiment.

If a second crash does occur, it could be a buying opportunity for long-term investors, rather than a reason to panic. By following Warren Buffett’s advice and focusing on high-quality businesses that trade at low prices, you could add stocks to your portfolio that produce excellent returns in the coming years.

Buying stocks with wide economic moats

A second stock market crash could be prompted by a weak economic outlook. As such, following Warren Buffett’s lead and buying stocks with wide economic moats could be a sound move. An economic moat is essentially a competitive advantage that a business has over its rivals. For example, it could be a unique product, strong brand loyalty or a lower cost base that ultimately produces greater profitability in the long run.

Companies with wide economic moats may be better able to survive a period of difficult operating conditions. This may mean that they are less risky than their sector peers. They may also produce higher capital returns in the long run as their competitive advantage allows them to occupy an increasingly dominant position within their sector. This could enhance your portfolio’s returns, while reducing its risk of loss during a period of decline for the stock market.

Buying cheap shares in a stock market crash

A second stock market crash could provide buying opportunities for value investors such as Warren Buffett. Certainly, valuing companies can be tough in a period where the prospects for the economy mean that the financial performances of businesses could materially change versus the recent past. However, comparing the values of businesses to their peers may provide an indication as to whether they offer a wide margin of safety.

Although it can take time for cheap stocks to recover after a downturn, the past performance of equity markets shows that a recovery is very likely. After all, the stock market has always recovered from its previous downturns to produce new record highs. A similar outcome to future bear markets therefore seems likely.

Cash holdings

Warren Buffett holds a significant amount of cash at all times. This enables him to more easily capitalise on a stock market crash, since he has significant liquidity through which to take advantage of lower prices during a bear market.

With the outlook for the economy being uncertain, it may be a good idea for you to hold some of your portfolio in cash now, and also refrain from being fully invested in shares should a second market downturn occur. A future bear market may be prolonged, and could provide even more attractive opportunities further down the line. Therefore, by taking your time to pick and choose the most attractive investing opportunities, you may be able to build a stronger portfolio as a result of a second stock market crash.

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Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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