The stock market crash may have prompted some investors to doubt whether buying cheap stocks can improve their long-term financial prospects. After all, many companies face difficult outlooks, while risks such as coronavirus and political uncertainty in the US could weigh on the prospects for global equity markets.
However, the stock market's past recoveries suggest that a turnaround will occur in the coming years. As such, now could be the right time to buy cheap shares that appear to be trading at a discount to their intrinsic values.
Past recoveries after a stock market crash
The 2020 stock market crash may have been faster than those experienced in previous years. However, it is by no means the first time that investors have faced severe declines in equity prices across a range of sectors. For example, the global financial crisis wiped over 50% off major indexes such as the FTSE 100 Index (FTSE: UKX) in 2008/09, while similar falls were present in the early 2000s as the dot com bubble burst.
Following those crises, the stock market recovered to produce new record highs. Therefore, buying cheap stocks after a downturn has generally proved to be a sound strategy for investors. Although when stocks are undervalued there are likely to be further risks ahead, adopting a long-term view regarding their prospects could allow you to benefit from a subsequent recovery. In doing so, you could obtain a rate of return that is ahead of that of the wider stock market.
Valuations do not always reflect a company's quality
While some cheap stocks should be trading at low levels after the stock market crash, many others appear to be undervalued. Investor sentiment towards equities and especially some sectors that have difficult near-term outlooks is relatively weak at the present time. This may provide investors with an opportunity to exploit mispricings through buying those companies with sound financial positions and wide economic moats while they offer good value for money.
This plan may not lead to positive returns in the short run. Past recoveries have sometimes taken many years to come into effect. But by owning a diverse range of stocks now while they offer wide margins of safety, you could benefit from their rising valuations and improving performances as the world economy's prospects gather pace.
Investing on a long-term basis
The stock market crash may allow investors to obtain a growth rate for their investments that is higher than that of the wider market. Since indexes such as the FTSE 100 and S&P 500 Index (SP: .INX) have delivered annualised total returns in the high single-digits in recent decades, this suggests that buying shares today could prove to be a very profitable move. In time, they could improve your financial prospects and increase your chances of enjoying greater financial freedom.
