Here’s why I’d buy cheap stocks right now and hold them to 2025

Cheap stocks could outperform the growth stocks that have done so well in recent years, says Andy Ross, and he sees one major reason why.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

sdf

Over the next four years, I anticipate adding quite a few cheap stocks, otherwise known as value shares, into my investment portfolio. I already hold a few, such as National Grid and Persimmon, as well as the investment trust, Merchants Trust.

Value shares tend to perform better during any period of inflation

As a general rule, value stocks perform better in high inflation periods and growth stocks perform better during low inflation.

Some experts are warning inflation will exceed 2% by the end of this year. That would be a big rise from now and would likely have an effect on the performance of growth shares versus value shares.

Overall, it’s unclear if, or when, inflation could rise significantly. What is more clear is that cheap stocks are a better hedge if it does occur.

Cheap stocks provide more margin of safety

Given there may be a reversal in the fortune of many growth shares, I’d plump for cheap stocks because there’s a greater margin of safety.

Buying shares with price-to-earnings ratios that are below 15 – a level that is often seen as separating undervalued shares from the rest – offers some protection against any downgrade in outlook or earnings. Shares on sky-high valuations should, and often do, fall much harder on any bad news.

I think Benjamin Graham, the inspiration for legendary investor Warren Buffett, was correct to say valuation and a margin of safety are very important.

Cheap shares have underperformed

Despite the low valuations, cheap shares have underperformed growth shares in the low-interest rate, low-inflation economic conditions we’ve nearly continuously had since the financial crash. The stock market crash of 2020 still means there are opportunities to pick up cheap UK shares. 

For me, the historical underperformance of value shares versus more racy and highly-rated growth stocks isn’t off-putting. While I may add some modestly valued growth stocks to my portfolio, many of my new stock picks over the next four years to 2025 will be cheap stocks.

The thing to watch out for when it comes to investing in cheap shares though is, value traps. This is where a share appears cheap but actually, the valuation is low because the business is worsening. That could well mean that the share price will fall much further. A low P/E doesn’t in itself make a share worth buying. I’d want to get a bigger picture and understanding before committing my money to a value share. 

That’s why I’d make sure to look at revenue and operating profit growth and how a company compares to the competition. I’d also look at whether the industry is growing or facing challenges. There are also many other considerations to take into account but these serve as a starting point. 

The bottom line is, as always, I’ll research shares thoroughly before investing, even if they are a cheap stock.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Andy Ross owns shares in National Grid, Persimmon and Merchants Trust. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Rolls-Royce's Pearl 10X engine series
Investing Articles

3 risks to the Rolls-Royce share price, after its 979% climb

After a 979% growth in the Rolls-Royce share price, our writer still sees things to like in the business. But…

Read more »

Buffett at the BRK AGM
Investing Articles

Can Warren Buffett principles help when looking for AI stocks to buy?

Billionaire Warren Buffett has made a fortune by applying old investing principles to new industries. Can our writer learn some…

Read more »

Portrait of a boy with the map of the world painted on his face.
Investing Articles

Up 36% in 3 months! Is my nightmare purchase of Glencore shares about to come good with a vengeance?

When Harvey Jones bought Glencore shares two years ago, he didn't expect to find himself sitting on a 45% loss.…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

£1,000 invested in Lloyds shares 5 years ago is now worth…

Anyone who’s owned Lloyds shares over the last five years is probably laughing right now with impressive returns that crushed…

Read more »

A mature woman help a senior woman out of a car as she takes her to the shops.
Investing Articles

If a 50-year-old puts £500 a month into a SIPP, here’s what they could have by retirement

Investing £500 a month with a SIPP could build a pension pot worth £269,900 or quite a bit more over…

Read more »

A rear view of a female in a bright yellow coat walking along the historic street known as The Shambles in York, UK which is a popular tourist destination in this Yorkshire city.
Investing Articles

How much do you need to invest in dividend stocks to target a £1,000 passive income?

Want to earn an extra £12,000 each year with dividend stocks? Zaven Boyrazian explores how much money investors need to…

Read more »

Finger pressing a car ignition button with the text 2025 start.
Investing Articles

FTSE shares for beginners: 2 solid picks to consider when starting a Stocks and Shares ISA

For those new to investing, Mark Hartley explains why he believes these two FTSE shares could help kickstart a resilient…

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

Here’s how to invest £10k to target a 7% dividend yield in 2025

Want to earn a lucrative and sustainable 7% dividend yield? Zaven Boyrazian explains the strategy he uses to generate plenty…

Read more »