2022 has seen some ups and downs on the stock market – and I expect the same will be true next year. But what if next year brings more than just turbulence and we actually see a stock market crash?
If that happens, I think it could present me not with an investment headache but rather an excellent buying opportunity. Here is why.
Defining a crash
In a stock market crash, shares fall by over 20% on average in a fairly short period of time. Over the last year or so, the tech-heavy US NASDAQ stock index has experienced such a crash.
We have had sizeable falls in the UK market this year, including around October’s budgetary shambles. By October, the FTSE 250 index had lost 30% since 2022 began. Over the past 12 months, the index has fallen 15%.
What we do know is that at some point the market will crash again. What is unknown is when.
Price versus value
However, falling share prices can indicate a sudden imabalance between buyers and sellers. They do not necessarily mean that a company’s underlying value has changed. To understand how this works in practice, just look at the price history over a 12-month period for a leading share. Then consider the gap between its high and low.
Take Unilever as a random example. At its low point over the past year, its share price has been 22% lower than at its peak. But has the underlying value of the business really moved around that much? It is true that the company is facing risks to profits, as inflation bites. But I do not think the underlying valuation of Unilever has really moved around over 20% in just a 12-month period.
How I’d invest
That mismatch between share price movements and changes in underlying value can work to my advantage as an investor.
In my Unilever example above, buying at a 12-month low price would have let me buy six shares for the price of five if I bought at the high point. The 20% fall in price of a market crash could let me do the same. In some cases, the price fall may be even more dramatic. I could not have known at the time that Unilever was hitting a 12-month low. But I know a stock market crash when I see one!
That is why, whether or not I expect such a crash in 2023, now strikes me as the perfect time to do my homework. As an investor, it pays to be prepared.
Preparing for a market crash
A crash may let me buy quality shares at cheap prices. But how would I know which ones to buy?
To do that, I think it helps to prepare well. My investing philosophy, like that of billionaire Warren Buffett, involves buying shares in great companies at attractive prices. By doing the research now and hunting hard, I can find companies I think have great business prospects. I can also decide what I think looks like a good price for them.
That way, I will be ready to pounce, no matter how fast or slow the next stock market crash is in arriving.
