The words ‘stock market crash’ can send a shiver down investors’ spines.
But a crash need not be an event to fear. Indeed, I plan to use the next one as an opportunity to try and build my wealth by buying high-quality shares at low prices. Here’s how.
Winners and losers
When a share’s price falls below what I paid for it, I do not lose any money – until I sell.
Sometimes there may be good reasons for me to sell even at a lower price than I originally paid. For example, a stock market crash could reflect worsening conditions in parts of the economy. That may mean the outlook for a business worsens, leading its valuation to fall. Holding the share for longer could be a mistake for me compared to cutting my losses.
In other situations though, a stock market crash can lead to a company’s shares tumbling even though its long-term underlying value may be broadly unchanged.
That can present me as an investor with a valuable opportunity.
Real-life example
Let’s consider a real-life example, via the retailer Shoe Zone. Look at how the share price has moved around over the past five years.
In the stock market crash between February and April 2020, as the pandemic took hold, the Shoe Zone share price collapsed almost 70%. At that point, it might have looked like a bargain for my portfolio.
But if I had bought the shares then, what would have happened next? Despite an initial recovery, the Shoe Zone share price ended up losing a further 30% between April and November that year. If I had invested £1,000 at that low point late in 2020 however, my holding would now be worth over £6,000.
Benefit of hindsight
I did consider adding Shoe Zone to my portfolio in 2020, as it happens.
The reason I did not was because I thought that the drivers for that year’s stock market crash – uncertainty about the length and economic impact of pandemic restrictions – posed a real threat to retailers like Shoe Zone.
It survived and the share price subsequently surged. The same was true for Card Factory, another share that crashed in 2020 before staging a strong recovery since. But many other retailers went to the wall. What might have looked like a bargain during the crash could have turned out to be a value trap.
Getting ready now
When the next stock market crash comes, I want to have a shopping list ready of what I think are great businesses that might suddenly become available at attractive prices. Such prices do not always last long, which is why I am acting now regardless of when I think the next crash might come. After all, nobody ever knows what will happen when in the stock market.
To do that, I am hunting for companies with outstanding business models I think are well-placed to withstand even significant economic challenges.
Resilient customer demand and a strong balance sheet can be important in such circumstances. Rather than waiting to identify such companies once the market has already started to crash, I am getting ready by hunting for likely future opportunities today.
