Buying and holding high-quality cheap shares is a proven strategy for building wealth. After all, that’s the epitome of buying low to eventually sell high.
The stock market’s performance has been fairly lacklustre of late, seemingly going nowhere. But zooming out actually reveals an interesting possibility.
In the last three months, the FTSE 350 is down around 5% as interest rates take their toll on businesses and households. But zooming out a bit further still reveals that the index is actually up by double-digits since October 2022.
And that might be an early indicator that the stock market is already in recovery mode. Even more so, considering inflation has almost halved since then.
Of course, the road to recovery still has a long way to go. And in the meantime, volatility remains a present threat. So how can investors capitalise on cheap shares without compromising the integrity of their portfolios should another spanner be thrown into the works? Let’s take a look.
Focus on long-term quality
Trying to predict what the stock market will do in the next couple of weeks or months is nigh-on impossible. There are simply too many factors at play, including ones that can appear out of nowhere. That’s why, even when economic conditions are good, the stock market can seem chaotic.
However, in the long run, shares ultimately move in the same direction as the underlying business. A deteriorating enterprise will see its stock price shrink, while a thriving one will enjoy new highs in its market capitalisation. And this principle doesn’t change when investing during times of volatility.
Instead of focusing on what a stock might do tomorrow, investors should focus on what the business will do in the next few years and beyond. Specifically, looking at whether the strategy seems realistic given its financial position, managerial talent, and competitive advantages.
Keep risk in check
Even if an investor executes the perfect due diligence and their research reveals what seems to be a terrific buying opportunity, a stock may still tumble. A new, previously unknown problem may be revealed, or a sector could become disrupted, invalidating an investment thesis seemingly overnight.
This is a challenge stock pickers have to contend with constantly. And it’s why managing a hand-picked portfolio requires constant monitoring. However, the impact of these situations can be mitigated through diversification.
By spreading capital across various top-notch enterprises operating in different industries and, preferably, geographies, a portfolio can be protected from the downside risk of any one position failing. Another tactic I’m constantly using is pound cost averaging.
The stock market is driven by mood and momentum in the short run. As such, cheap shares can become even cheaper for seemingly no reason other than investors are feeling particularly negative.
By taking a pound-cost-averaging approach, I can buy blocks of shares in high-quality businesses over several months. That way, if volatility drags the shares down further, but the underlying business remains fundamentally sound, I now have the capital at hand to buy more at an even better price.
