Volatility continues to persist in the financial markets. It’s hardly been a pleasant experience. But, it’s allowed me to capitalise on cheap shares of what I believe are fantastic companies trading at bargain prices.
With the near-term economic outlook still filled with uncertainty, there’s a chance that discounted stocks today could drop even further. But as a long-term investor, this may ultimately be irrelevant. After all, economic wobbles are only temporary. And companies that survive them intact often find their competitors in a weakened state – the perfect conditions for stealing market share.
Identifying bargains
One of the most popular and easiest ways to judge valuation is the price-to-earnings (P/E) ratio. Calculating the price relative to earnings and comparing it to industry peers quickly gives a rough indication of whether a stock is trading cheaply.
However, using this metric without context can be problematic and misleading. The P/E ratio can fall to alluring levels if the share price drops and the market capitalisation of a business tumbles. Therefore, it’s important to investigate what’s driving the metric.
For example, suppose a stock drops off a cliff because its products have been made obsolete by a competitor? In that case, the P/E ratio will suggest a buying opportunity has emerged even though the business is possibly doomed. And suppose a firm’s earnings have skyrocketed because of a one-time source of income? In that case, it could also look cheap when the reality might be completely different.
With that in mind, investors must remain vigilant when using valuation ratios. And they must carefully scrutinise each potential ‘bargain’ stumbled upon. Personally, in 2023, I’m on the lookout for shares that have been sold off due to short-term pessimism despite the long-term picture remaining uncompromised.
Investing with volatility
It’s virtually impossible to predict what’s going to happen in the coming weeks or even months. That’s because, in the near term, stock prices are driven by mood and momentum – something that can change at a moment’s notice. As such, investing during volatile periods can be a bit of a rollercoaster.
As previously mentioned, even if an investor were to successfully find and buy the best cheap shares available today, the valuation could continue to drop tomorrow. That’s why I’ve been deploying a pound-cost-averaging buying strategy.
I’ve been accumulating some capital over the last few months in an interest-bearing savings account. And I’m now in the process of drip-feeding it into the companies that I believe have the most promising long-term potential at a fair price. By not throwing all my money in one giant lump sum, I continue to have cash available. So I can top up on stocks at even better prices if the valuation continues to fall for unjustified reasons.
However, there’s always the risk of potentially being wrong. After all, there are countless factors influencing a business. And even if the threats today are negligible, that might change in the future before the stock has a chance to reflect the true value of the underlying business.
Diversification helps mitigate the impact of mistakes. And ensuring a portfolio contains a wide range of top-notch companies from different industries is generally a sound tactical decision. That’s especially so during periods of volatility.
