2023 was a terrific year for snapping up cheap shares. Following a brutal correction the year prior, many terrific companies saw their valuations get slashed only to start a long-awaited recovery in the last few months.
Despite this, there continue to be cheap buying opportunities throughout the London Stock Exchange right now. But the challenge is knowing how to find them without falling into a value trap.
Finding good value cheaply
It should come as no surprise that just because a stock looks cheap doesn’t necessarily mean it will be a good investment. In many cases, a ridiculous-looking valuation may be well justified if there’s a fundamental problem with the underlying business or a serious threat is looming on the horizon.
Therefore, simply buying up beaten-down stocks that have yet to recover is unlikely to yield impressive results. Instead, investors need to spend time investigating the pessimism surrounding a company. Short-term challenges or disruptions may be far less problematic if there’s a realistic path to recovery. In my experience, these are where some of the best buying opportunities can be uncovered.
So, where should investors first start looking? Personally, I like exploring the industries that are out of favour. And in the current climate, one sector I’m paying close attention to is property. With rising interest rates diminishing property values, while pushing up mortgage costs, real estate investment trusts (REITs) have been hammered lately.
However, with inflation seemingly cooling off, the Bank of England has hit pause on further interest rate hikes. And with property valuations starting to stabilise, REITs could be on the verge of a comeback. At least, that’s what I think.
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Quality over quantity
While economic conditions are seemingly on the mend, there remains plenty of short-term uncertainty that could reintroduce significant volatility to the financial markets. As such, diversification continues to play an important role in portfolio management.
Even after doing thorough research and due diligence, a seemingly rock-solid cheap stock could still end up underperforming. By owning a wide range of top stocks across multiple industries, the impact of this threat can be mitigated.
However, like any tool, diversification needs to be used correctly. Otherwise, investors could end up harming their returns instead of improving them. When building a custom portfolio, aiming for instant diversification is a common mistake.
Investing in mediocre businesses for the sole purpose of having exposure to a specific sector will most likely result in lacklustre returns. It could even end up destroying wealth rather than creating it. Instead, investors should take their time investigating and analysing businesses, only investing in a firm after discovering best-in-class opportunities.
Under this approach, a portfolio will be gradually diversified over time, giving the same risk-mitigation benefits without holding a bag of subpar investments.
