The FTSE 100 and stock markets around the world have enjoyed almost a decade of growth. The current bull market is one of the longest in history, and many investors have profited handsomely since the last financial crisis. The FTSE 100 has more than doubled since its depths of 2009, and many investors may feel that its growth prospects are bright at the present time.
While that may be the case, the next market crash is inevitable. No bull market has ever lasted in perpetuity. As such, planning for the next bear market could be a shrewd move for investors to make. By following Warren Buffett’s investment strategy, that task could be made significantly easier.
Warren Buffett’s focus on company valuations could help investors to successfully react to changing market conditions. For example, during the most difficult parts of the financial crisis, a number of FTSE 100 shares were trading at exceptionally cheap prices. Certainly, they had challenging outlooks. But they also offered wide margins of safety in many cases that would have allowed purchasers of their shares to capitalise on the bull market that followed the financial crisis.
Now, the same logic can be applied with the FTSE 100 trading at around 7,600 points. A number of shares seem to lack margins of safety, with their valuations being relatively high. Although there is scope for them to move higher over the coming months and even years, the reality is that their risk/reward ratios may be unfavourable. As such, selling overvalued shares in the near term could prove to be a good move in the long run. It may help an investor to lock-in profit from recent years, and avoid the next bear market.
Of course, it is difficult to know what to do with cash generated from selling shares. In the short run, it poses little problem for an investor. But in the long run, it declines in value when inflation is factored-in. Therefore, investors are generally unhappy about the prospect of selling shares and holding cash for more than a short period of time.
Warren Buffett, however, holds huge amounts of cash at all times. Berkshire Hathaway has over $100bn of cash at the present time, with Buffett normally holding between $20bn and $30bn. This is so he has the flexibility to buy shares at short notice should a financial crisis quickly emerge which causes stock prices to come under pressure.
Of course, the return on that $100bn of cash is much lower than what seems to be available at the present time in the stock market. And in the short run the FTSE 100 may outperform the return on cash. But in the long run, selling overvalued stocks could be a shrewd move. It may allow an investor to prepare for the next market crash, and to then buy stocks at relatively low price levels.
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