Buying any amount of shares at the present time may seem to be a risky move. After all, the UK faces an uncertain period from an economic and political perspective. Likewise, the world economy may experience a period of volatility due to US political risk, a global trade war and geopolitical challenges in the Middle East.
This, though, could be a good time to buy stocks for the long term. Value investors such as Warren Buffett have historically benefitted from investor sentiment fluctuating between fear and greed, with them purchasing stocks while they trade on low valuations in order to maximise their return potential.
This strategy may prove to be risky in the short run, but in the long term it may lead to high returns on your capital.
Profiting from sentiment
Warren Buffett’s mentor, Benjamin Graham, famously stated that “the stock market is a voting machine in the short run, but it is a weighing machine in the long run”. In other words, investor sentiment has a significant impact on share prices over a short time period, but the quality of a company and its financial performance impacts to a much greater extent in the long run.
Applying this idea in a practical sense means that investors can use market sentiment to their advantage, with it providing the opportunity to gain an improved risk/reward ratio. At the present time, for example, a number of stocks trade on low valuations that suggest they offer a margin of safety. Buying them now may not lead to high returns in the short run, since sentiment could realistically decline due to the aforementioned risks. However, in the long run their valuations may move closer to their intrinsic values and produce impressive capital returns in doing so.
Buying stocks while they are cheap, of course, is not an easy task. If it was, then all investors would be adept at timing the market. Perhaps the biggest obstacle facing investors, and which dissuades them from buying undervalued shares, is market noise. This is essentially the fear and uncertainty that emanates from their peers. While it may prove to be correct in the short run, market noise can cause an investor to become increasingly risk-averse at the most opportune moments to buy stocks.
Warren Buffett is able to shut out market noise. His track record shows that he pays little, or no, regard to what other investors feel at any given time. For example, he was buying bank stocks during the financial crisis, and has a long history of purchasing unpopular companies that provide long-term growth potential.
Buffett’s success suggests that being able to ignore market noise could be a major ally for any long-term investor. Given the risks that are facing the stock market, and the fear which many investors hold at the present time, now could be a favourable opportunity to buy a range of undervalued shares while other investors are more interested in selling, rather than buying. This strategy may lead to volatility in the short run, but it could deliver high returns in the long run.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.