Finding cheap shares to buy isn’t difficult at the moment. But choosing wisely is tricky. The coronavirus pandemic continues to plague both individuals and world economies.
While UK death rates continue to rise and Covid-19 testing capacity is thin on the ground, uncertainty reins. And as the pandemic continues to spread with no vaccine in sight, the scale of the economic damage being done is not yet clear.
All this has shaken the UK FTSE indices in recent weeks, but many analysts think there’s worse to come. If this is true, then we may find some of the UK’s best quality companies slipping into bargain territory. Existing shareholders don’t want their portfolios shrinking in value any further. But a crashing market can throw up a great opportunity for those looking to get started in stock market investing.
Billionaire investor Warren Buffett has made several fortunes. Each time he found himself in a market crash, he offset any losses by making quality purchases in undervalued companies.
Don’t forget to diversify!
Warren Buffett’s advice on portfolio diversification can confuse beginners. While most investment advice advocates portfolio diversification, Buffett once said: “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
This is because, if you’ve done your homework and are investing in sectors you understand, random diversification shouldn’t be necessary.
However, during a market crash, I think it’s apparent why diversification matters. The sectors most obviously hammered by the virus are airlines, travel and entertainment. If you’d only invested in these three sectors it could wipe your wealth out in one fell swoop. Likewise, if you were solely invested in oil, you’d be in trouble as oil majors sink under the weight of the crashing oil price.
I understand Buffett’s viewpoint on diversification. But I think it’s important that beginners don’t put all their eggs in one basket. Many different sectors are easily available for investors to buy, so it’s easy to created a diversified and balanced portfolio.
The world’s eye is on pharmaceuticals, for instance, as we wait with bated breath for whispers of a vaccine or miracle drug to crush the coronavirus. Meanwhile, as global tensions rise, defence is a sector I think could be gearing up for future growth. These are both sectors I’d consider adding to a diversified portfolio.
Overvalued to undervalued
Some of the UK’s best-loved FTSE 100 companies still have a high price-to-earnings ratio. So consumers may be misplacing their confidence in share prices higher than they’re worth.
Sometimes a market correction is necessary to bring overvalued shares back to earth. That means not only to a realistically valued state, but to an undervalued one. At this point, overpriced stocks become cheap shares to buy.
I think a market crash is a great time for beginners and seasoned investors to do their homework. Carefully research the companies you’re interested in. Then you can confidently buy shares in quality businesses when they’re at bargain prices. After that, just wait for confidence (and dividends) to return and watch their prices rise.
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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.