With the stock market having fallen by nearly 20% this year, there’s an abundance of cheap shares for investors to buy. But not all of these businesses may be attractive investments in the long run.
As such, investors have to be careful looking for cheap shares in the current market.
Finding cheap shares
Although there appear to be numerous opportunities to benefit from the recent stock market crash, investors need to be careful. Buying shares just because they look cheap can be an easy way to lose money. Sometimes, stocks are cheap because they deserve to be.
With that being the case, I’ve adopted a cautious approach to picking cheap shares.
It’s impossible to tell what’s in store for the stock market and economy in the short run. However, over the long term, history suggests an economic recession is unlikely to last forever.
What’s more, the economy has successfully moved from recession to an extended period of positive economic growth following every previous downturn.
Shares to avoid
Unfortunately, not every business will survive long enough to see the economic recovery. Companies with a lot of debt usually struggle the most in periods of economic uncertainty. So, it seems sensible to stay away from any companies with high levels of borrowing — even if their cheap shares look too good to pass up.
Businesses that produce commodities also seem at risk. Oil corporations are particularly vulnerable as they tend to have high fixed costs. Of course, not every company with a lot of debt will fail. And some commodity businesses may be able to survive the economic uncertainty.
But determining which of these cheap shares will succeed and which will fail, is quite tricky. On the other hand, defensive areas of the market appear to offer buying opportunities for long-term investors.
I’m looking at these parts of the market for cheap shares. Market leaders in specific industries will likely have the means to navigate the economic challenges ahead.
Companies that supply vital products for consumers and sectors, such as healthcare, should also be able to weather the storm. These organisations will face challenges over the next few weeks and months. However, their market positions should allow them to come out on top.
At the same time, FTSE 100 shares with wide economic moats have higher chances of survival. They may even be able to extend their market share to strengthen their long-run potential if smaller peers collapse.
Utility companies also appear to offer value after recent declines. They look like cheap shares after recent declines. In many cases, the shares are trading at levels not been since the last global recession. That means many stocks now look to offer excellent value for money.
Some companies might not survive the next 12 months, but others could come out stronger on the other side. While they may suffer further turbulence in the short term, these cheap shares could provide an attractive investment in the long run.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.