The recent stock market crash may have caused many investors to become cautious about buying equities. After all, the outlook for the world economy is very uncertain, and news regarding coronavirus could change quickly.
However, through buying high-quality businesses while they offer a margin of safety you could improve your long-term financial outlook. This strategy has been successful in the past, and could help you to retire early.
Due to the challenging outlook for the world economy, perhaps the most important criteria for purchasing any stock is its ability to survive a likely recession and the potential for a further market crash. Therefore, any business you seek to purchase should have a solid balance sheet, in terms of modest debt levels and substantial amounts of cash, as well as some defensive characteristics.
Such companies may be in a strong position to not only survive an economic downturn, but also to strengthen their market position. For example, they may be able to win market share from weaker competitors. Or they could capitalise on low valuations to buy competitors at bargain prices. Either way, they could generate higher levels of profit over the long run, and produce higher stock prices as a result.
Margin of safety after a market crash
Investing with a margin of safety is a sound strategy that helps to reduce risk and improve your return prospects. Essentially, it means buying an asset for less than it is worth. In doing so, you obtain a margin of safety that could be especially useful in the current uncertain economic climate, when the stock market’s recent rebound may give way to a market crash.
Assessing a company’s value at the present time is, of course, highly challenging. Earnings and asset prices could change, which could make some valuation metrics unreliable. However, by focusing on a range of measures, such as yields, price-to-book (P/B) and price-to-earnings (P/E) ratios and comparing them to industry peers as well as historic values, it may be possible to gauge whether a stock offers good value for money. Buying it at a discount to its intrinsic value could lead to a more favourable risk/reward opportunity.
The near-term prospects for the stock market are likely to be very uncertain. The risk of further coronavirus cases in the coming months may cause investor sentiment to rapidly shift from positive to negative, which could cause a further market crash.
Therefore, investing for the long term could be a shrewd move. It will enable you to look beyond the short-term volatility that is likely to be present across the stock market. And you could use it to your advantage in terms of buying high-quality businesses at low prices.
The track record of the stock market shows that it has always recovered from is lowest points during a variety of bear markets. Yes, that prospect may seem unlikely right now. But by adopting a long-term focus, you could stand to benefit from an equity market recovery that enables you to retire early.
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.