Buying cheap shares today may not produce an impressive return in the short run. After all, the world economy faces a period of significant uncertainty caused by coronavirus. Lockdown measures are likely to cause rising unemployment and lower GDP growth across many major economies. That, in turn, could lead to difficult operating conditions for many listed companies.
However, through buying undervalued shares today you could take advantage of the stock market’s cyclicality and its long-term recovery potential. This could improve your chances of retiring early.
Buying cheap shares
At present, an uncertain economic outlook may dissuade some investors from buying cheap shares. Risks, such as a second wave of coronavirus and increasing trade tensions between the US and China, could mean the stock market experiences a challenging period that limits its scope for capital growth.
However, often the best times to buy stocks have been when their outlooks are highly uncertain. Risks mean investors demand wider margins of safety. This could allow you to purchase stocks while they trade at even lower prices. And when they offer even greater capital growth potential.
Value investing appeal
Purchasing cheap shares allows an investor to take advantage of the stock market’s cyclicality through buying businesses when they trade at low prices and selling them when they trade at higher prices.
On a long-term basis, following a value investing strategy has been highly successful for a range of investors. They include Warren Buffett, who’s been able to ignore other investors during bear markets and recessions to purchase high-quality companies at low prices. Through holding them over the long run, it’s possible to obtain high returns that improve your retirement prospects.
Of course, assessing the quality of the companies you purchase is a means of limiting risks when buying cheap shares. Through focusing your capital on those businesses that have solid balance sheets and wide economic moats, you can reduce your chances of experiencing losses in the short run. Such companies may also be able to strengthen their competitive positions to generate higher returns in the long run through increasing their market share at the expense of weaker rivals.
Furthermore, diversifying across a wide range of businesses could improve your portfolio’s risk/reward ratio. It may reduce your reliance on a small number of stocks to produce your returns, which could enhance your long-term growth rate. It may also allow you to invest in a wider range of fast-growing sectors than would otherwise be the case.
The stock market has always recovered from its challenging periods to post long-term gains. So now could be the right time to build a portfolio of stocks that can benefit from a likely improvement in the economy’s growth rate in the coming years. Doing so could increase your chances of retiring 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.