The FTSE 100 index is still down by 17% since the beginning of 2020. While another major sell-off could be lurking just around the corner, I certainly wouldn’t count on it. After all, many companies listed in the index are trading on cheap valuations relative to pre-crash levels, offering a wide margin of safety for investors buying today. With that in mind, I’d follow the example of an investing mastermind like Warren Buffett and buy the best undervalued shares on the market to build serious wealth.
Warren Buffett’s value investing
The aftermath of a stock market crash provides ideal hunting ground for spotting undervalued companies. With depressed share prices that may be struggling to recover, investors can pay lower prices than they would in normal market conditions.
While it’s notoriously difficult to buy at the bottom, following Buffett’s advice to pay a fair price for high-quality companies means that timing the market becomes far less important. After all, Buffett owes his success to the time he spent in the market, not his timing of the market.
When on the lookout for the best undervalued shares, it’s important to keep a few key factors in mind. For example, evaluating a company’s price-to-earnings ratio. This measurement determines the market value of a company relative to its earnings. A low P/E (roughly less than 15) may suggest that a company’s shares are undervalued. Conversely, a high P/E (roughly greater than 15) could indicate that a stock is overvalued.
There are exceptions to this however, and it’s important to compare P/E ratios on an industry basis for a more accurate comparison. According to Buffett, more important factors include the strength of the underlying business and whether it possess a competitive advantage over its peers.
Make a million after the market crash
Market sentiment towards an undervalued stock often improves over time. Consequently, investors usually profit through a combination of considerable share price appreciation and healthy dividend payments. Additionally, if ploughed back into the original investment, these dividends fuel the compounding process.
Ultimately, buying the best undervalued shares may not result in you becoming a billionaire, like Warren Buffett. But it could certainly improve your chances of growing a tidy sum. Key to this undertaking is unlocking the potential for compound returns. This is the process that turns a relatively small investment into huge return.
To illustrate, a £10,000 investment that achieves an annual return of 9% would be worth £132,675 after 30 years. Supplement this with regular monthly amounts and your prospects of achieving a six-figure portfolio increase dramatically.
Evidently, the possibility of a second stock market crash remains on the horizon. That said, I believe investors who stick to their strategy and ride out the temporary market downswings can expect to profit handsomely over the long term.
Matthew Dumigan 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.