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Why I’d listen to Warren Buffett and buy cheap shares

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One aspect of Warren Buffett’s investment strategy that could provide scope for higher returns in the coming years is his focus on buying cheap shares.

At the present time, many UK stocks appear to be trading at price levels that are below their historic averages. This could signify that they offer the potential for recoveries in a long-term stock market rally.

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Although there is no guarantee that any share will rise in price, undervalued companies could have a greater chance of outperforming the stock market versus overvalued shares.

Warren Buffett’s focus on buying cheap shares

Warren Buffett has often been most active in the stock market during periods of great uncertainty. During such times, it is relatively common for share prices to fall to levels that may not necessarily represent the long-term financial prospects for businesses. As such, there may be opportunities to buy high-quality companies for less than they are worth. This could mean there is greater opportunity for capital growth compared to purchasing shares at, or above, their intrinsic values.

Of course, Buffett’s strategy has a long-term focus. He does not expect investments in undervalued companies to quickly yield a profit. In fact, due to difficulties in predicting the movement of the stock market, it is plausible for investments during periods of economic uncertainty to post losses in the short run. And they may even fail to recover over the long run.

However, Warren Buffett’s consideration for the quality of a business alongside its price may mean overall risks are reduced. For example, he has historically sought to purchase companies with strong market positions that may include recognisable brands. They may be better able to cope with present and future risks to deliver improving profitability.

Investing in cheap shares today

Despite the recent stock market rally, a number of UK shares appear to be trading at cheap prices. For example, many banks and commercial property companies trade at prices that are below their net asset values. Meanwhile, high dividend yields are available within the resources sector. And some consumer goods companies have price multiples that are below their long-term averages.

Buying such companies at cheap prices, as Warren Buffett has done in the past, could lead to higher returns than the stock market over the long run. This could aid an investor in building a portfolio at a faster pace than would otherwise be the case via the stock market. That is even with the current risks taken into account.

Even so, matching the stock market’s past annual total returns of 8% could lead to a generous portfolio over the long run. Warren Buffett’s strategy of buying cheap shares is not guaranteed to beat the market, of course. But history suggests it might do just that. Buying high-quality assets for less than they are worth could be a profitable long-term move.

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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.