Value investors could capitalize on the recent market crash through buying quality stocks at low prices.
Undoubtedly, there is a heightened risk of loss in the short run. The economy’s outlook is uncertain, and investor sentiment may weaken if unemployment data and consumer sentiment metrics deteriorate further.
However, following the advice of successful value investors such as Warren Buffett (Trades, Portfolio), Seth Klarman (Trades, Portfolio) and Howard Marks (Trades, Portfolio) could allow you to survive short-term risks and generate high returns in the long run.
Surviving the short run
Before you can look ahead to a recovery for your holdings, surviving short-term economic challenges is imperative. Some sectors could experience a sustained period of weak revenue that causes them to make losses. Weaker businesses with high fixed costs or large amounts of leverage may not survive a prolonged period of difficult operating conditions.
Therefore, ensuring that your holdings can survive a worst-case scenario could be a useful idea. Marks, the chairman of Oaktree Capital, adopts such an approach when managing his portfolio:
“We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones”.
Riskier stocks may currently offer relatively low valuations that could produce higher returns in the long run. But companies with more resilient outlooks could offer a more attractive risk-reward opportunity – even if they trade on a higher valuation today. They may be more likely to survive an economic downturn in the short run and take part in a long-term recovery.
Margin of safety
Investing during an uncertain period for the economy dictates that investors should seek a wider margin of safety than usual. Company earnings could suffer a prolonged period of decline across a range of sectors, while asset prices may fall. Therefore, investors should demand a larger discount to a company’s intrinsic value before purchasing it.
Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial)'s Buffett has used the margin of safety principle to great effect in the past and has a simple way of describing it:
“On the margin of safety, which means, don’t try and drive a 9,800-pound truck over a bridge that says its capacity is 10,000 pounds. Go down the road a little bit and find one that says its capacity is 15,000 pounds”.
Seeking a wide margin of safety for any stock you are thinking of purchasing may mean that you miss out on some great buying opportunities in the long run. However, it is likely to reduce your chances of buying stocks for a price that does not reflect the risks they face.
Avoiding mistakes
In an uncertain period for the stock market, it is tempting to copy the decisions made by your fellow investors. For example, you may be cautious about the prospect of buying stocks in a market crash. This may lead you to seek confirmation from your peers that your views are sound.
However, following other investors can cause you to copy their mistakes. A better idea is to focus on the fundamentals of a business and use your own analysis to determine whether it is a worthwhile investment opportunity.
According to Klarman, leader of Baupost Group, investing using your own initiative could be a helpful strategy:
“Avoiding where others go wrong is an important step in achieving investment success”.
Being a contrarian investor requires a large amount of self-discipline. There may be times when your views are the opposite of the market consensus. Despite this, going against the investment "herd" could enhance your long-term returns and increase your capacity to capitalize on market cycles.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Seth Klarman on Buying Stocks in a Market Downturn
- Benjamin Graham's Tips on Analyzing Stocks in a Market Crash
- Warren Buffett's Advice From the Financial Crisis
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