Value investors are currently facing one of the most uncertain periods for the stock market in many years. An economic slowdown is a given, but the length of time it will take for operating conditions to return to normal across a wide range of sectors is a known unknown facing all investors.
Peter Lynch faced many periods of stock market uncertainty during his career managing mutual funds. His capacity to take advantage of market declines through adopting a long-term view and focusing on company fundamentals helped him to generate average annualized returns of 29% when managing the Magellan Fund between 1977 and 1990.
A regular occurrence
The stock market’s decline over the past several months may have caught many investors by surprise. However, it is not the first time that share prices have fallen heavily in a short span of time.
The S&P 500, for example, has experienced 14 bear markets in total since the end of World War II. On average, they have occurred every five years.
Since bear markets are not an unusual or infrequent event, value investors should anticipate their occurrence at regular intervals. This is a strategy that has been used by Lynch throughout his investment career:
“A stock market decline is as routine as a January blizzard in Colorado. If you're prepared, it can't hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.”
Predicting the future
Even though the stock market regularly experiences bear markets and periods of volatility, consistently predicting when they will occur and how long they will last is impossible. There are a wide range of variables that can affect company earnings, investor sentiment and the prospects for the economy. Therefore, accurately predicting when the precise moment to buy or sell a stock is unlikely to be an achievable goal for investors on a regular basis.
Rather than seek to estimate how markets will perform over a short time horizon, value investors should use the stock market’s long-term growth prospects to their advantage. According to Peter Lynch, this strategy will be far more successful for the vast majority of value investors:
“Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide.”
Focusing on company fundamentals
Company fundamentals can provide value investors with a great deal of insight as to whether a stock is worth buying or not. For example, a business that has a solid balance sheet with minimal debt, strong free cash flow over a sustained period of time and an economic moat may deliver relatively impressive financial performance over the long run.
During periods of market uncertainty, company fundamentals could become even more valuable to investors. Bear markets and recessions can cause significant change within an industry that presents opportunities for the strongest businesses operating within it. Therefore, following Lynch’s advice on assessing the strengths and weaknesses of companies could be an efficient use of your time:
“Nobody can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts and concentrate on what's actually happening to the companies in which you've invested.”
Buying undervalued stocks
One of the challenges faced by value investors during uncertain market conditions is the potential for share prices to move lower in the short run. For instance, a company that appears to offer a margin of safety today may trade at a larger discount to its intrinsic value tomorrow. This could dissuade many investors from purchasing stocks at what ultimately prove to be attractive prices over the long run.
Lynch acts swiftly when a company he is positive about trades at a price he deems to be too low. He does not concern himself with the possibility of its price falling further in the short term, and does not aim to buy any stock when it trades at its lowest point:
“When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom.”
Read more here:
- Benjamin Graham on Buying Stocks in a Market Downturn
- Howard Marks on Managing Your Portfolio in a Crisis
- Seth Klarman on Investing in Volatile Market Conditions
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