Investing in the current bull market is not an easy task. Company valuations are exceptionally high in some cases, despite the economy's uncertain outlook.
As such, now could be a good time to revisit your core investment principles. They may help to provide clarity in challenging stock market conditions.
Berkshire Hathaway BRK.A BRK.B Chairman Warren Buffett (Trades, Portfolio) has always maintained a sound set of investment principles. His long-term view and focus on company valuations may be key reasons for Berkshire's 20% annual gains between 1965 and 2019.
Buying quality businesses with tough outlooks
The uncertain economic outlook means that many businesses face challenging financial prospects. This may weigh down their stock price performances in the short run, but could provide a buying opportunity for long-term investors.
For instance, a company with resilient finances and a large economic moat is likely to recover from short-term challenges to post rising profits. Likewise, sectors that are experiencing a tough period at the moment may enjoy improving performances as the economy recovers.
Buying attractive businesses when they face near-term difficulties is a means of obtaining a wide margin of safety. This may increase your chances of generating market-beating returns over the long run.
As Buffett once said, "The best thing that happens to us is when a great company gets into temporary trouble. We want to buy them when they're on the operating table."
Valuations are crucial in all market conditions
The current bull market has caused some stocks to trade on rich valuations. Even though in some cases they are dominant businesses that have a vast competitive advantage over their peers, overpaying for a stock can lead to disappointing investment returns.
However, as is often the case in a bull market, investors can become less concerned about price and more interested in growth opportunities. This can lead to an inefficient allocation of capital, since highly valued growth stocks may offer narrow margins of safety. In addition, their valuations could already take into account a "best case" growth outlook.
Therefore, buying stocks that offer a large discount to their intrinsic values is arguably a prudent strategy to use in the current bull market. As Buffett once said, "For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments."
A long-term approach to investing
The stock market's 55% gain since its three-year low in March may cause some investors to shorten their time horizon. For instance, they may seek to make a quick profit on stocks, since they could feel that recent upward trends will continue.
However, this is a more risky strategy. The stock market's performance is impossible to accurately predict due to the infinite number of variables that can affect its prospects. Moreover, bear market catalysts cannot always be foreseen prior to their occurrence.
Instead of becoming overly bullish in this market, a better approach may be to maintain a long-term outlook. This may encourage you to apportion capital to companies with challenging outlooks at the moment, but that offer strong recovery potential in future years.
A long-term investment strategy has consistently paid off for Warren Buffett (Trades, Portfolio) over previous decades. As he once said, "I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years."
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Charlie Munger: Seize Rare Investing Opportunities Today
- Joel Greenblatt: How to Find Today's Best Buying Opportunities
- Warren Buffett on Preparing for the End of This Bull Market
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