Waiting for attractive buying opportunities to appear is extremely tough in a rising market. Indeed, adopting this strategy over the past year could have meant missing out on the S&P 500's 50% gain.
In addition, low interest rates mean the return opportunities from holding fixed-income securities and cash savings in lieu of stocks are relatively low.
However, having the discipline to avoid today's overvalued stocks and instead wait for their share prices to fall could pay off over the long run.
The risks of buying shares in a bull market
The fear of missing out on further stock market gains could understandably encourage even the most ardent value investor to buy shares in today's market. They may feel they have little option but to buy stocks, since the return opportunities from other assets are relatively low. Moreover, they may take the view that an ongoing loose monetary policy and buoyant investor sentiment can lead to the continuation of recent upward stock market trends.
However, a strategy of buying overvalued stocks could be short-sighted. The existence of the stock market cycle means that purchasing equities following a bull run may limit future returns. Their narrow margins of safety prompted by excessively optimistic forecasts may not adequately factor in the risks they face. This may cause them to experience significant losses when the current bull market eventually becomes a bear market.
Waiting for better opportunities
Arguably, waiting for better opportunities could be a more logical approach. Not only could an investor avoid losses on today's overvalued shares in the next bear market, but they may be more able to use the market cycle to their advantage. For instance, they may purchase the same companies that they are currently optimistic about at a lower price further down the line.
This strategy has been successfully used by value investors, including head of Pabrai Investment Funds, Mohnish Pabrai (Trades, Portfolio). He has consistently outperformed his benchmark since 2000. As he once said:
"The single biggest advantage a value investor has is not IQ. It's patience and waiting. Waiting for the right pitch, and waiting for many years for the right pitch."
Maintaining discipline in today's market
While the theory behind waiting for lower stock prices may be straightforward, implementing it can be tough. In my opinion, a sound means of putting it into practice is to use the time spent waiting for more attractive stock prices to research companies and sectors. This may allow an investor to put together a list of companies they are positive about, in terms of their financial position and economic moat.
Having a list of companies to buy should they trade at lower prices can provide an investor with a large advantage over their peers. They will be in a position to quickly react to stock market movements that can mean attractive stock prices are only available for a short time. Evidence of this was apparent in the 2020 market crash, when a recovery had started to take hold before some investors had a chance to react.
By being prepared and disciplined, it may be possible to allocate capital more efficiently than is possible in today's bull market. This could allow an investor to obtain more attractive risk-reward opportunities in the long run.
Read more here:
- Bill Ackman: Invest Using Fundamentals Instead of Emotions
- Peter Lynch: Buying Familiar Stocks Can Be Dangerous
- Warren Buffett: Asset-Light Businesses Offer the Best Results
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