The stock market’s recent decline has caused significant fear among investors. This is evidenced by the 60% increase in the VIX index since the start of the year, with a higher figure representing weaker investor sentiment. This may mean some investors are less likely to purchase shares at the present time.
However, the stock market’s tumble should be viewed as a positive for long-term value investors who are net buyers of equities. In other words, investors who are set to buy a greater monetary amount of shares than they sell over the coming months now have a better opportunity to purchase high-quality companies when they trade at low prices.
A value investing approach
Of course, buying undervalued shares and holding them for the long run is a long-standing means of capitalizing on the stock market’s cyclicality. Indeed, a number of investors have followed a value investing approach in recent decades. Among them is Oaktree Capital founder Howard Marks (Trades, Portfolio), who said:
“Buying something for less than its value. In my opinion, this is what it’s all about—the most dependable way to make money. Buying at a discount from intrinsic value and having the asset’s price move toward its value doesn’t require serendipity; it just requires that market participants wake up to reality. When the market’s functioning properly, value exerts a magnetic pull on price.”
Waking up to reality
Clearly, it can take a prolonged period of time for investors to "wake up to reality." The average bear market has historically lasted for around 10 months. During this time, some investors may decide to sit out and wait for an improving performance from equity markets before buying, which could result in them not benefitting from the most attractively priced stocks.
Furthermore, with the stock market having always previously rebounded from its downturns to post new record highs, holding cash instead of buying shares could mean missing out on a major recovery.
A wide margin of safety
Of course, investors may wish to demand a wider margin of safety than usual at the present time due to the uncertain economic and geopolitical outlook. For example, they may require a 30% discount to a company’s intrinsic value to merit purchase, rather than their usual 15% discount, in case its outlook deteriorates in an era of high inflation, slower economic growth and rising interest rates.
However, investors should not, in my opinion, demand an unrealistically wide margin of safety before buying stocks. After all, the stock market’s future is perennially uncertain and present risks may already have been factored in to valuations. Even though equity markets may yet experience a further downturn, stocks could equally rise in price from their current levels. This could mean that extremely low valuations ultimately fail to appear.
Therefore, it may be prudent for investors to demand a wide but realistic margin of safety at the present time as part of their value investing approach. This will provide a degree of protection against further economic challenges, while enabling them to capitalize on low valuations that can ultimately generate high capital returns as investor sentiment improves over the long run.
