It is all too easy to follow the crowd when deciding how to apportion capital. At the moment, that means many investors are likely to follow their peers in avoiding the purchase of new shares. They may even copy their contemporaries in selling stocks now because they think high inflation, heightened geopolitical risks and rising interest rates will cause a further decline in market values.
In my view, the investment herdâs capacity to predict the future is extremely limited. In fact, consensus views are often wholly wrong. For example, over the past few years, most investors did not foresee the stock marketâs decline in March 2020, nor did they predict the recovery in the S&P 500 that propelled it to a new record high shortly thereafter. And while threats such as geopolitical uncertainty and high interest rates were present prior to the current bear marketâs commencement, the investment herd failed to accurately predict the stock marketâs 20%+ decline since January.
A value opportunity
In my opinion, the investment herdâs current downbeat assessment of the stock marketâs outlook may prove to be another example of their inability to accurately forecast the future. After all, the stock market has an excellent track record of recovery from its worst downturns. Although the current bear market may take time to evolve into a bull market, ultimately that is an extremely likely eventuality.
Therefore, now could be an excellent time to ignore your peers and snap up value opportunities in high-quality stocks. Currently, many shares trade at exceptionally low prices that do not reflect their underlying value. Some companies are trading lower due solely to generally weak investor sentiment towards equities that has meant they have essentially become collateral damage.
Adopting a contrarian strategy
Adopting a contrarian strategy like this can be a challenging task. After all, news of the stock marketâs outlook and the economyâs prospects is in mainstream media and is discussed in a variety of settings. Investors cannot realistically expect to completely isolate themselves from it.
However, they must find strategies to do so. This point has previously been highlighted by Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio). As he once said:
âYou need to divorce your mind from the crowd. The herd mentality causes all these IQs to become paralyzed. I donât think investors are now acting more intelligently, despite the intelligence. Smart doesnât always equal rational. To be a successful investor you must divorce yourself from the fears and greed of the people around you, although it is almost impossible.â
Practical strategies
In my opinion, a simple way to successfully ignore your peers is to rely on facts and figures when making decisions. For example, valuation metrics such as price-earnings or price-to-free-cash-flow ratios can highlight whether a stock trades at an attractive price. Other figures such as return on equity and long-term profitability can offer guidance on a company's competitive position, while gearing ratios can suggest whether it has a solid financial position.
Companies that appear attractive based on their fundamentals could offer long-term growth potential â even if other investors are currently downbeat about their prospects. Investors who rely on the former, rather than the latter, may be more capable of going against their peers and investing in stocks today ahead of a likely long-term market recovery.
