The S&P 500 Index’s slight rally since mid-June has prompted some investors to determine that it is the start of a new period of growth. Others, meanwhile, are less sanguine about the prospect of continued gains. They point to risks such as the war in Ukraine, high inflation and rising interest rates as reasons why equity markets will quickly return to their downward trend.
Of course, only time will tell which viewpoint is correct. Indeed, it is impossible to predict the stock market’s movements over even an incredibly short time period since there are an infinite number of variables that come into play, including decisions made by policymakers that have not yet been made, that interact with each other in an unknown fashion.
A simple strategy
In my view, focusing on company fundamentals as part of a value investing strategy is far simpler than making forecasts. Investors can, for example, use a checklist that includes considerations of factors such as balance sheet strength, competitive advantage and a company’s long-term track record of financial performance versus sector peers. And when a high-quality company based on such factors trades at a low price, buying and holding it for the long term is likely to be a relatively simple decision.
This strategy does not require extreme intelligence or vast experience. Even a handful of ratios such as debt-to-equity, return on equity and price-earnings provide guidance on the appeal of a specific stock.
Despite this, many investors would seemingly rather adopt the more complicated approach associated with trying to predict the future. This point has previously been highlighted by Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio), who said: “There seems to be some perverse human characteristic that likes to make easy things difficult.”
A successful approach
Due in part to the challenges involved in forecasting, I believe adopting a simple value investing strategy that focuses on facts is far more likely to succeed than apportioning capital based on future predictions.
A fact-based approach means investors accept the short-term performance of their holdings will be volatile and could even lead to paper losses. But with the stock market having a long track record of growth that has produced double-digit annual total returns over the past 30 years, such a strategy is very likely to come good over time.
Clearly, its returns in the short run may be viewed as disappointing by some investors. However, compounding can make a huge difference to portfolio returns in the long run. For instance, a 10% annualized return would equate to a doubling of a portfolio’s size in just over seven years. Investors who can identify and buy the best companies when they trade at low prices can outperform the market and further enhance their returns vis-à -vis their peers who persist in seeking to forecast its short-term performance.
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