Shares trading at dirt cheap discounts have long been some of the biggest beneficiaries of long-term stock market recoveries. That’s hardly surprising, given buying low and selling high is the most proven strategy for building wealth in the stock market.
However, investing in discounted companies also comes with a host of additional advantages. For one thing, the margins of safety on these businesses become far larger. So, even if an investor misjudges their forecast slightly, the depressed market cap usually means plenty of capital gains can still be achieved.
Major opportunities
The lower the price of a stock, the greater the potential return. After all, it’s far easier for a £100m company to reach £200m than for a £100bn one to reach £200bn. This is why small-cap stocks are often popular with growth investors. While the risk profile is higher, the potential gains can be enormous.
During a stock market crash or correction, new stock-picking opportunities often emerge. And sometimes these can materialise from even mature industry titans.
When emotions are running high, volatility is inevitable. And many investors aren’t comfortable watching their portfolio move up and down like a yo-yo. As a result, a mass sell-off ensues until the storm blows over, creating many new choices for cheap shares.
Of course, in practice, this is a classic investing error. Volatility may be unpleasant, but it creates countless opportunities. And selling during a time when share prices have already plummeted is akin to setting money on fire. Nevertheless, it happens every time there’s a spike in fear about the stock market or the economy.
With emotions making the decisions rather than logic, almost every company ends up being sold off in a crash or correction. And that includes the ones that are still delivering solid fundamental results. It’s how companies like Apple dropped by over 25% in 2022 despite achieving record sales and profits. And the prudent investors who capitalised on this irrational behaviour have enjoyed gains of over 55% since the start of 2023.
Cheap shares aren’t risk-free
Buying shares in proven enterprises with a track record of success at cheap prices can be a lucrative strategy. But that doesn’t make it foolproof. Every investment carries risk beyond just volatility. Apple may be the world’s first trillion-dollar company, but that might not last.
Already the company has to navigate a minefield of geopolitical issues to move manufacturing outside China without upsetting the Chinese government, which currently has the power to cripple production. Should the worst come to pass, competitors will undoubtedly swoop in to steal market share and potentially even the crown of the world’s largest business.
Therefore, even when investors spot a bargain likely to benefit from the tailwinds of the ongoing stock market correction, it’s critical to investigate any threats. If the risk doesn’t justify the reward, then perhaps it’s worth letting a few bargains go. At least, that’s what I think.
