Following Warren Buffett in buying cheap shares could mean impressive long-term rewards as the world economy recovers, in my view.
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Many of today’s cheap shares could hold appeal for investors such as Warren Buffett. His focus on achieving a discount to a company’s intrinsic value when purchasing shares could provide scope for capital appreciation over the long run.
With many other mainstream assets such as bonds and cash offering low returns at the present time, undervalued stocks may prove to be a profitable long-term investment.
Weak investor sentiment towards today’s cheap shares
Despite the stock market’s rebound since its March lows, many cheap shares are currently available to buy. Investors have a downbeat view of a number of sectors that face challenging operating conditions in the short run.
Where companies within those sectors have solid financial positions and competitive advantages, they may be likely to survive difficult current circumstances to benefit from a likely economic recovery.
Warren Buffett has previously purchased cheap stocks to generate high returns in the long run. Buying a company for less than it is worth may also reduce an investor’s overall risks. They will obtain a wider margin of safety in case its future performance is less positive than expected.
Recovering share prices
Of course, there is no guarantee that today’s cheap shares will recover from their current low prices. The economic outlook could worsen, while some companies may be unable to adapt their business models to changing operating conditions.
However, the track record of investors such as Warren Buffett shows that a long-term recovery is likely. He has benefitted from the world economy’s persistent return to impressive levels of GDP growth following a variety of crises.
For example, over the past 20 years, the early 2000s recession and the global financial crisis caused some stocks to trade at extremely low levels for a period of time. Following them, the world economy returned to positive growth over the long run, which prompted improving operating conditions and stronger investor sentiment towards previous cheap shares.
A lack of relative appeal
Cheap shares may also be appealing today because of a lack of opportunities available elsewhere. Low interest rates mean that cash and bonds have disappointing returns.
Therefore, they are unlikely to make up the majority of an investor’s portfolio. Meanwhile, high house prices may mean that the returns on property investment may be less impressive than those made on undervalued shares.
Of course, there may be further challenges ahead for the stock market. Risks such as the ongoing coronavirus pandemic and Brexit may limit the scope for stock markets to rise in the short run.
Therefore, diversifying across a range of cheap stocks could be a sound move. It may limit risk and allow an investor to follow in Warren Buffett’s footsteps to outperform the stock market as it delivers likely further growth in the coming years.
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Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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