The stock market crash in the spring caused many shares to look cheap. Some rebounded after the crash. But many stocks appear to be rolling over again now, perhaps because of the difficulties in the real-world economy.
Indeed, Covid-19 hasn’t gone away. And many companies are struggling to turn a profit because of increased costs and lower revenues. However, Warren Buffett made many of his billions by investing during uncertain economic times when stocks were cheap.
Will there be a second stock market crash in 2020?
The great thing about investing in shares when they’re down is the underlying businesses may go on to recover over time. Indeed, if the problems a company is facing prove to be temporary, shares can rise again. And that can happen for two reasons. Firstly, the share price may elevate to reflect the underlying operational progress. And secondly, the stock market can mark the valuation higher to match improved rates of earnings growth.
So that potential double-whammy can really drive up a stock. And it’s one of the reasons Buffett has been so successful by investing in good-quality businesses when they’re struggling and the stocks are out of favour with the market.
You’ve probably heard some of his advice urging us to buy shares when others are selling. For example: “Be greedy when others are fearful.” Advice like that indicates a contrarian approach to investing, which goes against the grain of most people’s emotions.
Right now, many people are fretting about a possible second stock market crash this year. And, of course, it’s possible that we’ll see one, but not certain. One way of dealing with the uncertainty is to listen to the news flowing from the individual company shares you are interested in buying. And keep a close eye on the valuation stocks are assigning each business.
If you focus like that it may give you the confidence to follow Buffett’s contrarian advice. But even he doesn’t manage to time all his stock purchases to perfection. Sometimes shares fall further after he’s bought them. But I reckon the best way to deal with situations like that is to adopt a long-term investing perspective and aim to hold for years rather than weeks or months.
When to avoid buying
The other half of Buffett’s advice is to “be fearful when others are greedy.” And with that, he’s talking about stock market exuberance. Sometimes individual share prices, or the entire stock market, can rise too far. And when that happens, valuations can move too high.
A high valuation makes it hard to bag a successful investment. Indeed, even great businesses can make poor investments if you pay too much for them. So Buffett tends to be reluctant to buy stocks when other investors are snapping them up with enthusiasm. And that usually happens when everything looks rosy in the economic garden.
The coronavirus pandemic has made the economic outlook uncertain. But it could have created ideal conditions to help us begin to make a million from shares, the Warren Buffett way.