Billionaire investor Warren Buffett is renowned for buying undervalued shares when stock markets are on the back foot. He makes no secret of it.
“The best chance to deploy capital is when things are going down,” Buffett said, so there should be plenty of opportunities amid the current uncertainty. Despite rallying in recent days, the FTSE 100 is down 4.32% year to date.
Some of my favourite shares have fallen by a lot more than that. I would like to buy one or two of them in November. But which?
I’m listening to Buffet
Buying undervalued shares works because stock markets are broadly cyclical, as are individual sectors and stocks. If I buy a stock after it has enjoyed a blistering run and investors are falling over each other to snap it up, there is a danger I will end up overpaying. This may leave me exposed when the wheel of fortune turns.
If I buy a stock when it looks down and out, I will secure a cheaper entry price, and reap the rewards if it recovers. That’s a big if though.
My aim isn’t to buy cheap shares. That’s the easiest thing in the world. It is also a good way of building a portfolio of bombed-out growth stocks and eternal value traps. Buffett preaches the importance of buying stocks that are good value instead.
Values stocks have been deeply discounted by the stock market, while the underlying business model remains strong. Again, this doesn’t mean simply buying the cheapest in the sector. I’m willing to pay relatively more for a company if its prospects are brighter.
This means buying a stock that is valued at below its underlying worth. As Buffett said: “Price is what you pay, value is what you get.”
He also likes to buy companies with wide economic moats, as that helps to protect them against competitors and new entrants. This strategy has made Buffett supremely rich, but then he’s an investment genius and I’m not.
FTSE 100 is full of undervalued shares
I’m just a private investor trying to pick up a bit of knowledge. Buffett famously said: “Never invest in a business you cannot understand.” I would modify this, and say never follow an investment strategy you do not understand.
The strategy of buying undervalued shares and waiting patiently for them to recover is so simple even I understand it. It’s the old ‘buy low, sell high’ mantra.
There are plenty of opportunities to buy low over the months ahead, as central bankers tip the world into recession to kill inflation. Buying undervalued shares should give me downside protection if markets head south, and turbo-charged recovery when they rise. That’s the theory, anyway.
It means I can buy FTSE 100 stocks today and don’t have to worry too much if share prices fall again tomorrow. It’s going to be a volatile winter, but when markets fall, I will take my chance and buy some more undervalued shares.