The recent stock market crash means that many FTSE 100 shares now trade at prices last seen during the financial crisis. In the near term, many sectors and businesses could experience exceptionally difficult trading conditions. Lockdown measures may lead to reduced sales that cause investor sentiment to decline.
However, by taking a long-term view of the stock market’s prospects it is possible to capitalise on its low valuations. The FTSE 100 has a track record of recovery and offers the prospect of diversifying across numerous companies. So this could enable you to access a favourable risk/reward opportunity over the coming years.
Margin of safety
As mentioned, some FTSE 100 stocks now trade at levels last seen over a decade ago. Investors are understandably concerned about the prospects for the economy during an unprecedented crisis. In the short run, sentiment could worsen should news regarding coronavirus deteriorate, or fail to improve.
However, it has always been difficult to ascertain when share prices will reach their lowest ebb during downturns and recessions. Just look at when the FTSE 100 reached its lowest price level in the 1987 crash, during the dotcom crisis and in the financial crisis. It happened when many investors felt things would worsen before they improved from an economic perspective.
Therefore, it is difficult to find the best time to buy stocks in the current situation. But through buying high-quality companies today while their prices offer wide margins of safety, you can take advantage of their long-term recovery potential.
Recovery potential
Just as it is difficult to know when the FTSE 100’s price level will reach its lowest point, assessing when a long-term recovery will take hold is also challenging. The economy’s performance generally lags investor sentiment. And this means buying stocks when their prospects are uncertain could be a sound move.
The FTSE 100 has a solid track record of recovering from its worst bear markets and corrections. Of course, such an outcome cannot be guaranteed in the coming years. But it seems to be highly likely based on past performance. As such, buying companies with solid balance sheets and strong cash flow now, and holding them for the long run, could be a worthwhile strategy.
Diversification
Buying and holding a small number of shares may be tempting to many investors. After all, selecting the biggest bargains in the FTSE 100 may prove to be a highly successful strategy. But it also means that risks are high. For example, should one stock in a highly-concentrated portfolio experience poor financial performance it would cause a significant decline in the overall performance of your holdings.
Therefore, diversifying across a range of FTSE 100 shares is key. That means buying businesses that operate in varied geographies and industries. Do so and it could improve your risk/reward prospects. It could also improve your financial future, and increase your capacity to capitalise on the low valuations that are present across the FTSE 100.