The FTSE 100’s recent market crash was swiftly followed by a rebound. But the index is still trading around 25% down on the price at which it commenced 2020. Therefore, the index may still offer a wide range of stocks that trade on low valuations. Over the long run, they could offer recovery potential.
Buying a diverse range of them today, and holding them through potential challenges in the near term, could yield high returns for investors.
Low valuations
Across the FTSE 100, stocks are trading on valuations that haven’t been seen since the global financial crisis over a decade ago. Indeed, many of its incumbents have valuations significantly below their long-term averages. And that could indicate they offer wide margins of safety.
In the near term, there’s a chance their prices will return to a downward trend following the index’s recent rebound. News regarding coronavirus may, unfortunately, remain challenging in terms of the number of new cases and deaths.
Furthermore, in some cases, low valuations are warranted. Sectors such as travel & leisure and retail, for example, are experiencing a significant amount of disruption. Profitability across those sectors, and many others, is likely to materially decline in the current year.
Recovery potential
However, the track record of the FTSE 100 has been mostly strong. It shows that buying a range of companies when they trade on low valuations has historically been a successful means of generating high returns in the long run. The index has always recovered from its worst downturns and bear markets to experience periods of strong growth.
Sometimes this can take many months, or even years. But past bear markets, such as the 1987 crash and the global financial crisis, have been followed by periods of sustained growth in the prices of FTSE 100 stocks.
Although this may seem unlikely at present, buying high-quality companies with strong balance sheets could be a means of capitalising on the low valuations present across the index.
Spreading the risk
Due to the uncertain near-term prospects for the FTSE 100, buying a diverse range of companies that operate in a number of sectors and geographies could be a logical move. It may reduce your exposure to specific regions and industries. It may also spread the risks within your portfolio across a wider area. This may increase your chances of taking part in what seems to be a likely recovery over the coming years.
Fortunately for investors, the cost of diversification has fallen in recent years. It’s now possible to build a diverse portfolio without paying vast sums in commission or dealing costs through online share-dealing providers.
Through spreading the risk across a wide range of businesses, you could limit your losses in the near term. And you could improve your return prospects over the long run.