For some people, investing in the stock market is akin to buying a National Lottery ticket. Ultimately, in their view, share prices are impossible to accurately forecast, and there is a significant amount of luck involved in investing in the stock market.
Of course, the success of investors such as Warren Buffett helps to disprove this theory. While share prices may be incredibly difficult to predict in the short run, a strategy that aims to buy high-quality stocks while they trade at fair valuations has a good chance of yielding high returns in the long run.
As such, rather than buying a National Lottery ticket, I’d look to follow Warren Buffett’s advice and focus on consistently outperforming the stock market through value investing.
High-quality stocks Investing in high-quality companies can increase your chances of generating impressive returns on the stock market over the long run.
While every investor will have their own interpretation of what constitutes a high-quality company, focusing on fundamentals such as debt, cash flow and profit track record could be a good place to start.
With interest rates likely to rise over the long run, buying companies that are highly-indebted could increase the risk of loss for an investor. Likewise, stocks with weak cash flow may be unable to pay a rising dividend, and businesses that have struggled during periods of uncertainty for the wider economy may prove unpopular as the trade dispute between the US and China intensifies.
Through buying shares that offer lower debt, strong cash flow and a track record of growth in a range of market conditions, it may be possible to improve the risk/reward ratio of your portfolio.
Value investing As well as buying high-quality businesses, Warren Buffett also seeks to purchase stocks that are fairly priced. Not only does this mean that there is an increased chance of generating high returns, it also reduces risk as a result of a margin of safety being on offer compared to a company’s real value.
Clearly, there are a variety of methods through which an investor can value a business. However, by remaining consistent in terms of the methodologies used and their application, it may be possible to find the most appealing stocks within a specific industry. Over time, they may be able to outperform their sector, as well as the wider stock market.
Holding period Although trying to predict the stock market’s movements in the short run may be a highly challenging process, over the long run it has historically risen.
Certainly, there have been major downturns that have seen 50%+ wiped off the value of indices such as the FTSE 100 and FTSE 250. But, through following Warren Buffett’s advice on holding for the long term, it may be possible for any investor to get rich and retire early.
Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019