The stock market has been buoyant of late, with the flagship FTSE 100 index of leading British shares edging close to its all-time high this week.
But the economy is struggling with challenges ranging from high inflation to sluggish demand. Sooner or later, I expect the financial markets and the economy to move in a parallel direction again. If business is struggling overall, the market cannot realistically be expected to keep inching upwards.
That is why I am preparing for a stock market correction. I do not know if one will come this year. But I am certain that, sooner or later, we will see a sizeable downward move in the market in a short timeframe. By getting ready for such an event now, I think I can build my wealth. Here’s how.
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How price drives value
Sometimes people talk about the valuation of a company, particularly when discussing its market capitalisation. But often what they really mean is not actually value but price. A market-cap, for example, is simply the aggregate price of a company’s shares.
Value is what a firm is actually worth. In an efficient market, a company’s market capitalisation ought to reflect its value. But markets are not always efficient. In a stock market correction, for example, shares can quickly move down in price by 10%, or more. But a firm’s value is unlikely to move around quite as much.
So if the underlying value of the businesses concerned has not similarly shrunk, there might be an opportunity for me to buy high quality companies at attractive prices. That is the investment philosophy of Warren Buffett. I use it to build my own portfolio of high quality shares.
Embracing a stock market correction
Ordinarily though, it can be hard to find such investments. I look at a company like Guinness brewer Diageo or instrument manufacturer Judges Scientific and like the way their business models offer the potential for long-term profits.
But other investors do the same, keeping demand for the shares high. That can push up their prices to a level where I find the businesses attractive – but not their share prices. In fact, that is how I feel about those two businesses currently, along with some others.
So I keep a list of what I think are high quality businesses, with an eye on investing in them if their share price reaches a level I find attractive. That way, if the price suddenly falls, I am ready to make a move.
Preparation is key
In theory, I could just wait for the next stock market correction and see what shares look attractively priced then.
But in such a situation, events can move fast. I may not have time to research companies and take a well-rounded view on whether they fit my investment objectives, let alone whether I see them as attractively valued. A correction can be short-lived.
So that is why I am taking those preparatory steps right now, by hunting for what I think are great businesses with strong long-term profit prospects.
