Looking at the history books, a correction or crash in the stock market has always been followed by an eventual recovery. And that includes some of the greatest financial disasters, like the 2008 mortgage crisis that sent the FTSE 100 plummeting by over 40%.
But as horrendous as these downturns are to experience, they create countless opportunities for brave investors. After all, not every business is compromised by catalysts like rising inflation and interest rates. In fact, plenty of stocks are being sold off despite being free cash flow positive and debt free.
This may seem unusual. But it’s important to remember that in the short term, share prices are ultimately driven by mood and momentum. Panicking investors often end up closing positions in top-notch enterprises due to the fear of potential loss. And that often becomes a self-fulfilling prophecy.
However, investors smart enough to look past a plummeting valuation and analyse the business itself can often find bargains in the chaos. So let’s explore how to capitalise on a stock market recovery.
When will the stock market recover?
Despite the volatile state of the equity markets, indices like the FTSE 100 and FTSE 250 have been secretly on the rise since October. Across the pond, the S&P 500 is already up over 20% over the same time period, leading some investors to believe that a new bull market has begun.
Assuming this is the case, how long before a complete recovery is achieved? Sadly, there is no definite answer because there are so many unknown factors. However, looking at previous crashes and corrections, the average stock market recovery time is usually around 19 months, once the bottom has been hit.
Providing that October is, in fact, the bottom, that would suggest we’re already halfway there. Obviously, this is far from guaranteed. But if true, then investors may be running out of time to snatch up high-quality shares at discounted prices.
Cheap or tacky?
Not every stock that’s fallen from grace is necessarily a bargain. The majority of investors are usually reacting with emotions rather than logic during times of volatility. But that doesn’t mean they’re always wrong.
Sometimes a company is sold off for good reasons. So investors need to take a closer look at the reasons why. With debt being near-free for the last decade, many firms have leveraged up and become reliant on external financing. And, arguably, these businesses are at the most risk today now that debt is suddenly becoming increasingly expensive.
Cost-cutting initiatives are seemingly everywhere to help pay down the loan tab. But enterprises that are already self-reliant and generating cash out of the wazoo have the benefit of significant financial flexibility. So while competitors are struggling to keep the lights on, these cash-generative businesses are busy ramping up internal investment, stealing market share, and securing their place as new industry leaders.
There are obviously other factors to consider when making an investment decision. But investors could stumble upon the best bargains to capitalise on this stock market recovery by whittling down the list to solely include nimble businesses trading at an historical discount.
