B. Graham: How to earn from the market sell-off

Many value investors may be finding it difficult to buy stocks currently. Weak sentiment among their peers and negative news regarding the Covid-19 virus could be holding them back at a time when valuations are low across a multitude of sectors.

In such a situation, the investment principles of Benjamin Graham can act as a useful guide. His long-term focus, willingness to go against the opinions of his peers and confidence in the stock market’s recovery potential are attributes that are as useful today as they always have been.

By channelling his viewpoints into your own actions, you can take advantage of the wide range of value opportunities available today.

Buying opportunities

Investors who are in any doubt about how weak sentiment currently is may wish to consult the VIX index. It is known as the “fear gauge” on Wall Street, and recently increased to its highest level since the depths of the global financial crisis.

According to Graham, this could be a worthwhile buying opportunity for value investors:

“The intelligent investor is a realist who sells to optimists and buys from pessimists”.

In the present investment climate, the second part of the quote is perhaps most relevant. However, Graham’s description of intelligent investors as “realists” highlights the fact that stocks could move lower in the short run.

Through being realistic about the returns available in the short run, which could be poor given the prospects for the coronavirus, value investors can shift their focus to the long run. Over a longer time period, the returns from purchasing undervalued stocks have historically been high.

Quality versus sentiment

Falling stock prices should not dissuade investors from seeking to find the most attractive companies available at the present time. In fact, it is arguably even more important to consider the financial strength of businesses in what is an uncertain economic climate.

Of course, just because other investors are pessimistic about a company’s prospects does not necessarily mean that it is worth avoiding. According to Graham, high-quality businesses will be rewarded in the long run through a rising stock price:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine”.

It makes sense now more than ever to focus on those businesses with wide economic moats, modest debt levels and high returns on equity. They are likely to experience stronger returns than those stocks which are currently relatively popular among investors.

History repeats itself

With the number of Covid-19 cases continuing to increase, it is easy for any investor to feel as though the outlook for the economy and the stock market will perpetually worsen.

That same feeling is likely to have been present throughout all of the S&P 500’s past bear markets. However, the stock market has been able to recover from all of its past challenges. In this sense, its performance has been highly cyclical.

Graham’s view of the stock market’s cyclical status serves as a valuable reminder that history really does repeat itself:

“Abnormally good or abnormally bad conditions do not last forever”.

The current bear market is highly unlikely to continue in the long run. As previous crashes have shown, every bear market has always been followed by a bull market. Value investors who buy attractive businesses today while they offer wide margins of safety could benefit the most from the market’s eventual recovery.

*Not a trade recommendation