I’m a firm believer in investing in quality companies when their shares are cheap. As I see it, this is the core to investing well.
This isn’t always easy to do. But for investors who are willing – and importantly, able – to look for opportunities in difficult situations, the rewards can be huge.
Finding stocks to buy
One of the best ways of finding cheap shares is by looking for companies that are facing specific, short-term problems. This can often generate attractive opportunities.
The pandemic is a great example of this. Rolls-Royce shares fell 88% between Februrary 2019 and October 2020 as demand for engine servicing fell away sharply due to travel restrictions.
These proved to be temporary, though, and the company’s earnings have recovered well. Investors who were able to see this could have benefitted from a 655% return on their investment.
Not every falling stock is a bargain, though. Former FTSE 250 stock Synthomer saw its share price fall around 64% in 2022 as demand for the chemicals it produces dried up.
Investors who piled in at this point would have been making a big mistake, though. An over-leveraged balance sheet subsequently caused the stock to fall by another 83%.
Where are the opportunities now?
With the pandemic over, investors have to look elsewhere to find cheap shares to buy. But there are some important trends that I think are worth paying attention to.
One is the emergence of weight loss drugs. The risk that these might cause demand for packaged food to fall has been weighing on the Kraft Heinz share price.
It’s also significant, in my view, that banking sector shares haven’t fully recovered to where they were before the crisis last year. Barclays for example is still 20% lower than it was last February.
Lastly, several real estate investment trusts (REITs) haven’t shaken off the effect of rising interest rates. One example is Warehouse REIT, which is still down 18% from this time last year.
In each of these cases, the risks are real. But I think these are the kinds of situations that generate the best buying opportunities for investors who are able to assess the risks and rewards accurately.
Investing in an ISA
For UK investors, I think the best way to take advantage of unusually cheap shares is by investing in a Stocks and Shares ISA. That way, any capital gains and dividends aren’t subject to tax.
The contribution limit is £20,000 per year. But I typically look to invest £16,000 in my regular ISA and £4,000 in a Lifetime ISA (LISA).
The benefit to a LISA is that my contributions get an immediate 25% boost from the government. The downside is that (having already bought a house) I can’t withdraw the cash until I retire.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
With my Stocks and Shares ISA, I can withdraw funds any time. That’s why I’d concentrate on investing there to try and retire early.
Working out when shares are cheap isn’t always straightforward and even the best investors make mistakes. But as examples like Rolls-Royce demonstrate, the rewards for doing it well can be huge.
The post £16,000 in savings? I’d buy cheap shares in an ISA to try and retire early appeared first on The Motley Fool UK.
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Stephen Wright has positions in Kraft Heinz. The Motley Fool UK has recommended Barclays Plc, Rolls-Royce Plc, Synthomer Plc, and Warehouse REIT Plc. 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.
