It seems like investors have turned from pessimism to optimism, as the S&P 500 is approaching what many market watchers consider to be bull market territory, up over 20% since its recent low in October 2022. Inflation has been cooling for several months now, so the thinking is probably that rate hikes are coming to an end soon. Investors are reacting to this expectation by pushing stocks higher.
As a result, folks might think that lucrative buying opportunities don't exist anymore given many companies' share prices have jumped higher in 2023. But this is a flawed assumption. That's because great stocks are still on sale right now. There's just something you need to know first.
It's all about quality
Just because a stock sells for a cheap valuation, it doesn't necessarily mean it's a good investment opportunity. A so-called value trap is a company that might have a cheap price-to-sales (P/S) or price-to-earnings (P/E) multiple, but the underlying business is facing some problems.
Take Carvana, for example, which trades at a P/S multiple of 0.2 (as of June 16). The company might be showing signs of life after a difficult 2022, but it's still dealing with challenges as it relates to used car demand and the current macro environment affecting its financial situation. Some risk-tolerant investors might view this as a potential buying opportunity, though.
Moreover, it's critical to always look for businesses that have strong financial positions. This means the ability to generate lots of free cash flow, as well as having a robust balance sheet. Carvana doesn't possess these attributes today, but a company like Apple does. In fact, the iPhone maker's debt-service coverage ratio, which measures its ability to pay off its obligations, was 5.1 during the first six months of its fiscal 2023. That's very good. But Apple's shares are historically expensive right now.
A business that isn't a value trap and that sells at an attractive valuation is PayPal (PYPL 2.90%). The digital payments leader currently has 433 million active accounts and processed $1.36 trillion of total payment volume in 2022, up 9% year over year. And as of this writing, shares trade at a P/E ratio of 28.2, near their lowest multiple ever. This is a good example of a great stock on sale right now.
Be prepared for volatility
Now that we've discussed that finding high-quality businesses that have strong financial positions is of the utmost importance, investors should prepare themselves mentally for a bumpy ride. Investing in the stock market can lead to life-changing wealth over time, but volatility is something that can't be avoided. That's because investor sentiment can shift at the drop of a hat. But zooming out and looking at long stretches of time proves that the stock market historically goes up.
A popular metric to gauge volatility is the Chicago Board Options Exchange Volatility Index, otherwise known as the VIX. It's often referred to as the "fear index." The VIX looks at how much variability is expected in the S&P 500 over the next 30 days. The higher the number, the more uneasy investors are about the near future.
While the VIX has declined 57% over the past 12 months, and it's close to its lowest levels in the past decade, investors should understand that things can change in an instant due to unforeseen events in the economy and the world. In early 2020, unsurprisingly, the VIX skyrocketed to over 80, its highest level ever, because of the coronavirus pandemic. There was just so much uncertainty about what was going to happen next.
I think investors should always keep the threat of heightened volatility in the back of their minds. Even though inflation might be coming down, there is still a lot of worry out there about the direction of the economy. And any unfavorable data could cause the VIX to spike in no time.
The stocks of some great businesses might be on sale right now, to be clear. But I think investors are now more prepared to better navigate the current environment, which should hopefully lead to peace of mind and strong portfolio returns.
