Forget Gold. I’d Follow These 3 Steps to Capitalise on a Stock Market Rally

Buying a diverse range of cheap, high-quality companies could be a sound means of capitalising on a stock market rally, in my opinion.

stocks rising

Image source: Getty Images

A stock market rally can never be guaranteed. The past performance of indexes such as the FTSE 100 and S&P 500 shows that they have experienced significant volatility and periods of decline. As such, defensive assets such as gold have proved to be popular among risk averse investors.

However, the stock market has delivered high single-digit annual total returns over recent decades, despite its periods of decline.

Therefore, a long-term investment horizon that seeks to purchase a diverse range of cheap, high-quality businesses could be relatively profitable compared to holding other mainstream assets.

Diversifying in a stock market rally

While risk reduction may not be the foremost thought for all investors when deciding how to capitalise on a stock market rally, it could be the most important aspect of investing. After all, it is all too easy to lose money from poor performances from a small number of holdings that can negatively impact on a portfolio’s prospects.

As such, buying a wide range of stocks that operate in different industries and geographies could be a sound move. It may mean lower company-specific risk, which is the threat of one holding dragging down the performance of an entire portfolio. It may also lead to a broader range of growth opportunities being present within a portfolio that enhances its returns in a rising stock market.

Buying high-quality businesses

Purchasing high-quality businesses may also be a logical move in a stock market rally. Clearly, deciding what are attractive companies is open to debate. However, companies with sound financial positions and wide economic moats could be a good starting point. They may be able to deliver relatively strong profit growth that enables them to command higher valuations than their peers.

Furthermore, financially-sound companies may be better placed to survive a period of volatile economic and stock market performance. As the last year’s events regarding coronavirus have shown, the future performance of the world economy is very unpredictable. This makes holding higher-quality companies even more important.

Purchasing cheap shares

Buying expensive shares in a stock market rally may mean limited scope for capital gains. Of course, even highly-valued companies can become even more expensive. However, the past performance of the stock market suggests that many companies (but not all) revert to their average valuations over the long run. This means that buying stocks with low valuations may provide greater scope for capital appreciation versus purchasing highly-rated businesses.

Of course, this strategy is not guaranteed to succeed. Growth stocks, for example, can rise to exceptionally high ratings that are difficult to justify based on previous averages or profitability. However, through buying an asset for less than its intrinsic value, it is possible to obtain relatively high returns in a long-term stock market rally.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Metals and Mining Stocks

growing plant shoots on stacked coins
Stocks for Beginners

1 Copper Stock to Buy as Copper Prices Shine

The price of copper continues to climb, and more copper production is on the way for this top stock up…

Read more »

silver metal
Metals and Mining Stocks

Buy the Dip: 1 Dividend Stock Due to Shine

This dividend stock's dividend just rose higher as the price of silver dropped, but don't let that scare you off…

Read more »

risk/reward
Metals and Mining Stocks

Iron Stomach? 2 Riskier Stocks That Could Pay Off Big Time in the Future

Two TSX stocks could deliver greater earnings to investors with higher risk appetites.

Read more »

Gold bullion on a chart
Metals and Mining Stocks

This Gold Stock Just Dipped 5%: Time to Buy?

This gold stock has been rising higher and higher but recently went through a 5% dip in share price. So,…

Read more »

Gold king in chess game face with the another silver team on black background (Concept for company strategy, business victory or decision)
Stocks for Beginners

Pan American Silver: Buy, Sell, or Hold?

PAAS stock (TSX:PAAS) is up 44% in the last year alone! But it's not all down to the rise in…

Read more »

Nuclear power station cooling tower
Metals and Mining Stocks

1 Canadian Mining Stock Worth a Long-Term Investment

Strong fundamentals should continue to boost Cameco stock's long-term outlook, as the nuclear industry's momentum continues.

Read more »

Super sized rock trucks take a load of platinum rich rock into the crusher.
Metals and Mining Stocks

Lundin Mining Stock: Buy, Sell, or Hold?

Lundin (TSX:LUN) stock saw its shares surge this last year with the price of copper, and more strong guidance could…

Read more »

grow dividends
Metals and Mining Stocks

Invest $5,000 in This Dividend Stock for $1,060 in Passive Income

Franco Nevada stock trades at a 20% discount to consensus price target estimates while offering investors a tasty yield of…

Read more »