Volatility and the secret to boosting your portfolio returns

I read a lot in the financial press and observe many headlines, but recently the media, yet again, have been warning investors of the need to be wary of [share price] volatility.

Headlines such as “June to be a volatile month” or descriptions of recent sharemarket volatility as being “unprecedented” actually amuse me because these are so ridiculous.

Of course, June will be volatile, as will the other eleven months of the year.

Is the market ever not volatile and is market volatility ever unprecedented?

Obviously, these commentators have forgotten about the 1987-crash, the dot-com bubble in 2000, and the global financial crisis (GFC) during 2008-09. There were also steep falls experienced in 2012 and 2013, and more recently, January/February 2016.

Then there are movements upwards in share prices. What about the level of volatility experienced by the markets in the 56 month period between March 2003 and October 2006 where the S&P/ASX 200 (INDEXASX: XJO) rose from 2,800.90 to 6,754.10?

Volatility means prices can move up or down, but it’s implied in the mainstream press as an overall negative.

There’s all the talk of volatility in the share price of a stock, but what about the volatility in the company’s annual earnings?

Take ARB Corporation Limited (ASX: ARB) for example.

Let’s focus on the movement of its earnings year-to-year.

Tabled below are ARB’s annual after-tax earnings and respective share price movements over the ten years to 2014-15:

     Financial year       Earnings ($’000) Movement in earnings (%) Movement in share price (%)
2005-06 15,782
2006-07 15,756 (0.02) 36.5
2007-08 19,647 24.7 (10.5)
2008-09 22,539 14.7 (7.8)
2009-10 32,628 44.8 60.01
2010-11 37,854 16.0 34.4
2011-12 38,499 1.7 19.9
2012-13 42,358 10.0 25.3
2013-14 42,570 .005 8.8
2014-15 44,093 3.6 8.3

Yes, the growth rates in ARB’s net profit do vary and, as you can see above, there’s a definite disconnect between the company’s earnings and its share price year-to-year.

However, this is what makes share price volatility such a beautiful thing for the opportunistic and long-term investor.

Investors buying shares in ARB during the global financial crisis (GFC) were buying amidst two consecutive years when the share price fell, yet in the same period its earnings had increased 43% (as an aside, the quality of management at ARB is such that they practically sailed through the GFC and the effects of high oil/steel prices. This is one reason why, I think, the company is always considered expensive).

When a company’s after-tax earnings continue to rise and the share market’s response is to have the shares marked down, this was an opportunity for the savvy investor.

ARB is merely an example of a solid growing business where, in the short term, share prices will not always rise or fall lockstep with the company’s earnings.

This goes for all companies, but perhaps the best companies to focus on are those that exhibit similar earnings stability to that of ARB.

Stocks like Ramsay Health Care Limited (ASX: RHC)InvoCare Limited (ASX: IVC), and Technology One Limited (ASX: TNE), also provide regular increases in profitability to their long-term-focused owners. Currently, they’re all considered expensive, but at some point in the future, volatility means you’ll have a chance to buy these companies’ shares cheaper than they are today.

Foolish takeaway

To achieve reasonable returns in the sharemarket, you simply have to be opportunistic when buying. This is easier said than done of course, but if you’ve researched your target companies effectively, and you know what’s worth owning, simply wait for the price to come to you.

Given share prices can rise when profits are falling, and vice versa, it’s best to try not to make sense of the market at all in the short-term. Like a small child, the market can react at any time with a temper tantrum and push the share price down sharply providing the savvy investor with his or her opportunity.

This is the real secret to boosting your portfolio returns:

  • concentrate on your businesses’ economic performance,
  • take advantage of bouts of irrational selling or misconceived worries about a company’s outlook, and
  • buy after the sharemarket has fallen out of love with the stock.

You should be more than pleased with the eventual outcome if you can find the fortitude to buy when others are selling and then hold your stock tenaciously for the years and decades ahead.

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Motley Fool contributor Edward Vesely owns shares in ARB Corporation and Ramsay Health Care

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