The Motley Fool

Why buying cheap really matters

Consider two investors:

1. The first investor has done his due diligence on a company and has decided to commence an investment based on the company’s:

  • strong balance sheet,
  • good-quality management,
  • insatiable demand for its products,
  • ability to raise prices,
  • strong growth prospects due to its heavy investments into overseas distribution, and
  • high brand recognition and consumer recall of its products (due to the investment of a lot of time, money and marketing nous)

In short, the company’s message strategy has proved to be extremely effective over the years and, as a result, its customers have a strong engagement with the branding promise and reassurance that this company provides.

It’s 30 December 2015 and, given all of the above, the investor decides to buy the company’s shares as a long-term multi-year investment.

By early October 2016, this investor’s shares are now down 21%.

2. The second investor has also conducted extensive research and studied her company’s financial statements, its growth strategy, the quality of its management, its branding, and its ability to raise prices and prospects for success overseas.

All of the above has certainly passed her quality-filters and, similarly to the investor in the first example above, decides to buy shares.

With her hard-earned savings now ready for allocation, she buy the ordinary shares in this company on 12 April 2016 and today, in early October 2016, the investor in this company … has enjoyed a 46.5% capital gain.

This situation begs answers to the following questions:

Has there been some market announcement that has adversely affected the future outlook for the first company, or is the second investor simply a better judge of business quality?

The answers to these are a resounding ‘no’.

In fact, each of these investors have purchased shares in the same company: Bellamy’s Australia Ltd (ASX: BAL).

As can be seen from the respective investors’ performance results, these investments have provided genuinely disparate investment outcomes, at least in the short-term, because the investment return of any share purchase depends entirely on the price that is paid for those shares.

The shares purchased are tabled below:

Company Purchase date Price ($) on date of purchase Price ($) as at 30 September 2016 Return (%)
Bellamy’s Australia Ltd (ASX: BAL) 30 December 2015 16.50 13.01 (21.1)
12 April 2016 8.88 13.01 46.5

Now, these are cherry-picked figures but it goes to show at the extreme how one class of shares can provide such divergent returns, at least in the short-term.

But what about the longer term? Surely the price doesn’t matter so much if you’re going to invest over many years or decades, right?

Well, let’s consider the examples of Cochlear Limited (ASX: COH) and Sydney Airport Holdings Ltd (ASX: SYD). Both of these companies’ shares have been outstanding investments over the last nine years:

Company Purchase date Price ($) on date of purchase Price as at 30 June 2016 Compound annual growth rate (CAGR) (%) *
Cochlear (ASX: COH) 2 July 2007 61.00 121.25 12.08
30 June 2008 43.65 121.25 18.25
Sydney Airport Holdings Ltd (ASX: SYD) 2 July 2007 4.05 6.94 12.26
30 June 2008 2.04 6.94 22.82

* inclusive of dividends

As you can see, there’s a huge difference in the results obtained depending on when the shares were purchased.

In terms of real money, here’s the result of investing $5,000 into each of these companies’ shares at the different dates (and price points) below:

Cochlear (ASX: COH) 2 July 2007 @ $61.00 30 June 2008 @ $43.65 Difference %
30 June 2016 $13,954.78 $19,115.21 37
Sydney Airport Holdings Ltd (ASX: SYD) 2 July 2007 @ $4.05 30 June 2008 @ $2.04 Difference %
30 June 2016 $14,157.78 $25,889.94 82.8

Foolish takeaway

Now, I’d like to make the point that for anyone buying Cochlear at $61 and Sydney Airport at $4.05, you’ve made an extremely good investment.

And I believe that investors buying into Bellamy’s at north of $16 have been too early but should nevertheless enjoy good returns on this purchase over the next decade.

The best thing you can do is avoid buying shares simply when you have the money, exercise patience and buy opportunistically into sound companies when the market has its regular downturns, such as in the period 2007-2009 and in January and June this year.

Your eventual return will depend on the price you pay, and the less you pay the better off you’ll be. At least now, by reading this, you can see for yourself the impact your buying decisions can have on your portfolio.

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Motley Fool contributor Edward Vesely owns shares of Bellamy's Australia. The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.