Why weak share prices can deliver strong returns

Buying or holding shares when markets are weak is usually the best strategy for long-term investors.

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Things are going pretty well in the markets now, with the All Ordinaries (INDEXASX: XAO) over 6,000 points and further erasing memories of the global financial crisis (GFC).

The All Ords peaked at over 6,700 in December 2007 before it fell precipitously to under 3,300 in early March 2009 — a 51% decline over 16 months.

It'd be easy to describe the period as an amazing buying opportunity … with 20/20 hindsight. But how many of you were brave enough to buy shares on the cheap?

Of course, you had to first realise things were cheap amongst all of the fear.

Just consider Macquarie Group Ltd (ASX: MQG).

There was indeed a great deal of pessimism surrounding banks at the time of the GFC. After all, Lehman Brothers in the US collapsed in September 2008, and Macquarie's share price was slashed due to concerns over its liquidity position and a general lack of confidence in the market.

Back in May of 2007, its share price reached a lofty $97 before bottoming in early March 2009 at $14.75.

Here at The Motley Fool, we certainly recommend investors invest over longer time frames, but it would have been a despondent long-term shareholder to see that, despite a rally in the share price to almost $60 by September 2009, Macquarie shares were back to around $20 in September 2011.

With the share price today over $108, investors paying anywhere south of $60 10 years ago have still received 10%+ per annum returns.

The share price of Cochlear Limited (ASX: COH) peaked at $77 just before the worst of the GFC. Since 2008-09, there have been product recalls and the spectre of increased competition in its core markets.

In the 7-year period to October 2014, Cochlear's share price essentially hadn't moved, with the receipt of dividends providing shareholders a compound annual growth rate of just under 4%.

A return to surely test the patience of long-term investors.

But today, the Cochlear share price is pushing $200 and has delivered average annual returns of around 12% over the last decade.

What investors didn't see

Macquarie continued to diversify itself away from its corporate financial advisory and capital market services, and increase the amount of business from funds management.

Its Macquarie Capital division, for example, reduced from almost 50% of total revenue to only 12% today, but its funds management arm has increased from 6% in 2007 to 25% in 2017.

What selling investors missed out on was management's ability to adapt and respond to changing circumstances. Now, with more recurring revenue under its belt, earnings are less volatile and the growth in dividends is more assured than it used to be.

As for Cochlear, what investors assumed is that the trend towards higher revenue, net profit and the maintenance of high gross margins was permanently impaired. Fortunately, this view was a long way from reality.

In both cases, Macquarie and Cochlear have demonstrated that their business models were able to thrive despite short-term setbacks.

Suffering in 2018

Recently, Technology One Limited (ASX: TNE) had to deal with a major commercial dispute with the Brisbane City Council and the fear of increased competition as it moves much of its product into the 'cloud'. Its share price has fallen 20% from its peak in late 2016 despite high single-digit profit growth and a continuation of revenue growth.

The share price of InvoCare Limited (ASX: IVC) has seen its price fall from over $18 last November to $13 today. That's a steep decline, perhaps brought about by the fact that the InvoCare equivalent in the UK — Dignity plc — saw its market cap thumped due to the increased competition in that market.

Foolish takeaway

I'm optimistic that both Technology One and InvoCare have competitive offerings for their clients and a moat that will help to protect margins.

The problem with markets is that many large and small investors can be notoriously short-term in their thinking. I can understand that when bad news hits though, some decide to sell first and ask the relevant questions later.

But I reckon it's better to just let things play out, especially if capable management remain in place and, for this reason, I think both of the companies above are worth a close look. 

What's critical is to not let the movement of share prices sway your thinking on the prospects for a business — even over time frames of several years.

Rather, it's the business itself that counts.

Holding on to your shares, therefore, can be the best thing you'll ever do, even after the proverbial kitchen sink has been thrown at you.

Just ask the long-term shareholders of Macquarie and Cochlear.

You might even decide to add to your positions when share prices are sluggish, or consider new positions in companies  such as the Top 3 ASX Blue Chips To Buy In 2018.

Motley Fool contributor Edward Vesely has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Cochlear Ltd. 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 Scott Phillips.

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