Investing secrets: So what if the market Crashes? Consider SBK, MPC, SAB

Hopefully you’ve had a chance to read Warren Buffett’s wonderful investing advice contained in his 2014 letter to Berkshire Hathaway shareholders. In this blog, Geoff Noble expands on the investing theme by using examples of shares in three blue chip South African companies. In a nutshell, getting started soonest, exercising patience and trusting to the power of compound growth delivers. – AH

By Geoff Noble*

When the average investor buys a stock, he or she sits back for some reason and hopes to see the latest purchase climb steadily upwards. Unfortunately, far too many of us buy a stock only to see it drop in price after the purchase. It is almost as if the market has conspired against us, and this drives home how very difficult it is to time the market. So, if we cannot time the market, would the next best thing be to just spend time in the market?

To illustrate this concept, imagine the unthinkable happening: your stock drops 20% or more the month after you have bought it. Armageddon! But is it really the end of the world? This is not necessarily the case for investors whose objective is to earn a healthy return in excess of inflation over the long term. These investors have a long-term horizon and invest in what I call dividend Payers & Growers™, the companies that consistently pay dividends and consistently grow their dividends year in and year out.

Let’s consider three such companies and the total returns (dividends reinvested) one would have achieved by investing in their stocks at two different points, namely in the month prior to each stock’s largest negative monthly return since 31 December 1985 and in the month after the decline. By comparing the performances to inflation over the investment period up to 31 May 2013, it can be determined whether good results were achieved regardless of when the investment was made.

First up is SAB-Miller (SAB). This worldwide industry leader has paid a consistent dividend over the long term and increased its annual dividend per share (DPS) by more than 15% per annum on average since 1986. SAB suffered its largest monthly drawdown of -27.59% in October 1987. An investor who invested R1 000 at the end of September 1987 would have achieved a return of R78 114 (18.31% per annum) as at end of May 2013. If the investor had delayed the purchase by one month, the investment would have been worth R107 879 (19.80% per annum). Of course, investing after the crash is the better outcome, but is the alternative that much worse considering the investor still comfortably beat inflation (8.06% per annum) by more than 10% per annum?

Figure 1: SAB after the “Crash”

Next up is Standard Bank (SBK). South African banks have strong pricing power and SBK has managed to grow its annual DPS in excess of 16% per annum on average since 1986. SBK declined by an incredible -42.55% in August 1988. An investor who invested R1 000 at the end of July 1998 would have had an investment of R8 220 (15.08% per annum) as at end of May 2013. As before, if the investor had delayed the purchase by one month, the investment would have been worth R14 141 (19.32% per annum). Again, investing after the crash is the better outcome, but even after losing almost half the initial investment in the first month, the investment still easily beats inflation (6.01%).

Figure 2: SBK after the “Crash”

Last up is Mr Price (MPC), a dominant brand in the retail market that has grown DPS just shy of 25% p.a. on average. The MPC share price dropped by -45.83% in November 2000. An investor who invested R1 000 at the end of October 2000 would have had an investment worth R35 974 (32.69% per annum) as at end of May 2013. As before, if the investor had delayed the purchase by one month, the investment would have been worth R66,412 (39.27% per annum). Again, investing after the crash resulted in the better outcome, but even after losing almost half of the initial investment in the first month, the investment outperforms inflation (6.03%).

Figure 3: MPC after the “Crash”

 So how do these illustrations assist when it comes to constructing portfolios or choosing investment products? It is clear that:

1. Paying the lowest price possible for an investment is always the better option. Mathematically this has to be the case, but being able to pay this “best” price requires that one is able to time the market perfectly.
2. If we concede that we cannot time the market, the next best investment idea is to spend as much time invested in the market.
3. Even when the unthinkable happens and prices crash, one can still achieve a great investment outcome.
4. Constructing a diversified portfolio of Payers and Growers™ securities should produce returns well in excess of inflation regardless of when you invest. The key is to take advantage of time and have a long-term investment horizon.

To conclude, focus on investing in great companies that pay income and grow that income. As Benjamin Graham once said: “The prime purpose of a business corporation is to pay dividends to its owners. A successful company is one which can pay dividends regularly and presumably increase the rate as time goes on.”

* Geoff Noble, CA, CFA is a portfolio manager at Grindrod Asset Managementwho co-manages a number of unit trusts. Prior to joining Grindrod four years ago he spent four years in Australia at Deloitte Corporate Finance, where he qualified as a Chartered Accountant.