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Why Investors Should Love Market Crashes

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When you buy stocks, you trade your cash for a chunk of a business. The lower the price of the shares you're buying, the more of them you can pick up for your money. Since the true value of those shares is based on the performance of the business behind them and not the random movements of the market, long-term investors should love market crashes.

After all, would you rather:

  • Invest $100 to get $50 worth of future business value, or
  • Invest $50 to get $100 worth of future business value?

All else being equal, market crashes are what provide you the opportunity to get more business value for the money you're investing.

What about the stocks I already own?
Of course, in an indiscriminate market crash, the shares you already own will fall along with the ones you're looking to buy. Unless you've got an urgent need to sell those, though, does it really matter? The crash has no impact on the real value of the business underlying those stocks. Indeed, the crash just might be providing you the opportunity to buy more shares of a company you already thought highly enough of to own.

That said, it's far easier said than done to watch your apparent net worth crumble in a market crash while stoically searching out ways to hand over even more cash to buy those falling stocks. In fact, it's darn near impossible to do, unless you've got both a stable financial foundation and the mind-set of a value investor in the best traditions of Benjamin Graham and Warren Buffett.

Mind over matter
Having a stable financial foundation matters, because the one thing that can ruin your best investing plans is being required to sell your shares while they're busy crashing for no good reason. With enough cash in the bank to handle life's little surprises, and enough insurance to cover the bigger ones, you can dramatically reduce the potential need to sell your shares to cover an unexpected event.

With that foundation firmly in place, you can then turn your attention toward what you're able to buy for the money you're putting to work -- the essence of value investing. Take a look at the companies in this table, for instance:

Company

Debt-to-Equity Ratio

Dividend Payout Ratio

5-Year Dividend CAGR

Consensus Long-Term Growth Rate

How Far It Has Fallen From Its 52-Week High

Hewlett-Packard (NYSE: HPQ  )

0.66

8.1%

8.5%

7.4%

51.4%

Teva Pharmaceutical (Nasdaq: TEVA  )

0.27

23.6%

24.9%

10.5%

35.8%

Johnson Controls (NYSE: JCI  )

0.44

25.5%

10.9%

17.6%

34.9%

Aflac (NYSE: AFL  )

0.28

29.6%

19.7%

11.1%

44.3%

Applied Materials (Nasdaq: AMAT  )

0.23

19.8%

13.4%

13.5%

35.9%

Stanley Black & Decker (NYSE: SWK  )

0.49

40.6%

5.3%

13.4%

34.9%

Arch Coal (NYSE: ACI  )

1.19

41.4%

17.9%

83.2%

56.4%

Source: Capital IQ, a division of Standard and Poor's, as of Sept. 22.

They've all lost at least a third of their market cap vs. their 52-week highs, yet they have:

  • Track records of directly rewarding their shareholders with rising though still well-covered dividends
  • Decent balance sheets, as evidenced by debt-to-equity ratios below 1
  • Solid, long-run potential growth prospects.

While that doesn't make them automatic buys, the combination of shareholder-friendly behavior, solid balance sheets, decent prospects, and a lowered market price should attract value investors' attention. Nevertheless, for a stock to fall that far, that fast often indicates that there are very real risks that had not been previously fully priced into their shares.

So what's wrong with them?
Hewlett-Packard, for instance, may be one of the most storied names in the technology business, but it's going through a world of hurt. Its CEO, Leo Apotheker, is on the way out, with Meg Whitman stepping in as the company struggles to reinvent itself away from PCs and toward cheap mobile computing and powerful servers.

Teva is feeling the pain of an adverse court ruling that is holding it responsible for cases of hepatitis caused by tainted vials of medication. For a business that's as reliant on quality controls as a pharmaceutical business, the hit to Teva's reputation matters as much as the specific settlement itself.

Johnson Controls' shares have been falling since July, driven in part due to lead poisoning problems that China is connecting to its battery unit. Aflac's debt rating has been cut by Moody's for its "risk appetite," which is hardly what investors -- or policyholders, for that matter -- want to see from an insurance company.

Applied Materials' rating has been cut to "sell" by Goldman Sachs, driven by yet another cyclical glut in semiconductor capacity. That's part of the industry, for sure, but it still impacts the company's ability to be consistently profitable.

Arch Coal's shares have fallen with the price of other energy sources, at least in part on fears of weakening global economy. And Stanley Black & Decker may owe some of its pressure to a report that calls out its lavish executive compensation package.

The future counts
The market currently views these companies as somewhat damaged goods, for reasons both within and out of their control. Still, the question of whether they're worth owning now depends on their prospects for the future, rather than their slip-ups in the past. After all, the market has a short memory, and improved performance in the future will quickly erase today's punishment for perceived -- or potentially even real -- wrongdoings.

If you think their futures are bright in spite of their current troubles, today's lowered prices certainly give you more for your money than you would have gotten at earlier, higher prices. If you're at all inclined toward value investing, that should bring a smile to your face.

Want more Foolish news and commentary on these companies? Click here to add them all to your Watchlist, or pick them individually, below:

At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. The Motley Fool owns shares of Aflac, Applied Materials, and Teva Pharmaceutical. Motley Fool newsletter services have recommended buying shares of Aflac and Teva Pharmaceutical. Try any of our Foolish newsletter services free for 30 days. 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.


Read/Post Comments (10) | Recommend This Article (39)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 23, 2011, at 6:59 PM, dividendgrowth wrote:

    It all depends on one's positions.

  • Report this Comment On September 23, 2011, at 10:56 PM, skypilot2005 wrote:

    + Rec

    Sky Pilot

  • Report this Comment On September 24, 2011, at 6:53 AM, daveandrae wrote:

    After more than thirteen and a half years of experience in this business, it is still amazing to me how market crashes occur at the same time tuition, taxes, and insurance is also due.

    Don't get me wrong, I still manage to dollar cost average into my positions each month rain or shine through dividend reinvestment and additional purchases. I just don't buy into the whole idea that the general public has a wad of cash, let alone the courage to invest it, at the bottom of a crash.

  • Report this Comment On September 24, 2011, at 12:53 PM, aptosjoe wrote:

    I believe that your basic premise is wrong. Are market crashes truely random events? I think not.

    Something causes a herd to stampede. In this case it's the economy. People out of work don't spend. Companies without customers don't hire. Do you really want to buy into this down spiral?

    I would rather wait for this event to run its course and place my bet when the markets are stable once again. And sure, I'll miss the bottom. But the really strong companies will still be there, just cheaper.

    Wall Street isn't Las Vegas and what's happening isn't a random event.

  • Report this Comment On September 25, 2011, at 10:48 AM, ubetcha54 wrote:

    Wall street has all the basics of Vegas! Just more sophisticated.

  • Report this Comment On September 25, 2011, at 12:38 PM, ogrhr wrote:

    We are all Earth's inhabitants , Earth's inhabitants are omnipotent。

    Clear truth;People value!

  • Report this Comment On September 25, 2011, at 1:10 PM, ogrhr wrote:

    We are all Earth's inhabitants , Earth's inhabitants are omnipotent。

    Clear truth;People value!

    Brand building business networks in the Earth's inhabitants,.

    The rules of civilized human needs

    A country's authoritarian rulers = a crime against humanity.

    Authoritarian rulers do not need to state the policy contradictions.

    China business to survive, everything is a dictator ruler inefficient planned economy!

  • Report this Comment On September 26, 2011, at 9:17 AM, edwjm wrote:

    This is nonsense. OArdinary ppl do not have an unlimited supply of money to invest. Market crashes mean mone needed for anything will deplete one's nest egg more drastically. The typical investor does not have an unlimited supply of fund to draw on to keep buying more and more stocks, only to see them keep going down and down and down !!

  • Report this Comment On September 26, 2011, at 2:26 PM, subdriver683 wrote:

    I think this article is well said, and should serve as a reminder to people not to lose sight of long term goals because of short term market movements (unless you own stocks that are speculative and not solid long term companies). While I don't have wads of cash lying around to take advantage of stocks going on sale, I do invest consistanly every month a set amount of money, and it's months like this I am able to buy more shares than last month (Which I think is what the author was trying to point out). Thanks for the reminder.

  • Report this Comment On September 29, 2011, at 1:49 PM, theoryMB wrote:

    Dear all,

    The biggest drawback of modern economics is the absence of theory capable not only to explain but also to reliably predict macroeconomic indicators, including the beginning and the depth of financial crises. In the "Theory of Macroeconomic Balance " (TMB) it is maid an attempt to construct such projections.

    TMB unveils quantitative development patterns of market economies and "code" of changes in stock market index over time. Quasiconstants and formulas of this theory make it possible to predict the values of GDP growth rate, share of gross private investment in GDP, total return of stock market, the beginning and value of large fluctuations in stock market indices, and other economic indicators by one month through long-term period .

    Visit: https://sites.google.com/site/theorymb/

    Best regards

    Vladimir Afanasiev

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Chuck Saletta
TMFBigFrog

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.

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10/2/2014 10:26 AM
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