Investor Lesson: Holding Great Companies Through Turmoil

In this podcast, Motley Fool senior analysts John Rotonti, Maria Gallagher, and Ron Gross take a look at how strong companies have bounced back from difficult times and how investors can apply those lessons today. They discuss:

• The tough decisions from management at Domino's (DPZ 0.97%) and Apple (AAPL 1.28%) that ultimately rewarded shareholders.
• How Disney (DIS 0.04%) found strength in its intellectual property.
• Key takeaways from investing through the Great Recession.
• Best Buy (BBY -0.97%) rebounding from being "Amazon's showroom."

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 26 2022.

Ron Gross: Here's one example where perhaps they didn't have that balance sheet that we would love to see our resilient companies have. What did they do? They laid off 3,000 employees. They discontinued about 70 percent of Apple's products and they got back to business of innovating. It's almost a three-trillion-dollar company today. Again, management's willing to pivot, to make tough decisions. If they've got the financials backing them, even better, but it really comes down very often to really strong operators and managers.

Chris Hill: I'm Chris Hill, and that was Motley Fool senior analyst, Ron Gross. Do you want to do well as an investor? Then you have to get comfortable with the idea of holding great companies through some turmoil. Yes, that includes what's going on in the market right now. In this Saturday classroom, we've got two more Motley Fool senior analysts, Maria Gallagher and John Rotonti, joining Ron to look at how strong companies bounced back from difficult times and how investors like us can apply those lessons today.

John Rotonti: Hi, Fools. I'm John Rotonti and I'm joined by Maria Gallagher and Ron Gross. This is what bad times teaches about good business. This feels particularly appropriate right now because more than 40 percent of the stocks in the Nasdaq have fallen at least 50 percent from their highs. Tech stocks are getting cut in half as the market is repricing or rerating these stocks down. Meaning that at this time, the market is willing to pay much lower multiples for some of our favorite growth businesses. These are tough times and we feel it too. We're invested in many of these businesses and are suffering paper losses right alongside of you. It hurts in the moment. It creates lots of fear and anxiety. Ron and Maria are going to try to help us get through this difficult time by sharing some lessons they've learned from businesses that have faced tough times in the past. Ron and Maria, welcome.

Ron Gross: Thanks, John. Great to be here.

Maria Gallagher: Thanks for having us.

John Rotonti: Who wants to go first?

Ron Gross: I could jump in, John. I have a few thoughts. First is from a portfolio management perspective, I think we want to make sure we're diversified. We talked about that a lot. At the Fool, we say 25 stocks or more is a nice level to spread your risk. We want to maintain a long-term outlook. We don't want to think in terms of how is the stock going to perform over the next year or perhaps even two years. We like to hold our stocks for five years and more. Just those two relatively simple things can help really mitigate the damage from a portfolio perspective. When we look at individual companies, so every situation or company is unique, but I think there are some common characteristics that many resilient companies possess. I love to see companies with those many of these characteristics as possible. I'll name a few. There are more, I'm sure. The first is a product or a service that people love. If you have a business that is founded on the concept of a mediocre product or a mediocre service, you're really fighting an uphill battle. Something that people really love and would miss if they didn't have, strong management obviously.

A Foolish tenant would love to see strong management or management that was put in place later to correct a problem, a company's board of directors' willingness to make a shift if necessary to make the company live to fight another day. From a financial perspective, strong balance sheet essential to invest during good times and weather the storm and potentially invest during bad times. Strong balance sheet essential pricing power, meeting the ability of a company to raise prices if necessary. Love to see that and then just a few more quickly. Company that's cash flow positive during difficult times or businesses that are not yet profitable but are addressing a large and growing addressable market that should lead to significant profitability down the road. There's plenty of companies we love right now that have not yet reached profitability or even are cash flow positive yet, but that we believe in as long-term investors. Finally, a company's willingness to innovate and pivot when necessary. Sticking to your knitting isn't always the right course. You have to be willing to make changes and you have to be willing to make tough decisions: layoffs, divestitures, cutting dividends. Sometimes, as a shareholder, you want to see a management team make those tough choices even if they're painful in the near term.

Chris Hill: Maria, that's a heck of a list.

Maria Gallagher: It's hard to think of something that Ron didn't just say, but I think what's really interesting is thinking about both the broader scale problems. If we're thinking about things like the great financial crisis, even 2020 understanding the external shocks to the system versus what's going on with an individual company. Understanding what expectations are baked into the stock price to then understand what you think is a reasonable growth rate for the company ahead and then understanding like Ron was talking about all of those different competitive advantages, things like enduring brand awareness, enduring customer loyalty is also a huge one. Having that financial ability to withstand lower revenue for a period of time on restructuring costs as well as understanding the difference between a popular brand and a brand that has a competitive advantage. What's the brand people are going to pay up for? A great example is always people pay up for that little blue box at Tiffany's. People aren't necessarily always going to pay up for their favorite brands even if you left the brand. Thinking about that customer mindset, the consumer mindset, and parsing it out into understanding that competitive advantage.

Ron Gross: John, it's really interesting what Maria said about price and valuation. It really brings back the idea of long-term. If you're looking for a one year investment and you're hoping to make a 20 percent return and you bought it wrong, you bought the price at perhaps when it was too high, that rate of return may not come to fruition. You might be very disappointed. But if you're going to hold the stock for five or 10 years and it's going to be up 500 percent, 600 percent, it matters less where you bought the stock. Maybe you only made a 450 percent return instead of a 525 percent return, but you're still growing your wealth rather significantly over time, and that's where the long-term time horizon makes the entry point just a little less important.

John Rotonti: A hundred percent, yeah. We just gave our members a great list there. Ron, you said a product that customers love, a product that is relevant and in demand, the right management in place, strong balance sheet, cash flows, or at least a company that can scale into having cash flows. Maria and you both mentioned customer loyalty, customer service. You both mentioned pricing power and competitive advantages. Are there any companies that we can learn from the past that exemplified this sort of resilience that we're talking about?

Ron Gross: The markets are littered with companies that have had difficulty, but have rebounded. But the market is also littered with companies who permanently were impaired and went out of business. The ones that were permanently impaired were the ones that didn't possess enough of the characteristics that we've mentioned earlier. Again, there are unique circumstances, and you could always point to different things that happens with companies, companies that survive because they file bankruptcy. I wouldn't necessarily call them resilient, but they were bailed out to a certain extent and live to fight another day during the financial crisis, government intervention. Even now, quantitative easing and keeping interest rates low are all ways that outside forces helped companies to be resilient. We'd love to see companies be resilient on their own. 

A non-tech company that always comes to mind for me when I think about resilience is Domino's, interestingly, DPZ. If you look back to around 2008, 2009, the stock was at four dollars a share and I think we're probably around $440 a share right now. Domino's needed to make some tough decisions right there. First of all, competition is fierce, whether it's from mom-and-pops or the big boys like the other major delivery companies like Papa John's. But they've recognized something and we're honest about it. They said, "You know what? Our pizza isn't that good and our menu isn't that inspiring. So we're going to make some changes and we're going to be honest with you about it." They revamped the pizza recipe, they added food items to the menu, they invested in marketing and digital, they have a very strong digital presence right now from an ordering perspective, they have a loyalty program, they bought back weak franchises to bring stronger operators into the fold. Here we are from $4-$440 because the company both have the balance sheet to withstand the tough times, but the management team was smart enough to make some very tough decisions.

John Rotonti: They did Ron. By coming out and saying, our pizza isn't that good, it was a brave and bold marketing statement that I think earned them a lot of brand equity with their customers. Like you said, they use their strong cash flows to invest in profitable delivery, and do all these other things, and now you have a multi-bagger stock. What about you, Maria?

Maria Gallagher: Domino's is such a great example and such a pizza that I think is always solid. No matter where you are in the world, Domino's Pizza is always going to be pretty good, which I think is.

John Rotonti: We're New Yorkers. Both of us.

Maria Gallagher: It means a lot coming from us. One thing I think about a lot is Disney. Disney obviously, everyone knows, everyone interacts with Disney on a day-by-day basis. What I think is really interesting and it's a show of competitive advantage too, is the amount of patents and trademarks they have. Disney has over 2,200 active patent families and 6,000 trademarks. They have that strong IP, and what we've seen is they were able to scale that with Disney Plus. They have over 118 million users of Disney Plus within two years, completely blowing expectations out of the water. What's really interesting is you had a pretty strong long period of time from about 2014-2019 where Disney stock wasn't doing very much. They weren't innovating in that way.

Then you saw Disney Plus you see this revamp of excitement about Disney there. I think a good example of a really big company, really well-known company who is able to be agile and still play with nostalgia. You see if there's a new cheaper by the Disney movie coming out, The Mandalorian there. You see that you can watch shows from your childhood, and they have all of these new franchises coming in, especially with Marvel. I think that it's such an interesting example of a company that, when you see companies get so big, you want to see them also be able to be nimble at periods of time and really especially during 2020, all of the amusement parks, all of the theme parks were shut down, and they were really able to scale up Disney Plus in. Like I said, they got to 118 million users, which is far in a way more than most people would expect to them. I think it's just a really strong example of a company that has grown but can still continue to grow with that good management and that IP.

Ron Gross: I think that's a perfect example. If we want to look at tech or even consumer tech, we need to look no further than iconic Apple. I'll take you back to 1997. Steve Jobs returns after 12 years. They've got products like the newton MessagePad, a handheld device similar to the palm pilot. They were 90 days from being insolvent. Here is one example where perhaps they didn't have that balance sheet that we would love to see obviously and companies have. But what did they do? They laid off 3,000 employees. They discontinued about 70 percent of Apple's products, and they got back-to-business of innovating. It's almost a three-trillion-dollar company today. Again, management's willing to pivot to make tough decisions if they've got the financials backing them, even better, but it really comes down very often to really strong operators and managers.

John Rotonti: Apple didn't have the balance sheet, but in all of those examples, what they did have was, they put the right management in place. Whether it was existing management that pivoted or bring in a different management team, and they were adaptable and they innovated, even Domino's innovated in its menu and in the food that it served. It innovated by investing in digital and different delivery options. In every case, it was the right management in place, an iconic brand, a product that customers really loved and coveted, product relevance and demand, and then the right management team to innovate and adapt as needed.

Ron Gross: You know John, it's interesting, we're looking back and saying in hindsight, here are some examples of resilient companies. I want to fully admit that it's not necessarily that easy to identify them in the moment. That's where that checklist comes in handy because even if you're getting a little bit nervous and you're having trouble seeing the forest for the trees, you can say, how many of these characteristics do they have? But I think of a company like Best Buy, which I know you know well, I left it for dead. It was Amazon showroom. Nobody was buying anything there. They would go check prices then go home and buy it on Amazon. The company has done a phenomenal job investing in their customer experience, their loyalty program. It's rebounded, it's thriving to a certain extent really, and I would have never guessed that would have been the case. I can't get it right every time, none of us can, but again, you go through those checklists and you see what exists and who's leading the company and do they have those things, those abilities to make the shift when necessary.

John Rotonti: It's interesting you bring up Best Buy. If for no other reason, once again, it was bringing in the right management team. When Best Buy was struggling, when Amazon was taking share from Best Buy, they brought in Hubert Joly as the new CEO. He recently retired. But like you said, he invested in loyalty, he invested in their showrooms, he invested in merchandising, he invested in getting the best inventory in the stores, and he said we're going to match any online price. So people that wanted instant gratification, people that wanted to touch and feel the product and walk home with it that day went to Best Buy stores because they could get it as cheap as they could online. Hubert Joly, bringing in the right management team, was a winning scenario.

In a lot of these legacy company strike back stories like Best Buy, like in Apple, Apple didn't bring in an entirely new CEO, but they brought back their founder. They brought back Steve Jobs. Best Buy brought in an entirely new CEO. If we look at tech again, AMD under Dr. Lisa Su, one of the greatest turnarounds of all time, she took over the stock. Like Domino's, it was a single-digit stock price. I don't know if it was six or seven or eight or nine. But now it is absolute monster multibagger because of the turnaround implemented by a new CEO, Dr. Lisa Su, and AMD's products whereas we as consumers don't buy them directly, trust me, they are relevant and in demand. They are powering many of the devices that we use every single day. Maria, do you have another company before maybe we talk about some of these periods in history that have been tough?

Maria Gallagher: Yeah, not to be a dead horse in terms of how important management is, but I think another great example is Starbucks. Howard Schultz had left the CEO position, but the business was really struggling, there was increased competition from Dunkin Donuts, McDonald's, the more niche coffee shops in those small baristas. People were saying there's no way people are going to keep spending five dollars for a cup of coffee. They were leaning into more music and more food, and Howard Schultz came back. 2008, he narrowed Starbucks' focus, went back to coffee. It closed 600 stores, laid off 12,000 workers in 2008, but it has actually really obviously continued to do super well. They introduced the loyalty rewards program to keep people around, so by the end of 2010, it was really back on track. One thing with Starbucks that I think is really interesting is one just being able to see these companies over and over again. You can't go someplace without seeing a Starbucks. There are over 32,660 around the world, so it's really a loyal place you can go. 

If you're traveling, you know you can get Wi-Fi there, you know that you can get a good cup of coffee. I think that's one of the things, as well as Starbucks is a really good example of a company that treats its stakeholders really well. It is known for treating its employees really well. It has good benefits for its part-time and hourly employees. It has college benefits for those employees as well, and so I think Starbucks is a really well rounded example of a company that had hard times but has really revamped, has really shown that you can grow steadily over time, continue to gain that market share and how important that good brand is, that good loyalty program, and having the consistency that anywhere in the world if you see a Starbucks, it's similar to if you see a McDonald's, you know what you're going to get same, as Domino's. You know what you're going to get and you're going to be pretty satisfied with it, and I think that type of consistency is very hard to build up, and once you have it, it's really important for those enduring brands. That's another example I would think of.

John Rotonti: The market has sold off in the past, whether it was dot-com boom, whether it was the global financial crisis in 2008 and '09. Are there any parallels or any lessons we can learn from those times to what we're seeing today in this sell-off in growth stocks that we're seeing today?

Ron Gross: For me, the lessons I've learned from investing through difficult times are A, don't be afraid to buy when things are weak because you get your best bargains, and for long-term investors, that should be something you are willing to do, even though it can certainly be scary to step-up when other people are running for the door. The other is to buy strong companies. It sounds simple but if your portfolio is filled with too much speculation, you're likely going to get hurt on a more permanent basis rather than just a short-term correction because not all of your companies will survive. Hopefully you're well-diversified like we spoke about earlier, and the strong companies will make up for those clunkers in your portfolio. But being well-diversified, making sure you understand your risk tolerance, and I think people think they understand their risk tolerance. Like Mike Tyson said, everyone has a plan until you get punched in the face. Everyone has a plan right up until things go bad, and then people start to freak out a little bit. Do a little soul-searching ahead of time so you know what you're going to do if things start to get weak. 2008, 2009 was really scary. We thought we were going into a depression. A year-and-a-half ago, two years ago, who knew what was going to happen with the global pandemic? Really scary times, so you have to understand yourself pretty well during those times.

John Rotonti: Understand the context. Maria, any last words?

Maria Gallagher: Yeah. I think it's all about also understanding expectations, like I said a little bit at the beginning, so understanding. Peloton is a great example. What are the expectations of an exercise like business that's worth $50 billion? What are those expectations for growth for this company, and understanding what makes sense, what you think is reasonable, and then where it might not be the correction that is abnormal, but it might be the run-up that's abnormal. Understanding those different aspects and thinking it through from both the macro sense and the micro sense, I think is really important to see what's the overall economy doing, what's the overall market doing, and then what are these specific companies doing, and what can I learn from each of those things to keep a clear head?

John Rotonti: There you have it, Fools. Ron Gross, Maria Gallagher gave you a resilient company checklist. Write those checks down, use them to measure your own portfolio resilience, keep the right mindset, and we'll see you next time. I'm John Rotonti, for Maria Gallagher and Ron Gross, we thank you so much.

Ron Gross: Thanks Fools.

John Rotonti: Fool-on.

Maria Gallagher: Thank you.

Chris Hill: That's all for today, but coming up tomorrow, we've got a preview of the dropout, Hulu's upcoming series about Theranos founder, Elizabeth Holmes. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.