Profiting From Volatility

With most companies issuing results this month, it’s a busy time for investors. And, given some of the volatility these results can induce, it’s also a period that can test your nerves.

Sometimes the market’s reaction is perfectly rational. But not always, at least not in the context of how a long-term investor would appraise things. A good example lately is (perhaps) sleep apnea specialist Resmed (ASX:RMD).

Since the company reported a 23% surge in revenue for its 4th quarter, and a 13% lift in operating profit, shares have plummeted over 20%. Ouch!

There has been some excellent discussion on the Strawman company page, with some members pointing to concerns over a dip in gross margins and the fact the result was a little short of the consensus estimate. More recently, it has emerged that short sellers are placing bets that a new weight loss drug could lead to a reduced incidence of sleep apnea and, in turn, lower demand for the company’s products.

Granted, none of this is especially good news. But does it mean that Resmed — a business with a remarkable track-record of shareholder value creation — should have over $10 billion in market value erased in just a couple of weeks? Especially, as some have pointed out, when you consider that sleep apnea is not purely a function of obesity (it can also be anatomically related, for example) and the addressable market remains significantly underpenetrated. And then there’s the fact that the efficacy, or otherwise, of this new wonder drug is far from firmly established.

Even if there is an impact to the long term earnings potential of Resmed, is that severe enough as to warrant such a substantial re-rate? Who knows — Maybe! 

The point is that such moves are yet another reminder of the skittishness of Mr Market. While that can be stomach churning, moves like this can be of great advantage to those who adopt an opportunistic mindset. 

Remember when Cochlear (ASX:COH) suffered a product recall way back in 2011? The news was unquestionably bad and saw the company suffer a 68% drop in net profit that year. Brokers scrambled to lower their guidance and issue frantic sell recommendations; shares dropped over 40% in the space of just a few weeks.

Things are always easier in hindsight but, as many level-headed investors noted at the time, the issue was far from existential. Indeed, since then, the company has significantly grown its earnings and shares are now trading at fresh record highs. Even if you bought the day before the recall was issued, you’ve seen your holding grow by 3.5-fold. Indeed, on top of that, a full half of your cost base has been repaid in dividends alone.

Needless to say, those that bought after the recall, or took the opportunity to average down, would have done significantly better.  

To be clear, this example says nothing about the future fortunes of Resmed shares. But it’s a good example of how far sighted investors can profit from the erratic, knee-jerk responses we so often see on markets.

Long live short-termism and irrationality!

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