Can quality be more important than price?

Paying too much for a share can result in disappointing returns. No company, no matter how good, is a buy at any price.

Share valuation is not an exact science.  Your valuation will never be exactly right, but by setting yourself some limits, you can reduce the risks that come from overpaying for shares.

However, there is some evidence to suggest that paying what might seem to be a moderately expensive price (slightly more than the suggested maximum) for a quality business can still pay off in the long run.   The caveat here is that you have to be prepared to own shares for a very long time.  Perhaps forever.

The way people invest is changing. 

Many people are not building a portfolio of shares during their working lives to cash in when they retire.  An increasing number will have a portfolio that may remain invested for the rest of their lives.  For them, a portfolio of high-quality shares of durable companies may help provide them with a comfortable standard of living, with the initial price paid for the shares not being too big a consideration.

Shares of high-quality businesses are scarce

We have to remember that the shares of high-quality businesses are scarce.  This scarcity has a value and might mean that investors undervalue the long-term value of them.

The ability of high-quality companies to earn high returns on capital for a long time can create fabulous wealth for their shareholders.  This is essentially how investors such as Warren Buffett have built their fortune.

Can quality be more important than price?  YES!

High-quality companies with high and stable returns on capital have created substantial wealth over the decades.  

Few if any of the shares could have been bought for really cheap prices.   

In many of the cases, the enduring quality and continued growth of the company could be seen to have been more important than the initial price paid for them.

How can you begin to own a portfolio of quality companies?

Settling on Quality

There is no scientific way of finding the perfect combination off price and quality.

• Should we pay dearly for high quality?
• And anything for moderate quality?
• Obviously, paying little for quality would be ideal, but practically impossible.  

Uncovering real gems at an attractive price.  Over time, you will find the right balance.



A good set of businesses at an attractive price.

For example, your portfolio may have

• an average ROCE (the companies forming the portfolio) of over 40%, 
• with a free cash flow yield of over 10%  

How can you reach this point of owning a portfolio of quality companies?

You have to progressively sell off stocks that did not meet the new philosophy and to only buy those meeting the quality requirements.

It will be slow work, requiring you to sell off cheap companies (gruesome companies) and to fight against your attachment to them.

You have to be convinced that this is the right way to go and you go all in.




Searching for quality is not about blindly following formulas.

While these are a good starting point, they remove the essential human element which is of such importance to some investors.

It is not enough to find a high ROCE and low P/E ratio.

You have to understand where the profits are coming from and above all, where they are headed. This is essential and you need to spend most of your time doing this.

The possible purchase price can be readily found in the daily newspaper or in real time online, but analysing a specific sector and the company's competitive position is what enables you to determine the intrinsic value, which is neither as obvious nor as easy to identify.

This is the great enigma of investment and you have to begin deciphering it.

Shift to Quality

Graham was too focused on price at the expense of quality.  Of course, this is an oversimplification.   Graham also took account of other factors, such as growth or stable results, although he didn't put as much emphasis on them.  

Most investors today pay attention to other drivers, such as growth or business quality, assigning increasing weight to them over time.



Philip Fisher

Philip Fisher played a pivotal role in the transformation undergone by many investors.  It was under the influence of his partner, Charlie Munger, that Buffett first became attracted to Fisher's philosophy.

Fisher put his money on investing in long-term growth stocks, with very robust competitive advantages that were capable of being sustained and increased over time.  The price paid for them was not as important, since if the company performed well it would be able to sustain a high multiple.  

This idea is less intuitive and therefore harder to digest than simply buying something cheap; it means paying seemingly expensive prices for something that will only yield results after a period of time.

This is ultimately the road that Buffett has gone down.  Thus, most value investors are also indirectly indebted to Fisher to some degree or another.

For those who have maintained a certain unshakeable bias towards investing in cheap assets, whose quality was not always proven, it can be a challenge to change their ways, especially when this mix had produced good results.

Every investor develops at their own pace.  



Joel Greenblatt

Joel Greenblatt's short book, The Little Book That Beats the Market, gives empirical proof that quality shares bought at a good price will always outperform other stocks.  

To do so, he classifies each stock according to two criteria: 

• quality, measured by ROCE (return on capital employed) and 
• price, measured by the inverse P/E ratio (price to earnings, the price that we pay for each unit of earnings).  [You can also use FCF yield, that is, FCF/price, instead of inverse P/E].

Greenblatt uses a numerical classification for both return and price:  1, 2, 3,4,...., with 1 being the stock with the highest ROCE under the return criteria and 1 being the highest free cash flow under the price criteria.   He then adds the points obtained by each share in both rankings to produce a definitive classification, which he calls the 'magic formula'.  

• The companies with the lowest sum of both factors deliver the best long-term returns.  
• Furthermore, the same is true throughout the ranking; companies situated in the lowest 10% post a better return than the second 10%, the second decile outperforms the third, and so on until the last 10%.

The exceptional results obtained by Greenblatt is surprising, but logical:  good companies bought at reasonable prices should obtain better returns on the markets.

The problem with applying this approach is that the formulas deliver over the long term, but they can also underperform for relatively long periods, for example, three years  this makes it though for both professional and enthusiast investors to keep faith when things are not working.

Understanding Economic Cycles and Market Valuation.

Understanding the economic cycles and market valuation will not help anyone predict the direction of the market in the short term or even in midterms like a year or two.  However,

• it keeps investors from looking in the rear-view mirror, and 
• they will have a clearer view of the future and be able to stay rational when the market gets euphoric or sinks into fear again.

For analyzing individual companies, having a good knowledge of business cycles and the likely future market returns can be useful in evaluating

• management's capital allocation decisions, 
• their aggressiveness in accounting and 
• the quality of earnings related to pension-fund return assumptions.

Buffett is a bottom-up value investor and rarely talks about the general market.  But he has a tremendous understanding of 

• business cycles, 
• the role of interest rates, 
• market valuations and 
• the likely future returns and risks.

Over the long term, investors should always be optimistic.  They should focus their investments on the quality companies that not only can pass the test of bad times, but also can come out stronger.

Now, more than any other time, it is vital to invest only in good companies.

Quality first, then Value.

Over the long term, investment return is more a function of business performance than valuation, unless the valuation goes extreme.

More effort should be put into identifying good businesses and buying them at reasonable valuations.

Investors should not be obsessed with the valuation calculations. All calculations involve assumptions. They are valid only if the underlying businesses perform as expected.

Checklist for Buying Good Companies at Reasonable Prices

Here is a summary of the questions an investor should ask for investing in good companies at fair prices.


Questions 1 - 19:  Focus on the areas of the business.

Business Nature
1.  Do I understand the business?
2.  What is the economic moat that protects the company so it can sell the same or a similar product five or ten years from today?
3.  Is this a fast-changing industry?
4.  Does the company have a diversified customer base?
5.  Is this an asset-light business?
6.  Is it a cyclical business?
7.  Does the company still have room to grow?

Business Performance
8.  Has the company been consistently profitable over the past ten years, through good times and bad?
9.  Does the company have a stable double-digit operating margin?
10. Does the company have a higher margin than competitors?
11. Does the company have a return on investment capital of 15% or higher over the past decade?
12. Has the company been consistently growing its revenue and earnings at double digits?

Business Financial Strength
13. Does the company have a strong balance sheet?

Business Management
14. Do company executives own decent shares of stock of the company?
15. How are the executives paid compared with other similarly sized companies?
16. Are insiders buying?

Business Valuation
17. Is the stock valuation reasonable as measured by intrinsic value, or P/E ratio?
18. How is the current valuation relative to historical range?
19. How did the company's stock price fare during the previous recessions?


Question 20:  Confidence in Your Business Analysis or Research

20. How much confidence do I have in my research?




The final question centers on how you feel about your research.  Though it is not directly related to the company, your own analysis is a vital consideration.  It determines your action once the stock suddenly drops 50% after you buy.

That same 50% drop can trigger opposing actions depending on your level of confidence.

• If you are assured in your research, the 50% drop in price is a great opportunity to buy more of the stock at half the price.  
• If you don't have confidence, you will likely be scared into selling at a 50% loss.

It will happen after you buy the stock and, paradoxically, it happens only after you buy.  So, get prepared!


The checkup questions are based on the company's financial data.  None of them should replace your work of understanding the business and learning about its products, its customers, its suppliers, its competitors, and the people who work in the company.  The warning signs serve as reminders of where you are.  They are not meant to substitute for understanding.  If we paid attention only to the numbers and signs and ignore the business itself, understanding of the company business is incomplete.

If we gain a solid understanding of the business, these numbers and signs will help us to appreciate where we are and where we are probably going.  If business understanding is qualitative and the numbers are quantitative, both are needed to gain the confidence we need for our research.

The checklist is a useful tool for investors to maintain discipline in their stock picking.

How to find Quality Companies? (Checklist)

Here is a useful checklist you can use when you are searching for quality companies:

1.   Company's sales record.

• You want to see high and growing sales, year after year.
• A ten-year period of increasing sales and profits is a good sign.

2.  Company's profits.

• You want to see high and growing profits, as measured by normalised EBIT, year after year.
• A ten-year period of increasing sales and profits is a good sign.

3. EBIT and normalised EBIT 

• Check that these are roughly the same in most of the last ten years.

4.  EBIT margin.  

• The EBIT margin must be of at least 10% almost every year for the last ten years.

5,  ROCE

• The company must have a ROCE that is consistently above 15% over the last ten years.
• ROCE = (EBIT / average capital employed ) x 100%

6.  DuPont analysis

• Carry out a DuPont analysis to find out what is driving a company's ROCE.
• ROCE = EBIT/Capital Employed = (EBIT/Sales) x (Sales/Capital Employed)
• ROCE = {Profit margin x Capital turnover)

7.  Annual report

• Read a company's annual report to provide context for the numbers.

8.  FCFF and FCF

• Look for a growing free cash flow to the firm (FCFF) and free cash flow for shareholders (FCF), over a period of ten years.
• FCFF and FCF should also be roughly the same in most years.
• That is, little debt.

9.  Operating cash conversion ratio 

• Look for companies that turn all of their operating profits (EBIT) into operating cash flow, as represented by an operating cash conversion ratio of 100% or higher.
• Operating cash conversion ratio = (operating cash flow / operating profit) x 100%
• That is, high quality earnings

10.  Capex ratio

• Look for capex ratio less than 30% almost every year over the last ten years.
• That is, low capex requirements.
• Capex ratio = Capex / Operating Cash Fow

11.  Compare Capex to its depreciation and amortisation expenses.

• If the company is spending more on capex than its depreciation and amortisation expenses, it is a sign that it is spending enough but you need to be sure it isn't spending too much.

12.  FCFF/Capital Employed or CROCI

• Check for free cash flow to firm return on capital invested that is higher than 10% almost every year over the last ten years.
• This is also known as cash-flow return on capital invested (CROCI)
• CROCI = adjusted free cash flow tot he firm (FCFF)/average capitl employed

13.  Compare FCFps to EPS

• Look for free cash flow per share to be close to earnings per share in most of the last ten years.
• That is, high quality earnings.

14.  Free cash flow dividend cover

• Free cash flow per share should be a larger number than dividend per share in most years.
• That is, the free cash flow dividend cover should be greater than 1.
• Free cash flow dividend cover = FCFps / DPS
• Occasional years when this is not the case are fine.

15.  Consistent Growth

• Prefer more consistent growth in turnover and profit to more volatile growth.

Comments:


Don't worry if you cannot find a company that meets ALL of the criteria above.

There are some exceptional companies that do.

Typically you will not find hundreds of them.

Companies can improve and the ones that might not have been good ten years ago can be good companies now.

If you can find companies that have a high and improving ROCE and have been good at converting profits into free cash flow over the last five years, you should consider them as well.

Can quality be more important than price?

"It is better to pay a little too much for something that is a very good business than it is to buy some bargain but really a company without much of a future."  
- Warren Buffett, chairman and CEO of Berkshire Hathaway.


Paying too much for a share can result in disappointing returns.

No company, no matter how good, is a buy at any price.

Share valuation is not an exact science.

Your valuation will never be exactly right.

By setting yourself some limits, you can reduce the risks that come from overpaying for shares.



Paying for a quality business can still pay off in the long run.

There is some evidence to suggest that paying what might seem to be a moderately expensive price (slightly more than the suggested maximum) for a quality business can still pay off in the long run.

The caveat here is that you have to be prepared to own shares for a very long time.  Perhaps, forever.



The way people invest is changing.

Many people are not building a portfolio of shares during their working lives to cash in when they retire.

An increasing number will have a portfolio that may remain invested for the rest of their lives.

• For them a portfolio of high-quality shares of durable companies may help provide them with a comfortable standard of living, with the initial price paid for the shares not being too big a consideration.

Are investors under-valuing the long term value of high quality businesses?

Remember, the shares of high quality businesses are scarce.

This scarcity has a value and might mean that investors undervalue the long term value of them.

The ability of high-quality companies to earn high returns on capital for a long time can create fabulous wealth for their shareholders.

This is essentially how investors have built their fortune (such as Warren Buffett).



Challenge your thinking by answering these questions

1.   Can you list some examples of high-quality companies with high and stable returns on capital that have created substantial wealth over the last decade?

2.   Look at them carefully.  Do you agree that few, if any, of these shares could have been bought for really cheap prices?

3.   In many of these cases, do you concur that the enduring quality and continued growth of the companies could be seen to have been more important than the initial price paid for them?

"Margin of Safety" as the Central Concept of Investment

The Intelligent Investor by Benjamin Graham

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.
Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

MARGIN OF SAFETY CONCEPT: STOCKS SHOULD BE BOUGHT LIKE GROCERIES, NOT LIKE PERFUME

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Better Investing

A.  Analyse Growth

Step 1: Historical Sales

Historical sales growth is the first of four indicators BetterInvesting uses to identify well managed growth companies.

It is desirable to invest in companies whose sales growth is strong and consistent and generally growing faster than the overall economy and inflation combined. *

Is the company's historical sales growth rate acceptable for a company its size?
Check growth rate % - have sales grown faster than the competition and the economy?
Check growth rate trend - have sales figures changed direction recently? If sales are up or down do you know why? Are the forces that caused growth in the past the same ones that will create growth in the future?
Does the company deserve further study?

Compare your candidate company to:
Others in the same industry
Peer group average
Industry average

* Review background economic and inflation data
Gross Domestic Product Data
Inflation Data


Step 2: Historical Earnings Per Share

Historical earnings per share (EPS) growth is the second indicator BetterInvesting uses to identify well managed growth companies.

It is desirable to invest in companies whose EPS growth rate is strong and consistent and generally growing faster than the overall economy and inflation combined.

Is the company's historical EPS growth rate acceptable for a company its size?
Check growth rate % - have earnings grown faster than the competition and the economy?
Have EPS figures changed direction recently? If so, do you know why?
Does the company deserve further study?

Compare your candidate company to:
Others in the same industry
Peer group average
Industry average


Step 3: Historical Stock Price Review

You've reviewed the company's historical sales and earnings growth. Both should be growing
1. Faster than the economy and inflation combined
2. Faster than competitors
3. Consistently

If these conditions have been met then check that EPS is growing in line with sales.
1. Check that the graph lines of sales and EPS are mostly straight and moving together in parallel toward the upper right-hand portion of the graph.
2. Compare the growth rates of both sales and EPS using the rates given in the data grid.

Next, determine whether the company's stock price has tracked the growth rates of Sales and EPS. A company's stock price will typically follow the earnings growth rate -- price follows earnings. Looking at the graph you can see the relationship of stock price to EPS.

Steady growth in stock price is an indicator of management's ability to grow sales and EPS and that the market has confidence in the company.

It is desirable to invest in companies whose share price increases as its sales and earnings increase. Price bars show how much movement up and down there is in the stock price each year. Skilled management can control the variables in the company so that the high and low prices travel smoothly upward. More up and down movement means more risk.

Check
Are earnings growing in line with sales?
Has the company's stock price moved in line with EPS?
Does this company deserve further study?


B.  Evaluate Management

Step 1:  % Pre-Tax Profit on Sales

% Pre-tax Profit on Sales is the third indicator BetterInvesting uses to identify well managed growth companies. A good percent pre-tax profit margin shows a company is well managed.

It is desirable to invest in companies whose percent pre-tax profit is increasing or at least staying the same. Examining the most recent five year average helps us determine this.

Is the 5 year average percentage of pre-tax profit on sales increasing or at least staying the same?
Is the percentage of profit consistent over time?
Does this company deserve further study?

Compare your candidate company to

Others in the same industry
Peer group average
Industry average

Step 2:  % Earned on Equity

% Earned on Equity (ROE) is the fourth indicator BetterInvesting uses to identify well managed growth companies. It tells how effectively company management is using the shareholders' money to make a profit.

It is desirable to invest in companies whose ROE percentage is increasing or at least staying the same. An exception is when a company is paying off debt, which is covered in the next section.

Is the percentage of ROE increasing or at least staying the same?
Is the percentage of ROE consistent over time?
Does this company deserve further study?

Compare your candidate company to
Others in the same industry
Peer group average
Industry average


Step 3:  Total Debt

One indicator of management skill is how debt is employed.

Most companies borrow money to help them reach their goals. Companies go into debt to buy equipment, real estate, and many other things. Some industries use debt more than others. Borrowing some money can be very good because it helps the company do things it could not afford to do on an all cash basis. Borrowing too much money can be very bad because it increases risk in two ways:

1. Debt increases the risk to common shareholders because the company must pay the claims from debt and preferred stockholders before common shareholders receive anything.

2. High levels of debt are risky for a company because it has to pay its debt obligations whether it's doing well or not. If the company runs short of money during a recession, the debt obligations could force the company to go out of business.

Check:

Is the total debt increasing or decreasing?
Review the company web site and official reports to understand the reasons for significant changes in total debt.

Look at Total Debt and % Debt to Capital together to understand how the company is managing debt.

Step 4:  % Debt to Capital

One indicator of management skill is how debt is employed. Look at Total Debt and % Debt to Capital together to understand how the company is managing debt.

The percent of total debt to capital helps you understand whether company management is using debt conservatively or liberally. The ratio enables you to make valuable comparisons between the company you are studying, peer companies and the industry.

Some industries such as banks, financial institutions, and utilities typically operate using higher levels of debt. Some successful companies in other industries have proven that they can carry high debt over many years. Younger companies often have relatively higher levels of debt, but because they are young they don't have a track record that shows they can manage it well over many years. This adds considerable risk as an investment.

Check:

Is percent of Debt to Capital increasing or decreasing markedly?
Review the company web site and official documents to understand the reasons for changes in debt levels (company expansion, acquisitions, divestiture, etc.)
Is the company on a "spending spree" financed by debt?
Is the company borrowing enough to help it stay competitive?

Compare to:
Historical trends
Peer Group
Industry averages


C.  Forecast Sales Earnings

Step 1:  Forecast Sales

If the company you are studying has not met any of the BetterInvesting standards you have studied so far, you should discard the company and begin the study of another.

If all preceding indicators have met the BetterInvesting standards then you have more than likely identified a quality growth company. You now need to consider its potential as an investment for your portfolio.

You must predict how well your investment candidate will perform in the future by estimating sales and earnings.

First, forecast the rate at which you believe sales will continue to grow in the future.

Forecast company sales by considering:

1. Historical results -- consistent strong growth
2. Competition
3. Changes in consumer or market preferences
4. Changes in products or services offered

Is your forecast moderate, meaning it does not rely on extreme conditions or situations?
Is your forecast sustainable, meaning it does not rely on events or circumstances that are not likely to occur regularly?
How does it compare to other companies you may have studied?


Step 2:  Forecast Earnings

Forecast the rate you believe earnings will grow in the future. Your forecasted earnings growth rate will establish an estimate of how much money the company will be earning per share five years from now. This EPS forecast will help you establish an estimated high price the EPS would support.



D.  Assess Risk and Reward

Step 1:  Forecast High Price

How high is the price of the stock likely to go in the next five years?

The answer comes by multiplying the highest likely earnings per share by the average high price earnings ratio.

1. The default high EPS forecast is determined by your entries in the preceding screen.

2. The average high PE forecast is determined by reviewing historical data and current PE primarily, and competitive information as well.

Changing the numbers in the boxes changes the forecast.


Step 2:  Forecast Low Price

How low is the price of the stock likely to go in the next five years?

The answer comes by multiplying the lowest likely earnings per share by the likely average low price earnings ratio.

The default values displayed are based on historical averages.

You need to decide whether or not they reflect the company in the next five years and adjust if necessary.

Step 3:  Assess Stock Price

Now that you have estimated the high and low prices for the next five years, find the current price and determine where it falls within the high-low range.

The range between the high and low prices is divided into three zones: sell, hold and buy.

1. If the current price is in the top range, the stock is in the sell range.

2. If the current price is in the middle range, the stock is in the hold range.

3. If the current price is in the lower range, the stock is in the buying range.

Step 4:  Determine Potential Gain vs. Loss

Even though well considered, forecasts are not certain.

By comparing the current price to

1. Your forecast high price and
2. Your forecast low price

you determine your potential gain and potential loss.

It is desirable to invest in companies offering a potential gain at least three times the potential loss.


E.  Determine 5 Year Potential

Determine 5 Year Potential

Compounded Return is the projected annual price appreciation plus the projected average annual yield.

The Price Appreciation is the increase in the price of the stock, assuming you sold the stock at its projected high price.

The Yield is the projected average annual return on the price, paid as a dividend. Yield is calculated by dividing the dividend by the purchase price of the stock.

If the company performs as well as you expect, and you sell the stock at the forecast high price, this will be your financial return.





Better Investing - Core SSG
http://www.betterinvesting.org/public/default.htm

http://www.betterinvesting.org/NR/rdonlyres/CB93E207-7341-4225-B609-8197173DFBB9/0/P1JudgmentandtheSSG4pp.pdf

http://www.betterinvesting.org/Public/SingleTabs/Webinars/archives.htm


Stock Research Form

4.0 CONCLUDING DIALOGUE (STOCK SELECTION REPORT)

To complete, make selections from choices presented in each statement below.

1.       The company is (well-established) (new) and operates (internationally) (nationally) (regionally).

2.       The product line or service is (diversified) (limited) and sold to (consumers) (manufacturers) (other companies) (government(s)).

3.       Business cycles affect sales and earnings (minimally) (moderately) (severely).

4.       Interest rates for T-bills are historically (low) (average) (high) and seem to be (trending upward) (steady) (trending downward).

5.       Current inflation rates are (low) (average) (high) and seem to be (trending upward) (steady) (trending downward).

6.       In its industry the company is the (largest player) (in the top tier) (an average or smaller size company).

7.       The company has a (continuous dividend record for ________ years) (an inconsistent dividend record) (no dividend record).

8.       The business cycle seems to be (trending upward) (steady) (trending downward).

9.       The current stage of the business cycle tends to (help) (not effect) (hurt) the profits of the company which suggests (no concern) (caution) (optimism) for the company under review.

4.1 YOUR PROJECTIONS ON THE SSG (SUMMARY)
	Projection	Rationale
Sales Growth Rate (%)
EPS Growth Rate (%)
High P/E
Low P/E
Low Price
% Payout
4.2 YOUR FINAL RECOMMENDATION (BUY, SELL, HOLD)

When to Sell?

Selling “Myths”
• MYTH – Once a stock has doubled our investment it is time to sell.
• MYTH – Wait until a stock is back to even before selling.
• MYTH – Sell if the stock price falls 10% (or some other %) below the
purchase price.
• MYTH – Only sell when your SSG says “Sell.”
• MYTH – If a company is meeting our growth expectations, then do
not sell.
• MYTH – Don’t sell a stock until you have found a good replacement.
• MYTH – Sell everything when we are going into a bear market.
• MYTH – Don’t sell because it’s a “good company.”

Valid Reasons to Sell
• When something is truly wrong with the
business and it won’t likely be fixed within a
year
• When the stock price has risen so much that
future gains are unlikely.
• When you find a better stock. Frequently this is
a back‐door way of exiting a weak holding.

How can you become a better seller?
•Write it down – have written rules for selling just like you do
when buying
•For an investment club – rotate stock assignments so one person
isn’t identified with “her” or “his” stock
•Remember, stocks are a means to an end. The goal is to grow
your wealth. You aren’t being disloyal to a stock if you sell it.

http://www.betterinvesting.org/NR/rdonlyres/12386A1B-284F-4E75-B02C-D9396B363B26/0/StockUpFeb2015Slides4pp.pdf

Making investing enjoyable, understandable and profitable...*

Is it not true, that the really big fortunes from common stocks have been garnered by those who made a substantial commitment in the early years of a company in whose future they had great confidence and who held their original shares unwaveringly while they increased 10-fold or 100-fold or more in value?

The answer is "Yes."  

 
------------------


BENJAMIN GRAHAM'S 113 WISE WORDS
The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement."

 
-----------------
 
PHILIP FISHER'S WISE WORDS
"The refusal to sell at a loss, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process.

More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous."

(Common Stocks and Uncommon Profits)

 
--------------------


Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

 

Experts reveal their investment tips for volatile times

'Don't panic': Experts reveal their investment tips for volatile times
January 21, 2016 - 9:53AM

China fears! Billions of dollars lost! Unprecedented volatility!

With investment markets in full blown panic mode, two listed investment company stalwarts are advising investors to keep cool heads as they wade through some of the most volatile times on record.

Tom Millner, chief executive of the $900 million BKI Investment Company, urges investors not to see red despite nearly $120 billion wiped off the Australian share market since the start of this year.

Around $120 billion has been wiped off local shares in 2016.

Ross Barker, managing director of the $6.2 billion Australian Foundation Investment Company (AFIC), believes now is a great time for investors to cherry pick where to put their funds.



These are their investment tips for navigating through the volatility in 2016:

1. Don't jump

"It's about buying good, quality companies that have strong businesses through cycles," Ross Barker, managing director of AFIC, said.

As the markets yo-yo with gains and losses throughout the trading day, Mr Barker has this to say to investors: "Don't panic."

Herd or mob mentality often permeates the market when investors dump stock in a state of panic, resulting in the overselling of companies.

Australian shares tumbled to a 2 1/2-year low on Wednesday as investors worry about China's growth prospects and slowing global commodity markets.

China's sharemarkets are as volatile as ever, but AFIC managing director Ross Barker believes the country's growth prospects are still strong.

"People get caught up in the mentality of the moment and they can often sell good things when they shouldn't be selling," Mr Barker said.

"There's concerns about China but we're still confident about the growth prospects of the economy."

2. Take your time

Blue-chip stocks such as BHP and Rio have been two of the biggest market casualites, shedding 40 per cent and 24 per cent respectively since last year.

"Be patient."

That is Mr Millner's response to the panicked selling since the start of this year that has spared few companies on the ASX.

Casualties such as BHP Billiton and Rio Tinto, two of the largest resources stock on the sharemarket, have shed 40 per cent and 24 per cent respectively since last year.

But Mr Millner remains confident major Australian resources companies exposed to commodities such as oil, coal and copper in particular will bounce back as the imbalance between supply and demand is adjusted and the Australian dollar continues its descent.

He believes large resources companies may rebound over the next 12 to 18 months.

"It's just short term noise - so be patient," he said.

3. Buy quality

If a company is temptingly cheap but there's little basis for future growth, don't buy it.

"Stick with quality is my advice," Mr Barker said about picking stocks amid the market downturn.

Healthcare and diversified financial stocks are AFIC's picks thanks to an ageing population, while companies that source their revenue from overseas markets are also attractive.

The LIC has bought stakes in companies such as annuities giant Challenger and Macquarie Group.

"It's about buying good, quality companies that have strong businesses through cycles," he said.

4. Stay for the long haul

"We tend to try and hold a stock for at least 10 years," Mr Millner said.

While the thought of clinging to a company for a decade might not be every retail investor's cup of tea, holding a stock for a few years rather than dumping them at the first sign of trouble could yield strong growth potential.

Investors who bide their time and reap the dividends from blue chip companies or businesses with strong fundamentals will benefit through the volatility.

"We're in this for this for the long haul, and we do like the thematics of healthcare in particular with an ageing population."

BKI has been buying stock in Ramsay Healthcare and Sonic Healthcare as part of their long term investment strategy.

The company returned 10.9 per cent for the year to December, beating the S&P/ASX300 Index's 2.8 per cent over the same period.



Read more: http://www.smh.com.au/business/markets/dont-panic-experts-reveal-their-investment-tips-for-volatile-times-20160120-gm9y62.html#ixzz3xpm6Yn2E

Analysing the substance and character of a business is the holy grail of investing. Guessing a price that someone else is willing to pay, is not.

By 1969, the stock market had reached new highs, and the Buffett Partnership continued to beat its returns.  As the market continued to climb even higher, Buffett announced that he would close his partnerships.  He told the partners that the speculation-driven stock market didn't make sense; he wanted no part of the folly.

Buffett sold everything in the portfolio except for shares in Diversified Retailing, Blue Chip Stamps, and Berkshire Hathaway, which now included insurance and banking businesses as well as equity investments.  Avoiding the speculative market, Buffett continued to hunt for attractive underated businesses.  In 1971, he bought a controlling interest in See's Candies.

By early January 1973, the Dow had climbed to an all time high of 1,051 points.  But only $17 million of Berkshire's $101 million insurance portfolio was invested in stocks; the rest was in bonds.  Not long after this high, the market swooned.  The it racheted down further.  By October 1974, it hit a low of 580 points.  Investors panicked but Buffett rejoiced.  He was in his elements once again.

Over the following years, Buffett bagged big game at  bargain prices, adding Wesco Financial and buying large blocks of stocks in The Washington Post and Geico.  In 1977, Buffett bought The Buffalo News. 

Buffett's belief that analysing the substance and character of a business was the holy grail of investing.  Guessing a price that someone else was willing to pay - irrespective of fundamentals - was not.

A quality strategy - appreciating the future earning potentials of wonderful companies.

Though Warren Buffett popularized the idea of the moat, he credits partner Charlie Munger for bringing him around to the idea that "it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

A quality strategy is a bet that the market doesn't appreciate wonderful companies enough, particularly their earnings potential many years out. 

As Charlie Munger said, "If a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with one hell of a result." 

(Of course, it's not easy to identify in advance firms that can sustain such high rates of return for so long.)




http://news.morningstar.com/articlenet/article.aspx?id=643125&SR=Yahoo

How do I take qualitative factors into consideration when using fundamental analysis?

Qualitative Factors in Fundamental Analysis

Fundamental analysis is the method of analyzing companies based on factors that affect their intrinsic value. There are two sides to this method: the quantitative and the qualitative. 

-   The quantitative side involves looking at factors that can be measured numerically, such as the company's assets, liabilities, cash flow, revenue and price-to-earnings ratio. 
-   The limitation of quantitative analysis, however, is that it does not capture the company's aspects or risks unmeasurable by a number - things like the value of an executive or the risks a company faces with legal issues. 
-   The analysis of these things is the other side of fundamental analysis: the qualitative side or non-number side.

Although relatively more difficult to analyze, the qualitative factors are an important part of a company. 

-  Since they are not measured by a number, they more represent an either negative or positive force affecting the company. 
-  But some of these qualitative factors will have more of an effect, and determining the extent of these effects is what is so challenging. 
-  To start, identify a set of qualitative factors and then decide which of these factors add value to the company, and which of these factors decrease value. 
-  Then determine their relative importance. 
-  The qualities you analyze can be categorized as having a positive effect, negative effect or minimal effect. 


The best way to incorporate qualitative analysis into your evaluation of a company is to do it once you have done the quantitative analysis. 

-  The conclusion you come to on the qualitative side can put your quantitative analysis into better perspective. 
-  If when looking at the company numbers you saw good reason to buy the company, but then found many negative qualities, you may want to think twice about buying. 
-   Negative qualities might include potential litigations, poor R and D prospects or a board full of insiders. 
-   The conclusions of your qualitative analysis either reconfirms or raise questions about the conclusions of your quantitative analysis. 

Fundamental analysis is not as simple as looking at numbers and computing ratios; it is also important to look at influences and qualities that do not have a number value.

Charlie Munger: I have seen so many idiots getting rich on easy businesses. Don't buy cheap bargains, but look for very good companies.

Don't buy cheap bargains, but look for very good companies.
I have observed what would work and what would not.
I have seen so many idiots getting rich on easy businesses.
Surely, I am interested in the easy businesses.

Quality Persists

Once you have determined that a company does meet your quality standards, its status is not likely to change - at least for a while.

In fact, the only factor that could change your assessment is the data that is reported every three months, so you can be reasonably confident that your assessment will survive at east that long.

And there's an 80% chance it will last a good deal longer.

So it pays you to collect and maintain a "watch-list" of good companies and wait for them to hit an attractive price - just have them available should your portfolio management strategy call for selling or replacing one you already own.

Hopefully, you won't have to find out the hard way - QUALITY first, then PRICE. When in doubt, throw it out!

The most important task is in investing into a company is in assessing its quality.

Hopefully you won't have to find out the hard way that buying a good company for too high a price is still better than buying a poor company - even at what you may think is a bargain price.

No matter how low it may be, a company that doesn't meet the quality requirements will always be too expensive - at any price!

If you are not critical enough about quality, you can easily be seduced into believing that a stock is a bargain when you actually shouldn't touch it with a 10-foot pole.

Here is a statement you may have to think about a little:  The worse a company performs, the better a value it will appear to be.   Why do you suppose that is?

If you ignore the poor operational performance and just look at the price, you'll be in the market for someone else's mistake!

Sure, you will be able to pick up the stock at bargain-basement prices - but for a good reason.

You will think you made out like a bandit when, in fact, whomever you bought the stock from will turn out to be the lucky one.

The most important point here is that you simply cannot afford to ignore the quality issues or treat them lightly.  

Unless the company completely satisfies your quality requirements - and I don't mean it's marginal or might have some problem - your evaluation of the price of the stock can be invalid and, in fact, hazardous to your financial health.

When in doubt, throw it out!

Buffett's Investing Wisdom - Buy Wonderful Companies

It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. – Warren Buffett

Interestingly enough, Buffett’s mentor, Benjamin Graham, was quite fond of jumping at fair companies trading at wonderful prices. Graham termed this “cigar butt” investing -- as in, he was looking for discarded cigars that still had a few good puffs left in them. In Buffett’s pre-Berkshire days, he ran with this page from Graham’s book. To be sure, Berkshire Hathaway itself looked a lot like a cigar butt when Buffett bought it -- at the time it was a bedraggled textile business that was markedly unprofitable.

Through his career, though, Buffett realized that the real money wasn’t in puffing on dirty cigar butts. Instead, the big profits in investing come from finding well-run companies that dominate their industries and hanging onto those companies for a long time. Of course, Buffett isn’t one to pay any crazy price for a stock, though, so part of the investment process is determining what a fair price is for the stock and looking for an opportunity to buy the stock at that price.

Costco (Nasdaq: COST) is a great example of a company that dominates its industry. Sure, there are other warehouse-shopping clubs out there, but in terms of quality of operations and management, none stack up. And Buffett -- and even more so his right-hand man, Charlie Munger -- are not shy about professing their admiration for the low-price giant. The problem for investors is that it’s highly unlikely we’ll see shares of Costco trade at true bargain levels unless something dramatically changes the quality and outlook for the company.

In a similar vein, Visa (NYSE: V) and MasterCard (NYSE: MA) are among a very small, very dominant group in the growing and highly profitable credit card industry. As the nature of the global payment system continues to move rapidly away from cash and toward cards and electronic payments, both of these payment-network operators stand to rake it in. Just like Costco, though, investors looking for a “blue light” special on Visa or MasterCard shares will likely find themselves with their hands in their pockets as long as the major growth and success continue.

It’s not just academic to say that investors who balk at a premium price for these companies missed out. Over the past five years, the S&P 500 is up 35%. Costco is up 93%. As for Visa and MasterCard, they’ve tacked on an amazing 162% and 127%, respectively. And investors that bought those companies five years ago weren’t buying on the cheap. In 2008, Costco fetched an average price-to-earnings multiple of 23.5, while Visa and MasterCard sported respective multiples of 53 and 45.

Today, the stocks of all three of these companies still sport higher-than-average earnings multiples. But all three are also still top-notch businesses with stellar growth and profit potential.


Ref:  Warren Buffett's Greatest Wisdom