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.

The Quality of Companies: Practically all the value investors have gone down the same path of Buffett.

Graham was too focused on price at the expense of quality.  

However, in hindsight, it was clear that the portfolio of quality companies is the best approach to stand up to any market situations.

Indeed, past financial crises confirmed that high-quality companies at reasonable prices perform better over the long term than companies which are straight cheap.

Buffett invested in very underpriced real assets in the beginning of his investing career.   After partnering Charlie Munger, he focused on higher-quality stock, proxied by the degree of competitive advantage they enjoy.

Many investors have gone down this same path of Buffett, practically all the value investors.  The main reason is that it delivers better results over the long term, although there aren't many studies to back up this assertion, making it initially a far from obvious conclusion.



Why have practically all value investors followed Buffett, preferring quality companies?

Maybe, when they are young and start out investing, they have an excessive desire to do well and make their mark.  They tend to favour the cheapest companies, which on face value offer the greatest potential upside.

With experience and maturity, and after having stepped on a few booby and / or value traps (cheap companies in bad businesses, which languish for years, failing to create value) and their economic situation improves, their tastes tend to shift towards quality, even if they have to pay a bit more for it.

Practical suggestions on switching stocks

Let us summarize our practical suggestions in the matter of security switches as follows:

The investor who begins with a list of standard, first-grade common stocks can expect some of them to lose quality through the years.

His aim should be to replace these, with a minimum sacrifice of dividend return and with a fair chance of recouping any loss of principal value resulting from their sale.

The best means of accomplishing this is by seeking out attractive issues in the secondary group.  A competent security analyst is usually in a position to recommend a number of such issues which by objective tests appear to be worth substantially above their selling price.  

The fundamental principle of every security replacement should be the following:
Each dollar paid for the issue bought should appear to obtain more intrinsic value than was represented by a dollar's worth of the issue sold.

We believe, in sum, that quality may be approached soundly by way of value.  If the value is abundant, the quality may be deemed sufficient.


Benjamin Graham

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.

Quality first, Price second

Philip Fisher: Quality first, Price second

Fisher formulated a clear and sensible investing strategy (which I'll get to in a second), wrote one of the best investment books of all time, Common Stocks and Uncommon Profits, and made a good deal of money for himself and his clients.

His son wrote that Phil's best advice was 
-to "always think long term," 
-to "buy what you understand," and 
-to own "not too many stocks." 

Charles Munger, who is Buffett's partner, praised Fisher at the 1993 annual meeting of their company, Berkshire Hathaway Inc. (BRK/A): "Phil Fisher believed in concentrating in about 10 good investments and was happy with a limited number.  That is very much in our playbook. And he believed in knowing a lot about the things he did invest in. And that's in our playbook, too. And the reason why it's in our playbook is that to some extent, we learned it from him."

In addition to the warning against over-diversification — or what Peter Lynch, the great Fidelity Magellan fund manager, calls "de-worse-ification" — the book makes three important points:

(1)  First, don't worry too much about price.  (Quality first, Price second)
-  "Even in these earlier times [he's talking here about 1913], finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear."
-  In fretting about whether a stock is cheap or expensive, many investors miss out on owning great companies. My own rule is: quality first, price second.
(2)  Second, Fisher says that investors must ask, "Does the company have a management of unquestionable integrity?" 

(3)  Finally, Fisher offered the best advice ever on selling stocks. "It is only occasionally," he wrote, "that there is any reason for selling at all."

Yes, but what are those occasions? They come down to this: Sell if a company hasdeteriorated in some important way. And I don't mean price! 

Fisher's view, instead, is to look to the business — the company itself, not the stock. 

"When companies deteriorate, they usually do so for one of two reasons: 
- Either there has been a deterioration of management, or 
- the company no longer has the prospect of increasing the markets for its product in the way it formerly did."

A stock-price decline can be a key signal: "Pay attention! Something may be wrong!" But the decline alone would not prompt me to sell. Nor would a rise in price. 

Time to sell? If you did, you missed another doubling.

"How long should you hold a stock? As long as the good things that attracted you to the company are still there."

How You Can Tailor-Make a Winning Portfolio

How You Can Tailor-Make a Winning Portfolio
By Dan Caplinger March 25, 2009

Anybody can throw a bunch of investments together and call it a portfolio. It takes a lot more, however, to find a select group of promising prospects that fit well with your temperament, your time horizon, and your particular financial goals.

Too often, investors don't think about their investment portfolio as a single unit. Instead, they grab shares of various stocks and funds willy-nilly, based solely on their individual characteristics -- never thinking of a new stock's impact on the holdings they already own.

Make the right portfolio
In this month's brand-new issue of Motley Fool Champion Funds -- which goes live this afternoon at 4 p.m. EDT -- Foolish fund expert Amanda Kish takes a look at this question from a unique angle. Part of what Amanda's newsletter offers subscribers every month are three model portfolios, each of which represents a blend of some of the funds that the service has recommended over the years.

But of course, unless you're just getting started with your investing, you'll probably already have some stocks and funds to bring to the mix. In addition, even if you have cash available, you may not have access to buy the exact funds you want -- especially if you have to choose from a fixed menu of investment options, as many workers must in their 401(k) plans.

Given those limitations, what's the best way to choose investments in a way that will complement your existing portfolio rather than create problems?

Watch out for the concentration trap
With individual stocks, problems often come from haphazardly choosing promising companies that aren't well diversified. For instance, here's an extreme example of stocks you might have been tempted to add to your portfolio based on these news items from early last year:

• With the discovery of a massive oil field off the cost of Brazil, Petroleo Brasileiro (NYSE: PBR) found itself fortuitously positioned to take maximum advantage of the news.
• The red-hot Haynesville shale play brought quick profits to natural gas players like Petrohawk Energy (NYSE: HK) and Chesapeake Energy (NYSE: CHK).
• Demand for fertilizer rose much faster than supply, giving industry players like Potash Corp. (NYSE: POT) and Mosaic (NYSE: MOS) great returns during the first six months of 2008.
• Early in 2008, heavy demand for industrial metals from China and other development-hungry economies bolstered prospects for copper producers like Southern Copper (NYSE: PCU) and Freeport-McMoRan (NYSE: FCX) -- and with China's economy forecast to grow strongly, the end seemed far away.

Clearly, if you'd acted on those temptations, you would've owned a portfolio that was way overweighted in energy and commodities stocks -- stocks that came crashing down during the latter half of the year.

Dealing with funds
With mutual funds, there are a bunch of things to keep in mind when tailoring a fund portfolio for your particular wants and needs. For instance:

• If you have a strong relationship with a particular fund company, you might want to use their offerings in particular asset classes rather than mixing and matching across different fund companies.
• Even within broad categories like large-cap value or small-cap growth, you'll find dozens of different strategies. Some may appeal to you more than others, even if all of them have been equally successful at creating gains over the long haul.

Champion Funds gives portfolio recommendations for conservative, moderate, and aggressive investors. But if you find yourself halfway between two of those categories, then an easy way to split the difference may be to add another fund.

In this month's newsletter, Amanda goes through these and other reasons you may have for making switches -- and gives you a useful set of tools to help you evaluate whether a particular fund you may have in mind is the right one to keep your overall portfolio strong. And with dozens of different fund recommendations to choose from, Champion Funds subscribers don't have any shortage of great funds to plug into their overall investment strategy.

Putting together a tailor-made portfolio will take some work, but the rewards will last a lifetime.

For more on winning investment strategies, read about:
Yes, you can defend your portfolio from losses.
Will 7% returns really make you happy.
Want to retire? You need options.

Fool contributor Dan Caplinger is constantly making adjustments to his portfolio. He owns shares of Freeport McMoRan and Chesapeake Energy. Petroleo Brasileiro is a Motley Fool Income Investor pick. Chesapeake Energy is a Motley Fool Inside Value recommendation.

http://www.fool.com/investing/mutual-funds/2009/03/25/how-you-can-tailor-make-a-winning-portfolio.aspx

Fix Your Portfolio Now!

Fix Your Portfolio Now!
By John Rosevear November 20, 2008 Comments (5)

"The world breaks everyone and afterwards many are strong at the broken places. But those that will not break it kills." -- Ernest Hemingway, A Farewell to Arms

I've never had much fondness for Hemingway, but I always loved those lines, which I freely interpret to mean something like, "Everyone gets roughed up by experience. If you learn from it, that roughing up can be of great value. If not, be prepared to get roughed up again and again."

The market roughs everyone up, too. Yes, everyone. Even Peter Lynch and Warren Buffett have taken huge lumps from time to time. Not for nothing does investment manager and author Ken Fisher refer to the market as "TGH" -- the Great Humiliator.

And wow, have we been roughed up lately. It's not over, either -- while it's possible the stock markets have found their low points, there's clearly a rough economic grind ahead. If you're an employee of Citigroup (NYSE: C), General Motors (NYSE: GM), or any other company that's discussing difficult cuts and painful reorganizations -- and not too many companies aren't -- things could get a lot rougher from here.

But even if you stay gainfully employed in a job you love until it's time to retire many years from now, your portfolio has probably taken quite a hit lately. What can we do to make the most of what we have left?

Taking a hard look at where you're at nowIf you've avoided looking at your portfolio recently, that's understandable -- but in order to take action, you need to know how much damage you've really taken. And yes -- now is the time to take action, while the markets are staggering, while other investors are demoralized.

Yes, now. Just about everything is down right now. High fliers and sturdy recession-resistant businesses alike are sitting near their 52-week lows. And while the latter have, generally speaking, fallen less than the former, they're also more likely to make you some money between now and the end of this mess. While there are a number of steps you can take right now to improve your portfolio, a move to better stocks is one that could deliver the biggest rewards.

Buys for right now

How can boring stocks make you money while the market is down? With dividends, of course! While it's true that no dividend is safe in a really deep recession, the ones paid by boring-basics businesses are less vulnerable than most. Kleenex kings Kimberly Clark (NYSE: KMB) are sporting a 4% dividend yield at current prices. Pharmaceutical cash machine Pfizer's (NYSE: PFE) yield is 8%. On the other side of the health coin, Altria (NYSE: MO) sports a yield that's also approaching 8% -- and speaking as an ex-smoker, I can attest that demand for cigarettes isn't likely to dive too much in the face of something as nerve-wracking as a massive worldwide economic meltdown.

On the other hand, there's a good argument for buying the beaten-up high fliers that are likely to fly again here, while they're cheap. As I write this, Apple (Nasdaq: AAPL) is within a few cents of lows it hasn't seen since early 2007. Marvel Entertainment (NYSE: MVL), a company thought by many to be in the early stages of a long-growth trajectory, is also closing in on 52-week lows. If those two manage to hold the line in the near term and recover their growth mojo in the longer term, buying them here could look like genius in a couple of years.

Those are big ifs, though. With so much uncertainty, it's important to step carefully.

One way to maximize your chances of a good buy in this difficult environment is to stick with opportunities vetted by experts with a good track record. The team at the Fool's flagship Stock Advisor newsletter has been through the recession wringer before, and is sifting through the post-crash rubble looking for the best buys in all corners of the market.

Looking to get started today? You can see their best ideas for new money, and get complete access to all of their recommendations, right this minute with a no-obligation free 30-day trial.
Thank you for signing up to receive The Fool's daily market commentary, covering all aspects of the ongoing financial crisis.

Fool contributor John Rosevear owns shares of Apple. Pfizer and Kimberly Clark are Motley Fool Income Investor picks. Pfizer is a Motley Fool Inside Value recommendation. Marvel Entertainment and Apple are Motley Fool Stock Advisor picks. The Fool owns shares of Pfizer. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure The Motley Fool's 2 Top Stocks

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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 icon found on every comment.

Report this Comment On November 20, 2008, at 5:16 PM, SteveTheInvestor wrote:
Stock Advisor? Oh... you mean the portfolio that's down what, 16% after 6 or 7 years? Doesn't inspire much confidence if you want some honesty. When we should have heard suggestions to pare back on stocks, all we got was "buy now" because they are "on sale" and "poised to pop". I got whacked big on Stock Advisor stocks but if I had not finally chosen to ignore the advice and sell some things, my losses would now be double or triple that.
Yeah, I know.... think long.... and here's what Warren said. Based on the history, I guess you need to be about 20 years old to have a long enough time frame, huh? And Warren? Frankly, I don't care.

Report this Comment On November 20, 2008, at 6:04 PM, PapaRossi wrote:
I fixed my portfolio, I sold off all of the MDP stocks and resigned my membership and my portfolio went from neg 8% to a pos 87%.
After numerous warnings to the MDP about the future direction of the stock market which were ignored by the team and laughed at by the fools.......Well Papa's laughing now...;-))

Report this Comment On November 20, 2008, at 6:27 PM, DefinedRisk wrote:
I wouldn't buy anything without some downside protection. What indicates that this is the bottom? How much worse can it get? I don't know, but going forward using the old fashioned 'buy & hold' or 'modern portfolio theory' (yes that is now old fashioned to me) principles is suicide. Defined Risk Strategies have proven effective since 1997. They eliminate most of the downside risk and participate in market growth.... what could be better? Learn more: http://www.swanconsultinginc.com/

Report this Comment On November 20, 2008, at 7:23 PM, fe3lixallen wrote:
comments....
This one is good:
"if you want some honesty. When we should have heard suggestions to pare back on stocks, all we got was "buy now" because they are "on sale" and "poised to pop"'
this one is good also..
"Yeah, I know.... think long.... and here's what Warren said. Based on the history, I guess you need to be about 20 years old to have a long enough time frame, huh? And Warren? Frankly, I don't care."
Hey guys.. don't you get it? Buy and hold and think "long term". Reeeeeeal long term. Ha ha.
Lots of college educations and retirements may have been ruined. But, "long term", who cares? Not TMF, apparently.
Long term.. we are all dead.
TMF should have seen what was coming ecomically. What's worse, they are seeing the confirming "data" now and still not doing anything about it. TMF had no plan for an extended bear market - and they have none now. They keep saying "no one knows which way the market will go". But, doesn't common sense tell you that in an environment of world-wide deteriorating economics the bet "down" would seem to make more logic than the bet "up".
No rocket science degree necessary.
If you don't know how to deal with another big, big drop - it's time to "get out" or seek other advise. There is a very real possibility (not high probability but real possibility) for another 200 S&P point decline. If you want to, and can afford to take the risk - do so. Otherwise, put your money in a guaranteed savings account and save what you have left.
.

Report this Comment On November 21, 2008, at 10:11 AM, TheDash9 wrote:
I'm liking Muni Bonds these days. http://www.molifeney.com/content/view/120/57/

http://www.fool.com/investing/general/2008/11/20/fix-your-portfolio-now.aspx


Comments:

Not unexpected comments.
It is difficult for investment advisors in this difficult period.
Consequences and not probabilities should determine the actions taken by each investor.

To Upgrade the Quality of Your Portfolio

To upgrade the quality of your portfolio

For those who already hold a portfolio of stocks that may have been selected without reference to value, a culling approach to upgrade the quality of your portfolio by replacing overpriced stocks with those offering better value, would be suggested.

Although it is probable that you hold some stocks that should be sold immediately, in making that determination you must be sure of what you are doing and not act with undue haste.

Solicit advice and input from others you respect, but keep your own counsel and do not be influenced by those whose knowledge is unlikely to be superior to your own.

Let’s also consider some basic selling issues:
Tax
Let’s say you buy a stock for $5 and it rises to $15 when its value is $11. If you sell it for $15 and the $10 profit was subject to 40 percent tax, you would be left with $11. If you consider that $11 would be a good price at which to buy the stock, there is not much point in selling at the same net price.
Management
Great businesses with sound corporate management are quite rare. If you are invested in such a company, selling and attempting to find a replacement with similar management qualities is likely to be difficult. Buffett says he is wary of the risk in switching allegiance to people less well known to him.
Fear of not being able to buy back at a better price.