Business Quality

Business quality is defined by the return on capital employed, calculated before goodwill.

The implication is that better returns are synonymous with a better-quality business.

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!

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."