“It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
The quote above is from Warren Buffett. It reflects his investment philosophy of prioritizing high-quality businesses over simply seeking undervalued stocks. Buffett's mentor, Benjamin Graham, focused heavily on buying cheap stocks (value investing), but Buffett refined this approach, emphasizing the importance of durable competitive advantages (moats) and strong management.
We look for undervalued companies but that is not the only thing we look at. We want to buy businesses that have that X factor or competitive advantage. We want something we can hold for years, not something we have to turn around and sell in 6-12 months. Quality is the most important factor in anything. Sure, I can go out and buy knockoff Apple products on the cheap, but if they break in 6 months I will just have to take the loss and go out there again and spend more money. If I had just paid the premium for genuine Apple products up front I would have saved myself time, money, and the disappointment of buying an inferior product. Sometimes if things are cheap there is a reason why, our job is find quality companies at appropriate valuations, not just cheap stocks.
What is a quality when it comes to a business? (a few examples)
1) The X factor or competitive advantage.
Every business should aim to have that sustainable long term competitive edge that protects it from competitors. Apple for example has multiple competitive advantages. A) Brand Power and Customer Loyalty: customers will pay premium for Apple products because of the quality and innovation. B) High Switching Costs: Apple creates a seamless experience when using their products. Once you get into the “Apple Ecosystem” switching to android will be difficult. Switching to a different operating system and brand will be difficult to adjust to which incentives users of Apple products to stay. C) Pricing Power: Apple can raise the prices of their iPhones and people will stay. iPhone prices have been increasing and Apple still dominates the smart phone market.
2) Companies with consistent and growing earnings.
When you have stable growth in earnings things are easier to predict. Take Coca Cola for example, they have much more stable earnings and growth than highly cyclical businesses like Airlines who have to deal with high fixed costs, variable costs that can fluctuate like fuel, and situations like COVID where the airlines were highly effected by market demand and macroeconomic factors.
3) Long-Term Growth Potential
The bigger a company gets the harder it is to grow. It is the law of large numbers, the larger a company gets the harder it is to sustain those large growth rates it has become accustom to. A company that is 10 billion in size only requires 10 billion in additional revenue to double where as a company that is 1 trillion in size needs 1 trillion in revenue to double. At some point and every company goes through this, it will hit a plateau and then it will start to decline and will eventually die over time. An example of a company that wont be able to sustain their high growth rate is Tesla. Tesla grew from 7 billion in revenue in 2016 according to the 10k to 97 billion in 2024. This 54% growth rate simply isn’t sustainable. You might have made the bet early on that growth will be high but it wont stay like that forever, if the market perceives or thinks growth cannot continue they will price that in and when they price in the new growth or no growth that is when you get multiple compression. My old boss showed me an example that made this very clear, take Cisco for example in the 90s, it had annual growth rate of around 35% but then the dot com bubble burst in 2000 and the stock plummeted. If you bought at the peak and held till now you still would not have made your money back. Growth investing when done wrong can be dangerous, you better know when to get out or reduce your position, markets and stocks don’t go up at high growth rates forever. It is much better to buy something you have conviction on and know that the growth can continue at sustainable rates.
