For the next issue, I'm working on a comparison of the characteristics of the positions in Berkshire Hathaway's investment portfolio (return on equity, price to earnings, debt levels, capital expenditure requirements) versus the over 2000 other companies held by Master Investors in my database.
There are a number of interesting differences, but so far, the most significant difference is the much higher average return on equity of companies (20% versus 12%) held by Buffett.
The following random thoughts have been inspired in part by that work, and in part by sixty years of life.
Investing in quality is different than value investing. Quality investing means paying a premium for the top one or two percent of US companies in terms of long term profitability, quality of balance sheet and sustainable advantage over competitors. Ironically, returns in quality investing are enhanced by an in-depth understanding of the relative values offered by the market to quality investors. The issue at the core of quality investing: how much of a premium is reasonable, and how much is excessive?
"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
- Warren Buffett
Investing is often uncomfortable. Inevitably, if you do this long enough, the market will turn against you. Successful investing depends on issues of judgment and issues of personality. Both price and quality matter. It's always a trade-off. But what is more important to you, as an investor? I am not suggesting that value investing is a strategy that lacks merit. So much of investing depends on what you hold, what you sell and what you buy during periods of adversity, and that depends, in part, on who you really are as a human being.
- Value investing: trying to get the most for the least.
- Quality investing: paying a premium quality. Quality is a philosophy of life as well as an investment philosophy. Quality friendships, for instance, take more time and effort than do casual friendships, but friendships you put effort into because you feel a deep kinship with another are deeper and more profound. They tend to outlast the difficult times, which all friendships must sooner or later endure.
Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, 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 a fine result. - Charlie Munger
Fastenal (FAST) sells nuts and bolts, sounds basic enough… but the returns are far from basic. The company averages around 20% returns on capital and produces very consistent results. 25 years ago, the stock traded for a split adjusted $0.32. Today, it trades at $44, or 138x the price in 1989. The stock has averaged 21.8% annualized returns not including dividends. This long term result nearly matches the company’s average return on capital over time.
Fastenal earned roughly $3 million in 1988, and a buyer of FAST paid somewhere around 25 times earnings for FAST in 1989. But a buyer could have paid 50 times earnings for FAST in 1989 (or roughly $0.65 per share) and the compounded annual return would have only decreased from 21.8% to 18.4%…. a big difference over time, but certainly still a splendid result.
Again, I cannot emphasize enough that valuation is more important over shorter time periods, quality is more important over long time periods (10-15 years or longer). The longer you hold a stock, the more important the quality of that company is, as your long term returns will approximate the company’s internal returns on capital over time.
- John Huber, Saber Capital Management
I'm a backslider when it comes to the quality versus price question. I generally pay the price for quality, but generally is a lot different than always. My life tends toward a deeper satisfaction and harmony when I put quality first though, so above my work desk I've posted the following as a reminder of what is most important:
Quality
In all things:
Friendships, your relationship with time,
with yourself (time in nature, music, books)
Strive for harmony, equilibrium.
Tell me, what is it you plan to do
with your one wild and precious life?
- Mary Oliver, “Summer Day”
And in investing
Invest with quality people
in quality companies when they are unpopular
“The quality of a man’s life is directly related to his commitment to excellence.”
- Tom Landry, coach of the Dallas Cowboys
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