“We believe in fundamental value and look to own high quality businesses, with low debt, excellent management, competitive advantage and pricing powers”.
I hope the above doesn’t match word for word of a fund manager’s slogan out there but it wouldn’t surprise me if it did!
I just wrote the above off the top of my head as something I expect to see whenever I go onto a fund manager’s web page. I have to ask myself if so many participants in the market are searching for this, what is the likelihood we can find these characteristics at bargain prices? It is also likely that higher quality businesses probably have performed well in the past, therefore have higher market caps and likely to be covered by far more professional research analysts.
I am finding myself less likely recently to try and pick companies that fit the above description that Buffett followers may often look for. (I refer more to his style over the last 3 decades or so that gets more publicity. Keep in mind an often overlooked factor in Buffett’s success is using leverage, and more unusual arbitrage and activist opportunities back in the 50s and 60s, a topic in itself to write about).
The more recent Buffett following approach consisting of higher quality companies I think going forward is getting more difficult. This comment may well likely to get a few people disagree with me, yet let me explain. Firstly Buffett tended to focus more on higher quality businesses when his assets got so large, thereby he could compound inside a great company. This was preferable rather than face the difficulty of selling and buying up cheaper lower quality stocks that his funds were too large to get set in. Lower quality names can sometimes require the need to exit quicker after perhaps a turnaround situation, an asset sale spinoff, a takeover or liquidation and then having to put the funds to work again in a new investment. For most of us we do not have to worry about that as out portfolios are not quite as large as Warren has to deal with! So why not continue to search amongst the deep value businesses that may not be quality, but the likes of Benjamin Graham and others have had so much success with? It is arguably a more quantitative approach that us average Joes can use rather than pretend we have the great business acumen of Warren Buffett. Whenever I look at an investment manager or blog nowadays, every man and his dog seem to all try and sell themselves with the more recent Buffett approach. As a result my sense is the higher quality companies that tick the box will be demanded by so many that it will be very difficult to acquire at a cheap enough price. I think in the Australian market there is already evidence of this with maybe a bubble forming in top quality growing companies. Dominos pizza, many health care stocks perhaps? Am sure we can name many other strong growing companies where the multiples are getting frightening. The markets globally are also paying high multiples for strong established defensive companies with high degrees of earnings certainty.
Don’t get me wrong, the really skilful investors whose style is to search for high quality companies will still succeed. I am just talking about that style as a group and its prospects in the near term.
I came across a link recently where Bell Potter identified some top quality stocks. I don’t want to have a dig at them but thought I would share the link to see how they fare after a few years. They do acknowledge they are not necessarily buy recommendations but I am sure their clients will probably read this with the bias to buy. The implication is that if we own “champion” companies we don’t have to be too concerned about the price we pay. Many times I actually agree with this. I just want to point out that this year that kind of thinking can be dangerous and it stems from my recent post how investors are paying up a lot now for quality and growth characteristics. Hence the outperformance of growth managers over value managers recently. One of the reasons high quality names get recommended is that if they turn out as shocking performers it is often more palatable for the broker. They can just say that who would have thought a great company like company X would be a loser? The average retail investor will accept that more than if the broker goes out on a limb and recommends a low quality company, riddled with debt and getting bashed up by the media which turns out to be a dud. As a result the risk is the high quality names are bid up too much which makes them risky investments. Here is the link to the Bell report for future reference anyway.
Later on the blog I’ll mention some books that I have recently read that may make you think more about investing in companies that may not have outstanding qualities but are cheap. Remember if we think in ordinary terms (like too many others), perhaps we are destined for ordinary returns?
Then eventually I will also write more about where I may look for buying opportunities that are not your typical great businesses, great management , low debt, high ROE that so many are trying to search for.
Before I wrap this up I will also place 2 links to read below if you have not already fallen asleep from my ramblings!
First is a link that probably better explains things than I have just done regarding different stages of Warren Buffett’s career.
The second link here is to an interesting piece that tries to analyse where Warren Buffett achieved most of his alpha. Note though they have only looked at things from after 1976. Some may be surprised that leverage is discussed as a key factor.
The conclusions I take away from all this is the media and many investors focus on Buffett and try to copy his style from the 1970s onwards. His style then changed to more higher quality companies partially as a result of having such large funds to manage. This part of his career from what I can tell was not as fruitful as his different style in the 50s and 60s. Not only that arguably it is more difficult to copy. Most investors have smaller portfolios to manage and would be better served reading up about the more “cigar butt”, deep value, activist and arbitrage strategies that Buffett used more in the 50s & 60s.
I’ll also add these links to the useful web links category I have on the blog.