Everyone has heard the Buffett quote: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
It’s one of those quotes that gets repeated so often the real message gets mistaken for “if you just do this easy thing, you’ll make a lot of money.” The problem isn’t that it’s hard to buy great companies. It really is easy. You can do it anytime. The hard part is buying them at a fair price. Here’s Graham:
The underlying problem of selection is that the “good stocks – chiefly the growth stocks with better than average prospects – tend to be fully priced and often overpriced.” At the other extreme new stock offerings, when the craze is one, are likely to combine fourth-rate quality with absurbly high price-earnings ratios. There are better opportunities in between these extremes, but most investors don’t look for them there.
As I see it, the fundamental problem in common stocks is the market’s injection of a large speculative element into the strongest and best companies by establishing an untenably high price for them…this has added greatly to the confusion that the shares of a good company are always a sound investment, regardless of price. From this it was an easy step to calling every Wall Street customer an investor — period. – via Securities in an Insecure World
As Graham explained, great companies command a premium. Investors perceive greatness and will pay more for it. Some are even willing to pay any price for it, which is the lesson of what not to do (and some even misperceive greatness and overpay for it).
Even Buffett pays a premium to some extent. Though, he still waits for a value opportunity. The premium he pays is the difference between a great price and a fair price (basically his margin of safety). I’m sure he’d wait for a great price if he could get it, but why risk waiting and missing out when he can buy a great company at a slight discount.
The point is fair prices don’t come around often, if ever. And when they do, it’s usually because the perception of greatness has changed. Investors discount a great company to a good company or even a bad company due to some bad news. Or it’s because of a market-wide crash, but then the perception of stocks has changed. With the former, you’re buying stock of a company which the market now views as less great, but you think is still great. And with the latter, you’re buying stock of a great company but the general view is all stocks are less great.
In both cases, it’s not easy despite how easy Buffett makes it sound.
But let’s say you can handle that easy part. What do you do while you wait for wonderful companies to go on sale? (Impatience alone is an issue.)
Go back to the key line in the Graham quote above:
There are better opportunities in between these extremes, but most investors don’t look for them there.
Before Buffett was buying wonderful companies, he (along with many other Graham disciples) bought (and sold) a lot of fair companies at wonderful prices and did really well.
- Buffett’s Bet on an ‘In-Your-Face’ CEO – Bloomberg
- When Success Looks A Lot Like Failure – M. Housel
- Getting To The Cause Of Quality – L. Swedroe
- Is the Golden Era of Dividend Growth Over? – Morningstar
- Gold May Not Be the Safe Haven Investors Think It Is – WSJ
- Set It and Forget It: How Default Settings Rule the World – ProPublica
- How the Hunt Brothers Cornered the Silver Market – Priceonomics
- No One Wins Gold for Practicing the Most – Scientific American
- Facebook’s Really Big Plan for Virtual Reality – Bloomberg