When I started in the investment business some 45 years ago, I was excited and eager to learn all that I could from as many sources as possible. I read and read and read, hoping to find the secret to investment success as we all do when starting out. I learned very quickly that there are no shortcuts. You have to experience the lows and highs, be embarrassed and frightened, and humbly accept the occasional success. So after being scarred, humiliated and whatever, what have I learnt from this long professional journey? Back to the top; Quality is Job 1. I have tried many strategies in an attempt to outperform the markets, some successful, most not but, at the end of the day, I finally realized that owning high-quality companies that had stood the test of time was the way to go.
The true nature of a high-quality business is rather simple-it has sustainable competitive advantages. Warren Buffett wrote that “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”
A business that enjoys sustainable competitive advantages is able to keep competition at bay. As a result, such businesses are able to grow their earnings. Mirroring this, the business value grows as well. The ability to keep competition at bay manifests itself in measures of economic earnings, specifically in higher returns on capital, superior cash generation and low capital intensity. Companies with exceptional profitability generate exceptional returns and have outperformed the market due to their superior earnings power. Why then do high-quality companies outperform over time?
As a result of casino mentality in the stock market, risky stocks are generally overpriced because investors are trying to own the next big thing. The tantalizing prospect of generating stratospheric returns from a small investment seems to blind people to the overwhelming probability of loss. Similarly, investors tend to underpay for less risky, high-quality stocks because these companies do not offer the theoretical possibility to shoot the lights out with one great stock selection.
Our goal then is to build portfolios of high-quality companies with sustainable competitive advantages, resilient financial results, and attractive long-term growth opportunities. We believe these companies will generate business returns consistently above their cost of capital, resulting in shareholder value creation that will ultimately be reflected in stock prices.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down”. – Warren Buffett
We may get our chance.