In 2016, Warren Buffett via Berkshire Hathaway bought Precision Castpart – a company that has soared 20 times in the last 13 years. Its revenue grew four times only in the same period. The Oracle of Omaha believes that due to its economic advantage, Precision Castpart deserves that valuation. Here we try to fix the misconception about value investing. Spoiler alert, value investing doesn’t necessarily invest in cheap companies (low P/E, low PBV). Investing in a growth stock is part of value investing
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In This Issue
Please throw away the concept that value investing is putting your money in a low P/E company with an outstanding or long reputation. It is cigar butt investing, not value. This article proposes another point of view about value.
- Even when investor buying certain stock at premium valuation (PE more than 100 for instance), in the long run, it still could beat the market – Lesson from 1973 Oil Crises.
- It really depends on your choice, several company from the same year even non existent today
- The difference between that two group is the existence of economic moat or durable competitive advantage.
Investing in growth stock is buying the expensive, but it doesn’t always mean overpriced
In 1971, Colgate has a 126 P/E ratio – more than Amazon’s in March 2021. At a glance, The oral hygiene manufacturer is overvalued by any old-school value investing measure. In fact, during the 1973 to 2019 period, investing in Colgate delivered a 7% CAGR return, capping the world index with only 6.2% CAGR. Far from bad.
Colgate isn’t an anomaly. We have another name: L’Oreal from Europe, Hershey chocolate, your daily mate – Heineken, Pepsico, Coca Cola, Kellogg – all recorded more than 50 earnings multiple (P/E ratio).
Invest in High Quality Business (CAGR 1973 – 2019)
World Stock Index (CAGR 1973 – 2019)
It is interesting to note that the year 1973 to 1975 is one of the longest bear markets in the US after the Great Depression. This means the year prior to it – 1971 and 1972 -is the time that the stock market possibly reached its highest valuation.
Investing in growth stock doesn’t grant the superior return in the long run.
Wait, it doesn’t mean that every single stock or superstar in the 70s delivered the same superior return. In the 1960s, when the smartphone was not yet invented, the copy machine is a breakthrough – it is really old days, but it is what it is. It was Xerox that was associated with this product. At that time, Xerox is a symbol of innovation – ambition – disruption. It changed the way we work – it provided a copy machine in every office and desk.
If you find it is hard to imagine Xerox, think about Apple, Amazon, Microsoft today – they revolutionize a lot of aspects of our life and our works. It is like Google is a search engine so does Xerox is document company.
You know the rest of the story – but we beg to be different. It is not mismanagement or decelerating innovation that kills Xerox. It is the expiration of its copy machine. As we discussed in the article about Amgen, the expiration of a patent is diminishing of economic moat. We suggest readers visit our post regarding this topic.
Like Colgate, Xerox isn’t alone. Companies like Polaroid, Avon also enjoy double-digit growth, strong balance sheets. And still, like Xerox – the competition eats their share and the stock price followed.
- It is surprising that the “survivor” is the group of customer goods: Altria (Philip Morris, Hershey). These capped the “tech” group like IBM, Xerox, Polaroid.
- We don’t know whether in the long run, current big five tech (Microsoft, Apple, google, Amazon) and our favorite (Visa, Adobe) will outpace the customer goods gang. But, due to the existence of economic moat, we have tendecny to believe that the techs will still reign the market. May be they will turn the table.
Economic Moat Role on Investing in Growth Stock.
What we have? low multiple is unneeded. But, choosing stellar growth isn’t enough – a strong balance sheet, accelerating revenue – turns to be ephemeral. What do investors really need to see?
“Economic moat,” said Warren Buffett.
Or, durable business advantage – if you like a more formal definition. This is why we post a lot of posts covering this topic along with many examples – real life and modern example.
This is the first thing investor needs to find out. Sometimes we wonder why people go in a hurry to calculate the DCF when analyzing a stock. The t component of your calculation is questionable without realizing the durability of the company’s competitive advantage.
Redefining Value Investing
Now, what is value investing?
In our perspective, something valuable is something with durability – and if possible, has a lot of room to grow. It doesn’t need to be very cheap or to be a significant bargain. Moreover, the value must cover the management aspect too. So, to recap, the value investing according to us:
Durable Competitive Advantage
This means a company has the capability to retain its market share as long as possible.
Room for Growth
It doesn’t have to be stellar or meteoric – because the spectacular one usually doesn’t last long. Company with “enough” potential.
Doesn’t Pay too much
High valuation is okay, the premium price is acceptable – but nothing in this world deserves to be bought at any price.
trust – but verify, said Vladimir Putin. something there is a leakage in the company business which become real trouble someday. A competitor which not recognized, a flaw in the product, management that sucks the money. Keep watching your investment regularly. That doesn’t mean you should watch the ticker every one hour.
At this point, we have a strong belief that readers get our point, to recap:
Old School Value Investing
- Find the stock with bargain, buy it then sell if the price reach fair value.
- Use metrics like P/E ratio, PBV to assess the company.
- Find the great companies, don’t overpay
- Use metrics like free cash flow, ROIC and ROIIC
It is a misunderstanding about value investing, and we are here, tackling the issue. Value investing is investing in a high-quality business with a durable competitive advantage along with good management and don’t overpay it.