Good companies vs. good investments

By bmvtyea | Bernie-flow | 18 May 2021


 

During the journey of several investors, from beginner to advanced, it is very common to think that great companies are great investments. However, this is often not true.

 

An excellent company will not necessarily be a good investment, and a not so good company can be a great investment.

 

The excellent stock companies are usually the giants that dominate their sectors, in a monopoly or oligopoly, with lasting competitive advantages and high barriers to entry.

 

The problem is that everyone knows that they are good, so their prices end up being quite high.

 

As Mohnish Pabrai, a successful investor and great admirer of Warren Buffett, said: "If the game were just to find great assets or high-quality companies, it would be very simple."

 

Reflecting briefly, this sentence makes sense, since it is not so complicated to conclude whether a company is of quality or not. For example, hardly anyone will say that Ambev, Coca-Cola, Apple, Google and Itaú are not excellent. But is it worth investing in?

 

One of the main pillars of value investing is the safety margin, which basically means buying an asset only when its price is below its intrinsic value (the estimated fair value). Thus, it is worth investing in the famous blue chips only when they are quoted at a discount.

 

Let's look at an example:

 

Whoever invested in Coca-Cola in 2000, when the brand was already consolidated in the market and known worldwide - and carried its shares for approximately 10 years -, did not obtain any return.

 

One of the main reasons was the price paid in 2000, when the P / E multiple was well stretched, to the point of not justifying the company's potential growth. Thus, in order to obtain returns above the market, Joel Greenblatt, in his book The Big Secret for the Small Investor, advises the small investor to look for bargains in small companies, known as small caps.

 

This universe of shares is not closely monitored by financial market analysts, so there is a greater likelihood of finding large asymmetries between price and value. It is here that retail investors are able to have advantages over institutional ones, as they are unable to move their huge amounts in a company with low market value.

 

Furthermore, Mohnish Pabrai argues that it is in these little-known companies that there is a greater chance of finding hidden moats, that is, hidden competitive advantages.

 

He asks why to bet on companies about which our knowledge has already been identified by the market if we can invest in those we know more than others (including, more than professionals in the financial market).

 

In other words, opportunities arise when we discover hidden moats before the majority.

 

In this way, we can apply an adequate safety margin and make good investments. It is in the safety margin that we can mitigate the risks of capital loss, betting on theses in which there are scenarios in which we gain a lot (when positive) or lose little (when negative). About the adequate margin, Pabrai also complements with the following reflection: the best strategy to invest is to buy great companies with wide avenues of growth at a cheap price and to hold them in the long term.

 

However, at the beginning of his journey, Pabrai used to buy not-so-good companies at an extremely cheap price, with margins of 50% to 60% discount. Thus, after about three years, he sold them at two or three times the capital invested.

 

The problems with this method are the constant search for new companies and the high transaction costs (and taxes) caused by portfolio turns.

Similarly, in the past, under the influence of Benjamin Graham, mega-investor Warren Buffett used to buy cigar butts, that is, extremely cheap bad companies. After meeting his partner Charlie Munger, Buffett began to look more fondly at good companies - and to pay a fair price.

 

Finally, which universe to enter into is a matter of profile. Those who wish to multiply their assets can consider looking for unknown assets at bargain prices with great potential for return, while others (who prefer to preserve their assets) may consider looking for excellent assets at a fair price.

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bmvtyea
bmvtyea

Young Brazilian newbie in Crypto


Bernie-flow
Bernie-flow

Trying to inspire those who doesn't have some financial conditions, such as myself, to growth a nice portfolio.

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