"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price" is a timeless quote by Warren Buffett, cited from his letter to shareholders in 1989.
Despite being one of the world’s most successful investors, he is also famous for his brilliant, thought-provoking quotes. This particular quote revolves around the thought that buying a stock is about more than just the price.
Value investing is not merely about buying cheap stocks, but more about buying great value stocks at discounted prices. Many investors make the mistake of disregarding value, basing their investment choices purely on market trend or timing. Even though it might work in the short term, we are interested in making money over the long term and beating the market year-on-year without any added risk.
With this quote Buffett is telling us how important it is to invest in fundamentally sound companies. In essence, we buy beaten down stocks with great fundamental value. These stocks have the ability to recover from a dip and make an upswing over the long run.
The ‘fair price’ Buffett is referring to is a price that is below the intrinsic value of the stock. Through fundamental, cash flow and earnings analysis, we calculate the intrinsic value (or what we call the fair value) of a share. Buying a wonderful company at a fair price is the better option, because of the longevity of our investment strategy. When buying into a company you should be confident that the company will show remarkable growth over years to come.
The best holding period is forever.
If you buy a company to hold it forever, you want to buy a fundamentally strong company and not just any mediocre company. Fundamentally strong companies may suffer a dip, but will always be able to recover from it. This isn't always the case with fair companies. They might not survive a dip, a correction or a bear market, because their fundamentals aren’t intact.
Businesses might appear strong by having a great dividend yield, but are they able to pay their dividends from free cash flow? How wide and deep is their economic moat? Does the business show any forecasted growth potential? These are all questions you should keep in mind when purchasing shares. All of these factors separate wonderful companies from fair ones.
How to determine if a company is wonderful or not?
The value of a stock is determined by fundamentally analysing a company. Investors have different ways of determining value. Here at STRIDE we fundamentally analyse a company by using a blended metric which we call the STRIDE Scores. We rate a company on strength, timing, returns, intrinsic value, dividends and earnings predictability. By combining these 6 scores we get an overall STRIDE rating, by which we determine the fair value of a stock and whether it is a buying opportunity, a hold or a sell. You can read more about it in our blog post: STRIDE Scores: Fundamental Analysis Made Easy.
After applying fundamental analysis you will be able to sort the wheat from the chaff in order for you to make the best buying decisions.
We can conclude that investing in a wonderful company, trading at a fair price is better, because the risk is much lower than investing in a fair company, even though the business might be trading at a wonderful price. Buying value is the best buffer against investing risk. At the end of the day it is value that makes the share price recover from a dip and not the price that you bought it for.
If you only buy fair companies, because of their great price tags and not their value, you are investing with great risk and could obliviously invest in stocks that show little to no future growth potential. The chances of a fair company's shares stagnating and eventually falling through the floor is too great and could cause you to lose all of your money. We don’t want that to happen to you, so make use of fundamental analysis and only invest in wonderful companies.