’ve never met a real investor who wouldn’t like to invest in a fast growing company that earns high returns on equity and capital. However, finding an undervalued great company that can compound for a long-time is hard. The question for us (which is always the question we ask) is: Can we find investment opportunities where we have a “margin of safety” from our purchase price where we feel comfortable with the management and where we are confident we understand roughly what the business/industry will look like down the road?

Many investors fumble when it comes to holding on and achieving the long-term return that the business itself delivers. Look at any stock with a great multi-decade return and don’t forget how many recessions, macro issues, temporary business missteps or urges to “re-allocate” to a slightly cheaper stock along the way, have now long been forgotten, but caused many to sell prematurely. Of course, extreme overvaluation can make anything a bad investment for a while. Microsoft roughly quadrupled its earnings from 1999 to 2013 yet that stock was down 30% over that same period, going from a 70x P/E to 9x. What’s important when selecting investments is being roughly right about the future business trends, not perfectly dissecting what already happened.

To us, a growth business with strong competitive advantages and high returns on invested capital could be more attractive as an investment than a statistically cheaper commodity business that faces increased competition. The hard part is finding a company where you think the nature of the business gives you confidence in predicting future growth – after all it is a competitive world. Capitalism is ruthless and business moats and advantages are harder to maintain today than ever before. Customer habits also change faster than ever, and COVID-19 will leave some long-lasting consumer and industry impacts long after it’s gone.

There is a common misconception that value investing is about finding the cheapest statistical stocks where the absolute cheapest stocks on a screen are considered value and the most expensive is considered growth.

Growth is a component of value. A growing income stream is often worth more than a static one. Buying a business with low growth or in decline can work, but you better buy it cheap and even so it’s not easy. Buying a business at a price that necessitates an extraordinary level of growth to earn a return might work out fine, though the pain for anything but perfection will be severe. We never forget that business success and allocating capital is still probabilistic—we try to and invest where the odds favor material upside and manageable downside over time. Investing for above average returns is not certainty; we leave dogmatic certainty to newsletter writers and politicians.

The reality is that growth is a component of a company’s valuation, and if we can pay an attractive price for a business that has a significant runway for growth, that is considered value.

The Wire

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