You get what you pay up for
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How many times have you gone with the cheaper product or service, only to regret it later? In other words…You get what you pay up for. Don’t feel bad, we all make this mistake. The other day, I was looking for a charge cord for my Apple AirPods, and instead of paying $40 to buy the quality product from Apple, I bought a cheaper knock-off from Amazon for a quarter of the price. Not surprisingly, I threw the crappy knock-off cord into the garbage a few days later.
Needless to say, “you get what you pay up for” also applies to investing. We have rarely regretted paying a higher valuation for a quality investment. That said, in today’s market, quality investments look expensive. Companies in our portfolio, like Apple, Microsoft, Costco, Constellation Software, Visa and Moody’s trade at high valuations. So many investors say they would love to own these companies but only at cheaper prices. I’ve got news for them: Quality companies should trade at expensive multiples. If you own a share of a great business that routinely grows its revenues and earnings year after year, then for the most part, its shares should also trade at higher values.
It is rare to buy quality on the cheap. Generally speaking, the prices of many quality companies’ stocks fell with the rest of the market in late February and March of this year, but like tennis balls, many of these companies bounced right back. For example, in March, Microsoft’s stock price fell 20%, but then investors realized that Microsoft would be a big winner in the work-from-home trend, and it recovered promptly by month end.
There is no official description of a quality company, but in our opinion, quality companies tend to have most of the following characteristics:
Recurring revenues
Competitive advantages that create a strong moat around its business
Scalable business with long runway of growth
A product or service that people can’t live without
Pricing power
An asset-light business model
High returns on equity and capital
Ability to reinvest the capital it earns at high rates
Strong balance sheets
Management that thinks long-term
Most publicly traded companies are average businesses at best. It is near impossible for an average business to become a quality business. With an average business, the best you can hope for is that you buy it at a really cheap valuation and wait for the stock to rise to an average valuation. To take advantage, you must sell this investment and go out and find another cheap business. Replicating this process over and over is difficult. With a quality company, you can afford to buy the stock at a high valuation if you have a longer time horizon. If you are right about the quality of the business, then over time, you will be rewarded for your patience. For example, we starting buying shares of Visa for our clients in 2013/2014 at around $40 USD per share (split adjusted). At that time, Visa’s share price looked expensive, but we had to believe that the company would continue to grow its revenues and earnings at an above-average pace. To us, Visa was a quality investment that we had to make. It checked almost all the boxes on our quality checklist. Today its stock is trading at around $200 a share, up five times from our original investment before dividends received. Visa’s stock did well over the years as the company delivered double-digit revenue growth almost each year and grew its earnings per share almost 300% over our holding period. We are still adding to our Visa position today. You can argue that I am cherry picking with this example, but our clients have been well rewarded with patient investments over the years in Apple, Google, Moody’s, Microsoft and Waste Connections, to name a few.
If you find one of those companies, our advice is to hold tight. There are probably fewer than 60 terrific quality companies right now trading on North American and European exchanges, but if you are lucky to pick one of these winners, your returns could be incredible. Since we can’t know which quality company will deliver outsized returns, we hold a basket of them, but ultimately the only way to generate outsized returns from stocks is to let your winners run and trim back when your holdings get too large in the portfolio.
In uncertain times, we take comfort in owning quality businesses and we believe we will get what we pay up for.
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By Barry Schwartz|, October 23rd, 2020
Baskin Wealth Management
Source
https://baskinwealth.com/blog/you-get-what-you-pay-up-for/
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