Here’s a great presentation by Fundsmith’s Terry Smith in which he illustrates how investors can generate excellent returns by focusing on high quality businesses, which may be trading at high multiples. Smith had the following to say about investors that focus solely on cheap prices:
I wish I’d kept a diary from my first day at work in 1974 in the financial service industry with two columns each day, and then I put a tick in the column when somebody said to me, on the one hand is that a cheap stock, or not a cheap stock? Is that a cheap fund or not a cheap fund? Is it cheap market, not a cheap market? Tick in that column.
On the other hand when they put one in the other column, is it a good company? And I know which column where the balance will be. Trouble is I don’t know exactly cuz I didn’t keep the diary. But overwhelmingly over the years and still to this day people ask us here, but is it cheap? It’s not the most important question!
Providing you get the first decision right, which is you’ve got good things. Whether or not they’re cheap is a secondary consideration. It’s why it’s second on our list.
Okay, don’t take my word for it. This is Warren Buffett’s side-kick Charlie Munger. I don’t know why he picked these particular numbers but what he said, over the long term it’s hard for a stock to earn a much better return than the business which underlies it. If the business earns 6% on capital over 40 years, no idea why he chose six percent or forty years but doesn’t matter, you hold it for that 40 years you’re not going to make much different than a 6% return. Here’s the punchline. Even if you originally buy it at a huge discount.
Conversely if a business earns 80% on capital over 20 or 30 years, even if you pay an expensive-looking price, there’s the punchline the other way, you’ll end up with one hell of a result.
You can watch the entire presentation here:
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