During this interview with The Compound, Jeremy Grantham explained why quality stocks are the only free lunch in the investment business. Here’s an excerpt from the interview:
Grantham: Quality has a claim on being the most mispriced characteristic in the marketplace. In the old days we used to be interested in price to book and small cap. Remember the small cap effect and the price to book effect?
But the academics got something right: they are risk factors. Price to book is the market’s definition of who’s got the most auspicious assets in the business, and small cap are more likely to go out of business of course, than large cap. So when you buy them you take on some risk and you expect a higher return.
Quality, on the other hand, they have less debt, they are less vulnerable to a financial crisis. They are solid enterprises with long histories, they are less vulnerable to an economic problem.
A AAA bond, everyone knows and expects it will yield one point less than say a B. That’s the law of nature. You take less risk. They go bankrupt less. They return less than all of your money less often. And of course you expect to get a smaller coupon.
The AAA stock however, has a long history of returning half a percent more than the market.
Of course it’s ridiculous, it’s the only free good. It completely clashes with the early versions of the efficient market hypothesis, it says by taking less risk of all kinds.
Less volatility, less any kind of risk, less beta, less bankruptcy risk you still get an extra half point a year. Whether it’s 100 years, the last 10 years have been a little bit better than that.
Last year has been considerably better than that. So it is very much a candidate for the only free lunch in the investment business.
I am proud to say we realised this forty five years ago.
You can watch the entire discussion here:
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One Comment on “Jeremy Grantham: Quality Stocks: The Only Free Lunch in the Investment Business”
If Grantham looked back 55 years (1968) rather than 45 years his conclusion (given the implosion of the “nifty 50”, all considered to be of the highest possible quality) would likely be quite different. I’m inclined to think that blog article three down from Grantham (“Howard Marks: In Investing Price Over Quality Ever Time”) is more aligned with reality.