In his book Investing For Growth. Terry Smith criticizes the obsession with “cheap” shares, arguing that owning shares in a good company is a much larger determinant of investment performance than whether the shares were cheap when you bought them. Here’s an excerpt from the book:
What has continued to amaze me throughout the past five years is not just this largely pointless obsession with factors which are unknowable, largely irrelevant, or both, but how infrequently I hear fund managers or investors talk about investing in something which is good. Like a good company with good products or services, strong market share, good profitability, cash flow and product development.
I suppose I had assumed that the Credit Crisis might have taught them that you will struggle to make a good return from poor-quality assets. I am not suggesting that there is no other way of making money other than to invest in good companies, but investing in poor or even average companies presents problems. One is that over time they tend to destroy rather than create value for shareholders, so a long-term buy-and-hold strategy is not going to work for them.
A more active trading strategy also has its drawbacks. Apart from the drag on performance from trading costs, it is evident from the performance of most funds that very few active managers are sufficiently skilled to buy shares in poor companies when their performance and share prices are depressed, and then sell them close to their cyclical peak.
Another obsession I have been surprised about is that with “cheap” shares. I have been asked whether a share is cheap many more times than I have been asked whether the company is a good business.
This obsession often manifests itself in the critique of our strategy which goes something like, “These companies may be high quality, but the shares are too expensively rated.” This is almost certain to be true, as from time to time the share prices are sure to decline, but it misses the point. If you are a long-term investor, owning shares in a good company is a much larger determinant of your investment performance than whether the shares were cheap when you bought them.
You can find a copy of the book here:
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