During this interview with The Market NZZ, Terry Smith explains why the quality of a company is more crucial than its valuation. By examining historical data, he demonstrates that even if investors had paid high price-to-earnings (P/E) ratios for certain quality companies they would still have outperformed the S&P 500 over fifty years.
Smith points out that people often misunderstand the impact of different compound rates of return, highlighting the significant yet often underestimated difference between a 10% and a 12% return.
Here’s an excerpt from the interview:
Smith: Valuation is not as important as quality. We looked back over fifty years at the P/E ratios you could have paid for certain companies and still outperformed the S&P 500. For L’Oréal, the starting P/E you could have paid was 281.
People are very bad at working out the difference between different compound rates of return. The difference between a 10% return and a 12% return isn’t something we can easily grasp. We think it’s 20%, but it’s not. Owning good companies is more important than owning undervalued companies.
Host: Can you elaborate?
Smith: There’s a great Buffett quote on it: «It is better to own a great company at a fair price than a fair company at a great price.
If you own a fair company at a great price, you hope that the price will adjust to the correct valuation. But after that, that’s the end of your good investment. You have to move on and find something else, whereas a great business is a gift that can keep on giving.
You can read a transcript of the interview here:
Terry Smith Interview – The Market NZZ
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