“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
At the heart of our investing strategy is the belief that when we invest in a company, we buy a small piece of the underlying business. It so happens that the businesses we invest in are listed on the stock market, and their market values fluctuate every day on the stock exchange. What changes in a more gradual way, over years is the underlying intrinsic value of the business. Instead of depending on price to be a guide, we focus on the characteristics of the underlying business and how it is changing over time. Our endeavour is to spot ‘wonderful’ or ‘high quality’ businesses that will stand the test of time – we would not mind owning these businesses even if the market were to theoretically shut down and we have no price indicators to judge the company by. As Warren Buffet famously said, “Price is what you pay. Value is what you get.”.
What makes for a truly valuable company?
The ecosystem around a company involves its customers, employees, shareholders, suppliers and others associated with the company. A truly exceptional company addresses the needs of all these participants, and functions very efficiently in a manner that it adds significant value to all these stakeholders.
Here are some of the traits of high quality companies that we have identified:
- Resilience: High quality companies perform well during good times and bad. In good times they grow well with the industry, but in tougher times, they grow perhaps at a lower growth rate even as some of the weaker players drop out of the race. We are very attracted to companies that have grown revenues and profits through several years, through good times and bad.
- Market Relevance: High quality companies address a large market opportunity, which sustains and grows with time. In many cases, the untapped potential may be large and we believe the best may be yet to come.
- Capital Efficiency: High quality companies are extremely efficient, and require less capital to sustain their growth. The greatest of businesses are those that require very little capital in order to grow. As a result of high levels of profitability and low capital requirements, they generate huge free cash which can be used to reward shareholders through large dividends and buy back of shares.
- Competitive Moat: High quality companies are able to maintain their competitive advantage over their competitors and the best of them keep working at increasing the moat – this helps protect and increase profitability and market share.
- Honest, Competent Management: This is perhaps the most important aspect of a high quality company because all the virtues listed above can come to nought if the company is not run by honest and capable management.
Spotting these traits in the thousands of companies listed on the stock market involves researching both quantitative and qualitative parameters. Financial parameters like revenue growth, margins, Return on Equity, Free Cash Flow generation, etc can tell you a great deal about the attractiveness of a company from an investment point of view. At Banyan Tree, we also depend to a significant degree on meetings with the company, its customers, suppliers and others in order to get a complete picture about the true worth of the company.
Despite all these efforts, a company may still perform poorly, but the probability of getting disappointed is definitely the least with companies which possess the traits we have listed above. A portfolio of such companies will never leave behind a dissatisfied investor.