22 March 2015
It is far better to buy a wonderful business at a fair price
“It is far better to buy a wonderful business at a fair
price than buying a fair business at a wonderful price.”
– Warren Buffett
If we step back and think about it, the above quote is just
a conclusion. Anybody who follows Mr. Buffett knows this conclusion. But why is
that and how did Mr. Buffett come to this conclusion?
The answers came to me when I was reading Snowball for the second
time during 2013. Earlier in Mr. Buffett’s career, he bought a windmill company
called Dempster Mill. You can find the details of the story in Snowball but the
short version of it goes something like this – Dempster Mill was selling at a
price much lower than its tangible book value at the time Mr. Buffett bought
it. The business was deteriorating rapidly and hemorrhaging cash at a
dangerously fast speed. Much sooner than Mr. Buffett had expected, the business
was facing real possibility of bankruptcy and Mr. Buffett had put a substantial
amount of the partnership’s money in it. To Mr. Buffett’s rescue, Charlie
Munger (Trades, Portfolio) knew a turnaround expert who was later hired by Mr.
Buffett to turn the business around. Mr. Buffett paid him handsomely to
relocate and finally the expert turned the business around. In the end, Mr.
Buffett made a ton of money out of this investment but the outcome could have
been very unpleasant had the turnaround did not work. This is an instance of
buying a fair business at a wonderful price. I wonder what would Mr. Buffett’s
results on this particular investment be had he held Dempster Mill for a much
longer period of time.
Later on in Snowball, as Mr.Buffett moved on from the 1950s
to the early 1960s, as we all know, he bought Disney and American Express at
wonderful prices due to temporary hiccups in the business, which made their
stocks plummet. What would happen if you bought American Express’s stock the
day before Mr.Buffett bought it and held it all the way through today? If
Mr.Buffett paid a wonderful price on the day American Express’s stock sank like
a stone, then you probably paid fair price, or more than the fair price the day
before. It turned out that over a long period of time, your compounded annual rate
of return on American Express (AXP) would have been only 0.1% worse than Mr.
Buffett even though you paid a much higher price. And we know Mr. Buffett has
done extraordinarily well with his American Express investment. This is the
power of buying a wonderful business at a fair price.
After we know the experiences that shaped Mr.Buffett’s
preference for wonderful businesses over fair businesses, the next step would
be asking us the question why that is. And of course the answer is over a long
period of time, stock return mirrors the growth of business fundamentals.
Wonderful businesses are able to compound the fundamental of the business at a
wonderful speed, which in turn results in a wonderful compounding of the stock
prices. Therefore, the fair price you pay today will almost always look like a
bargain price a few years out in the future. On the contrary, if you buy a fair
business or a lousy business, there is real danger that business fundamental
will deteriorate year over year and naturally so should the stock price. The
wonderful price you pay today will look like a ridiculously expensive price a
few years out. Look at what happened to Radio Shack (RSH), Weight Watchers
(WTW) and JC Penney (JCP). By the way, this should remind you of another Mr. Buffett’s
quote –“time is the friend of a wonderful business and the enemy of a lousy
business. ”
Now to step up the game, it is time to come up with your own
version of Mr.Buffett’s bite. Here is my version for your amusement:
“It is far better to buy a wonderful business at a fair
price than buying a fair business at a wonderful price because wonderful
businesses can compound their intrinsic values over time, while fair businesses
face the peril of deteriorating fundamentals over time. Fair price may look
like a bargain and wonderful prices may look awfully expensive a few years out
in the future.”
Let me end this article with a challenge to the readers –
decode the following wisdom from Mr. Buffett.
“A good business earns high return on tangible assets. A
great business not only earns high return on tangible assets but also grows.”
price than buying a fair business at a wonderful price.”
– Warren Buffett
If we step back and think about it, the above quote is just
a conclusion. Anybody who follows Mr. Buffett knows this conclusion. But why is
that and how did Mr. Buffett come to this conclusion?
The answers came to me when I was reading Snowball for the second
time during 2013. Earlier in Mr. Buffett’s career, he bought a windmill company
called Dempster Mill. You can find the details of the story in Snowball but the
short version of it goes something like this – Dempster Mill was selling at a
price much lower than its tangible book value at the time Mr. Buffett bought
it. The business was deteriorating rapidly and hemorrhaging cash at a
dangerously fast speed. Much sooner than Mr. Buffett had expected, the business
was facing real possibility of bankruptcy and Mr. Buffett had put a substantial
amount of the partnership’s money in it. To Mr. Buffett’s rescue, Charlie
Munger (Trades, Portfolio) knew a turnaround expert who was later hired by Mr.
Buffett to turn the business around. Mr. Buffett paid him handsomely to
relocate and finally the expert turned the business around. In the end, Mr.
Buffett made a ton of money out of this investment but the outcome could have
been very unpleasant had the turnaround did not work. This is an instance of
buying a fair business at a wonderful price. I wonder what would Mr. Buffett’s
results on this particular investment be had he held Dempster Mill for a much
longer period of time.
Later on in Snowball, as Mr.Buffett moved on from the 1950s
to the early 1960s, as we all know, he bought Disney and American Express at
wonderful prices due to temporary hiccups in the business, which made their
stocks plummet. What would happen if you bought American Express’s stock the
day before Mr.Buffett bought it and held it all the way through today? If
Mr.Buffett paid a wonderful price on the day American Express’s stock sank like
a stone, then you probably paid fair price, or more than the fair price the day
before. It turned out that over a long period of time, your compounded annual rate
of return on American Express (AXP) would have been only 0.1% worse than Mr.
Buffett even though you paid a much higher price. And we know Mr. Buffett has
done extraordinarily well with his American Express investment. This is the
power of buying a wonderful business at a fair price.
After we know the experiences that shaped Mr.Buffett’s
preference for wonderful businesses over fair businesses, the next step would
be asking us the question why that is. And of course the answer is over a long
period of time, stock return mirrors the growth of business fundamentals.
Wonderful businesses are able to compound the fundamental of the business at a
wonderful speed, which in turn results in a wonderful compounding of the stock
prices. Therefore, the fair price you pay today will almost always look like a
bargain price a few years out in the future. On the contrary, if you buy a fair
business or a lousy business, there is real danger that business fundamental
will deteriorate year over year and naturally so should the stock price. The
wonderful price you pay today will look like a ridiculously expensive price a
few years out. Look at what happened to Radio Shack (RSH), Weight Watchers
(WTW) and JC Penney (JCP). By the way, this should remind you of another Mr. Buffett’s
quote –“time is the friend of a wonderful business and the enemy of a lousy
business. ”
Now to step up the game, it is time to come up with your own
version of Mr.Buffett’s bite. Here is my version for your amusement:
“It is far better to buy a wonderful business at a fair
price than buying a fair business at a wonderful price because wonderful
businesses can compound their intrinsic values over time, while fair businesses
face the peril of deteriorating fundamentals over time. Fair price may look
like a bargain and wonderful prices may look awfully expensive a few years out
in the future.”
Let me end this article with a challenge to the readers –
decode the following wisdom from Mr. Buffett.
“A good business earns high return on tangible assets. A
great business not only earns high return on tangible assets but also grows.”
