08-27-2021, 10:56 AM
Thought this was an nice comment from SeeksQuality on Seeking Alpha this morning on his thought process on paying a premium for quality vs. buying "value" stocks.
It is true that there are often real reasons why a company is trading at a premium valuation. But conversely, there are also often real reasons why a company might be trading at a discount valuation. The key pitfall for a value investor is a "value trap", in which a weak company is trading at a discount -- yet weak performance continues to pull the stock down. This often leads to a dividend cut and selling at a steep loss.
Does it make sense to sell a strong company at a premium valuation to buy a less-strong company at a moderate valuation? Does it make sense to buy a weak company at a discount valuation? Perhaps! The market tends to overreact to both strength and weakness, so trades like this can often allow the investor to profit from a "correction" period. I did that with ORCL earlier this year, reaping a 15%+ gain in one month as the valuation corrected. But trades like this weaken the operating performance of your portfolio. If you want to own strength, you need to swap back into the stronger company as soon as the correction period is over. Longer term, I want to own MSFT in this space.
The most impressive results are when you can buy strength at a discount valuation. AAPL in 2016. SPG a year ago. It can be a little scary to look past the FUD of the market correction to see the strength, but if you can manage that then you do very well.
Yet there are also times when TRYING to do this hasn't worked out so well for me. Back in 2011, I knew that HPQ was a solid company with a wide moat. Their printer-ink business alone justified the price of the company, and they had a couple other profitable franchises as well. How can you go wrong buying a great company like that as a discount?!? I dunno, but I somehow managed to lose $4k in 2011 and as if that weren't enough I came back to lose another $2.5k in 2012. Value Trap!
Thus I've come to the conclusion that the best opportunities are buying strong companies at valuations that are near or even above the market average. Nike in 2016. MSFT in 2017/2018. Perhaps AMZN today (though the multiples on that one are still VERY high)? None of these traded at a discount -- but the operational performance and subsequent price strength more than justified those purchases.
Nothing against paying less for a purchase, but the most important thing for me at this time is to buy strength. If I can buy strength at "fair value" or even at a modest premium to FV, then that works out very well for me! If the price drops further, I will happily add more. At this point in my investing journey, I don't want to be gambling large sums on discounted weakness.
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I've had many more losing trades when buying value stocks than when buying best of breed at premium valuations. Some of my worst sales were when I trimmed or sold great stocks that I thought were overvalued to free up funds for cheap stocks that I thought looked like better values.
When investing for the long-term it's better to just buy the best companies and hold them forever rather than waiting for a perfect price to do it or buying lesser companies just because they are cheaper.
It is true that there are often real reasons why a company is trading at a premium valuation. But conversely, there are also often real reasons why a company might be trading at a discount valuation. The key pitfall for a value investor is a "value trap", in which a weak company is trading at a discount -- yet weak performance continues to pull the stock down. This often leads to a dividend cut and selling at a steep loss.
Does it make sense to sell a strong company at a premium valuation to buy a less-strong company at a moderate valuation? Does it make sense to buy a weak company at a discount valuation? Perhaps! The market tends to overreact to both strength and weakness, so trades like this can often allow the investor to profit from a "correction" period. I did that with ORCL earlier this year, reaping a 15%+ gain in one month as the valuation corrected. But trades like this weaken the operating performance of your portfolio. If you want to own strength, you need to swap back into the stronger company as soon as the correction period is over. Longer term, I want to own MSFT in this space.
The most impressive results are when you can buy strength at a discount valuation. AAPL in 2016. SPG a year ago. It can be a little scary to look past the FUD of the market correction to see the strength, but if you can manage that then you do very well.
Yet there are also times when TRYING to do this hasn't worked out so well for me. Back in 2011, I knew that HPQ was a solid company with a wide moat. Their printer-ink business alone justified the price of the company, and they had a couple other profitable franchises as well. How can you go wrong buying a great company like that as a discount?!? I dunno, but I somehow managed to lose $4k in 2011 and as if that weren't enough I came back to lose another $2.5k in 2012. Value Trap!
Thus I've come to the conclusion that the best opportunities are buying strong companies at valuations that are near or even above the market average. Nike in 2016. MSFT in 2017/2018. Perhaps AMZN today (though the multiples on that one are still VERY high)? None of these traded at a discount -- but the operational performance and subsequent price strength more than justified those purchases.
Nothing against paying less for a purchase, but the most important thing for me at this time is to buy strength. If I can buy strength at "fair value" or even at a modest premium to FV, then that works out very well for me! If the price drops further, I will happily add more. At this point in my investing journey, I don't want to be gambling large sums on discounted weakness.
-----------------------------------------------
I've had many more losing trades when buying value stocks than when buying best of breed at premium valuations. Some of my worst sales were when I trimmed or sold great stocks that I thought were overvalued to free up funds for cheap stocks that I thought looked like better values.
When investing for the long-term it's better to just buy the best companies and hold them forever rather than waiting for a perfect price to do it or buying lesser companies just because they are cheaper.