Quantity AND Quality

When I offer my daughter the option of ice cream or cake, she frequently replies she’d like ice cream AND cake. To her, I offer a false alternative when the “OR” can very clearly be an “AND.” In this case, her reasoning is sound.  There is no need to give in to the tyranny of “or,” instead we should–as Jim Collins recommended in Built to Last–embrace “and.”

I see this every day while investing. Should you invest in Growth OR Value?  Properly understood, this is a false alternative, because growth is one of the most important inputs to value.  

The value of a company is based on it’s future cash flows. If those cash flows are growing, the company is clearly worth more than if they are not (you get more cash flows over time, all things equal). Value is based on Growth, so Value AND Growth must be understood.

For example, if you want a 12.5% return over the long run, you should pay eight times earnings for a 0% growth company, and 15 times earnings for a 6% growth company (almost twice as much!).  Growth has a HUGE impact on Value.

Another mistake investors make is to focus on either Quantity OR Quantity. Once again, Quality is a key input to Quantity. For instance, a company with high barriers to entry and superior management is more likely to achieve quantitative measures of performance like sales per share, profit margins and growth rates than a company without these qualities.  

The degree of certainty that a quantitative result will occur is a qualitative factor, so the quantitative result is driven by the qualitative situation. Once again, Quality OR Quantity is a false alternative–you must pay attention to Quality to correctly grasp Quantity.

Just think about Coke. An inexpensive, frequently purchased product with addictive qualities (caffeine, taste, habit) is much easier to quantitatively predict than an expensive, infrequently purchased product with no addictive qualities (like washing machines). Quality heavily impacts Quantity.

Successful investing is about understanding the nature of each investment. To successfully do this, you must focus on Growth AND Value, Quality AND Quantity. Don’t suffer from the tyranny of “or,” do as my daughter does and embrace “and.”

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Quantity AND Quality

Stick to your knitting

There are many ways to invest, but, what’s more important than any particular method you choose to is whether you stick to it.

One fundamental choice is passive or active. Passive investing is investing with the market. This method is agnostic about market value and broadly diversified. It’s low cost and tends to beat most active managers, but can go through long periods of poor absolute returns, like we’ve seen over the last 12 years. If you don’t want to search hard for superior investors and can’t stand being out-of-step with other people, then passive is probably your best approach.

Be careful, though, not to waffle between passive and active. More important than your choice of passive or active is whether you can and will stick to your choice. Those who switch between passive and active do worse than those who stick to either passive or active.

Active is investing differently than the general market in an attempt to beat market returns. This is very difficult to do, but if you can find a superior money manager, it can make a huge difference in your long term wealth. Once again, you must stick with the approach for it to work, and this will be hard to do when your active manager is out-of-step with the market, under-performing the market, and charging you higher fees than passive investing. Once again, if you switch back and forth between passive and active, you will do worse than either approach.

Within active, there are several approaches, too. There’s macro investing: trying to bet on economic trends in the attempt to have exposure to the best sectors or countries. There’s market timing: trying to anticipate market sentiment and buy when things go up and sell before they go down. There’s growth: trying to buy the fastest growing companies to beat overall market growth. There’s value: trying to buy companies selling at the lowest price to underlying fundamentals. Value has the best long term performance, but even it goes long periods of under-performance between bouts of out-performance.  

I’m going to risk sound like a broken record, but it’s too important not to emphasize again: it matters less whether you choose value, growth, marketing timing or macro, and more whether you stick to it. Value may out-perform over the long run, but it won’t work if you try to do it when it’s “working” and try to do the other methods when they’re “working.” The academic and anecdotal research on this is unequivocal, people who try to switch methods at just the right time grossly under-perform those who stick to one method consistently.

I’m a dyed-in-the-wool value investor, I’ll readily admit, because it works better than the other options. To succeed, though, I have to stick to it in good times and bad, not just when it’s “working.”

If you want good investment results, pick your method and stick to it. Though some work better than others, nothing works as poorly as trying to switch between them.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Stick to your knitting