Paying Up for Quality

 | Sep 08, 2013 | 8:00 AM EDT  | Comments
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Stock quotes in this article:

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Regardless of whether we want to believe it, the vast majority of investors -- think 90% to 95% -- truly will not spend the required time to properly assess and value businesses when choosing investments. Take an extreme example, Warren Buffett, who is widely considered the best investor over the past 50 years. In his biography, The Snowball, author Alice Schroeder revealed the following about Buffett:

"[His passion for money-making] had led him to study a universe of thousands of stocks. It made him burrow into libraries and basements for records nobody else troubled to get. He sat up nights studying hundreds of thousands of numbers that would glaze anyone else's eyes. He read every word of several newspapers each morning and sucked down The Wall Street Journal like his morning Pepsi, then Coke. ...He read magazines like the Progressive Grocer to learn how to stock a meat department. ...He spent months reading old newspapers dating back a century to learn the cycles of business, the history of Wall Street, the history of capitalism, the history of the modern corporation. He followed the world of politics intensely and recognized how it affected business. He analyzed economic statistics until he had a deep understanding of what they signified. ...And all of this energy and intensity became the motor that powered his innate intelligence, temperament, and skills."

Very few of us are going to devote this level of intensity, just as very few professional golfers will spend hours deliberately hitting golf balls buried deep inside bunkers like Tiger Woods does, or shooting 500 free throws a day like Michael Jordan did. Yet that doesn't mean there aren't plenty of other great golfers, basketball players or investors.

But, time and time again, most investors are better served simply sticking to high-quality investment options, even if these come at a slightly higher price. Leave the special situations, turnarounds and other financially complex situations to the folks who have the time and ability to properly investigate them. Put your own capital in well-established businesses with debt-light balance sheets, and you'll find that your investment performance will be just as good as that of many professionals.

In the past five years, the S&P 500 has risen approximately 32%, and this period includes the market meltdown that began in the fall of 2008. Over that same five-year period, your returns would be enviable to all if you had owned names such as Johnson & Johnson (JNJ), Coca-Cola (KO), American Express (AXP), Visa (V) and the dozens of other names we would all view as high-quality businesses. Those four stocks, by the way, have respectively gained 24%, 41%, 88% and 145% over that time.

Of course, these returns were in the past -- but the future will be no different. Aside from the mega-cap names, there are dozens of other high-quality businesses from which to choose. Among them are such names as medical-supply company Bard (BCR); automotive-parts retailers Advance Auto (AAP) and Gentex (GNTX); veterinary-products company Idexx (IDXX), and industrial-goods maker Raven Industries (RAVN).

As with any investment, you want to always ensure that you're paying a sensible price. But, for most investors, it's worth paying up for a quality business -- so long as the price is fair -- that has the ability to produce growing cash flows year in and year out. That should give you better odds vs. trying to pay a bargain price for an inferior business.

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