On Wednesday, I articulated why paying 20x-25x earnings for a business like Chipotle Mexican Grill (CMG) could constitute an intelligent investment decision. I'm sure some people from the value-investing school will brand me a heretic for saying this, but I'm willing to stand by my opinion.
When making an investment, I do two things. First, I look at any investment not as owning a three- or four-letter ticker symbol but instead as owning part of a business. Second, I'm looking to pay a price that I calculate to be comfortably below the intrinsic value of a business, what Ben Graham defined as a margin of safety.
Some investors may quickly claim that buying a business at 20x earnings gives no margin of safety. I would respond that those investors are focusing strictly on the quantitative aspects. To be sure, the quantitative numbers are critical. However, one cannot ignore the value the qualitative aspects, and therein lies a very important observation: In the long run, quality often delivers more value than statistical value. Every year, when a company like Chipotle delivers strong growth, higher profits and more cash flow, the intrinsic value continues to increase. So in essence, the margin of safety for these companies is the qualitative nature of the business, not a single-digit valuation ratio.
Back in 2008 and 2009, when Chipotle shares were bouncing below $100 and trading between 20x and 30x earnings, a statistically oriented investor would have quickly passed up on the idea. At year-end 2012, Chipotle earned $8.75 per share. The quality delivered the margin of safety.
Looking today, other high-quality stocks trade for what I would say is a fair statistical valuation but an undervalued qualitative valuation. Wells Fargo (WFC) is one such name. Of the major financial institutions, it boasts the highest price-to-book ratio, but we can look back and see why. Since the financial crisis of 2008, Wells has given investors the greatest degree of capital preservation.
Dialysis maker DaVita HealthCare Partners (DVA) is another excellent example. Since it trades at 21x trailing earnings, perhaps there are better opportunities, but if the past is any indication of future potential, then paying a higher multiple (maybe not 21x but perhaps 18x) is warranted. Revenue has grown every single year since 2003. Over that same stretch, earnings per share have gone from less than $2 to nearly $7. There is something to be said for businesses that have these kinds of track records.
Price is what you pay, and value is what you get. But sometimes more value can be attained when you pay a little more. Would I buy Amazon (AMZN) today? Not at all. But would I pay a relatively higher price to own Amazon over Wal-Mart (WMT)? Yes.