Legendary investor Warren Buffett is known for his value investing strategy, which focuses on buying stocks that are undervalued or trading at a discount to their intrinsic value. However, while Buffett values a good bargain, he doesn’t only buy cheap stocks. He believes that a quality business is more important than the price you pay for it.
Buffett’s philosophy is that investors should be looking for wonderful, profitable businesses that can be worth hanging onto for the long haul, even if they are trading at a fair price. This idea is encapsulated in one of his most famous quotes, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Investors Shouldn’t Wait for Stocks to Hit Rock Bottom
Investors should not attempt to wait until a stock hits rock bottom to add it to their portfolio. Similarly, mediocre companies shouldn’t be bought just because they trade at a lower multiple than a wonderful company. While valuation metrics can be helpful in comparing stocks, they shouldn’t be the only criterion.
Walgreens’ Example: A Seemingly Wonderful Price with Risks
For example, Walgreens Boots Alliance (WBA) might appear to trade at a wonderful price of just six times earnings, and the stock is near its 52-week low, but it also comes with risks. While Walgreens’ dividend has an attractive yield of 5.4% at the current share price, the business itself doesn’t look all that strong. It often nets single-digit percentage profit margins — and sometimes even falls into the red.
The company is also in the midst of broadening its operations into primary care, a venture that may or may not prove to be successful. Overall, Walgreens is what Buffett would call a fair business, and one that may not be worth picking up, even if the price does appear to be wonderful.
Eli Lilly’s Example: A Wonderful Business
Wonderful businesses, on the other hand, can and often do trade at premiums, precisely because they are wonderful. Healthcare company Eli Lilly (LLY) is an example of what Buffett would consider to be a wonderful business. The company is highly profitable and boasts a hopeful pipeline of potential treatments, which includes a weight-loss treatment in Mounjaro that analysts predict could generate $100 billion in revenue and be the first drug to achieve such a feat.
Over the years, the company has demonstrated growth in its already strong business, generating $22.3 billion in revenue in 2019, and reaching $28.5 billion in the past year, with profit margins exceeding 20%. Despite these impressive figures, investors seeking a bargain may be discouraged by its high price-to-earnings ratio of 48.
However, for those willing to hold their investment for at least five years, the multiple may decrease as the company’s earnings continue to increase. Eli Lilly is an example of a wonderful business that perhaps may never get to a wonderful price but could remain at a fair price given its growth potential.
Investors Should Focus on Quality over Price
While there are many cheap and beaten-down stocks that investors can choose from in the market, not all of them are good buys or have good value. Investors should focus on finding wonderful, profitable businesses for the long haul. Focusing excessively on price and valuation could cause investors to overlook excellent businesses that may never become available at heavily discounted prices.
Basically, Warren Buffett’s quote “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” should be a valuable reminder to investors that quality should be the priority when considering which stocks to invest in. While cheap and beaten-down stocks may seem like good deals, not all of them have good value or are worth buying.
Instead, investors should focus on finding profitable businesses with attractive growth prospects that can be held for the long haul. It’s important to keep in mind that valuation metrics shouldn’t be the only criterion for comparing stocks, and worrying too much about the price and valuation can mean missing out on wonderful businesses that may never fall to deeply discounted prices. By prioritizing quality over price, investors can potentially maximize their returns in the long run.
