Quality Investing: Owning The Best Companies For The Long Term (TOP 5 LESSONS)

the quality investing strategy is one of the best ways to build wealth in the stock market buying and holding quality companies is a winning strategy for long-term investors in the book quality investing owning the best companies for the long term we can learn how to identify a quality company and how to apply the quality investing strategy in this video we will go over the top 5 lessons from this book the first lesson is the quality investing strategy quality investing is a way to pinpoint the specific traits aptitudes and patterns that increase the probability of a particular company prospering over time as well as those that decrease such chances the author believes that three characteristics indicate quality these are strong predictable cash generation sustainably high returns on capital and attractive growth opportunities these traits combined can enable a virtuous circle of cash generation which can be reinvested at high rates of return be getting more cash which can be reinvested again a simple example illustrates their power say a company generates a free cash flow of 100 million dollars annually its return on invested capital is 20 percent and it has ample opportunity to reinvest all cash and expansion at the same rate sustained for 10 years this cycle of cash generation and reinvestment would drive a greater than six-fold increase in free cash this is the magic of compound return since share prices tend to follow earnings over the long term the more capital that can be deployed at high rates of return to drive greater earnings growth the more valuable a company becomes warren buffett summarized this point leaving the question of price aside the best business to own is one that over an extended period can employ large amounts of incremental capital at a very high rate of return the second lesson is the patterns of a quality company some patterns indicate a quality company let's check the main ones the first is customer benefits the products of quality companies confer considerable benefits on their customers and understanding the relative value of these benefits is an important part of business analysis people have a favorite soda primarily because they enjoy the specific taste factors like taste and image are tough to measure objectively but offer considerable intangible consumer benefits with purchases based on intangible benefits price is usually secondary for customers the value of knowing or believing that they are choosing the most reliable or highest quality product can translate into a highly sustainable willingness to pay a premium price for example if a failure of a machine can cause the shutdown of a manufacturing plant customers will work with suppliers that offer a quality product even at a higher cost than competitors the second is good management it is not always the case that a quality company has an excellent management team but the combination of strong management and a well-positioned company can be powerful good managers have a long-term vision for a business and the tenacity to realize it they are never satisfied but are instead driven by an indefatigable and passionate quest for improvement good management recognizes that a top priority is developing and deploying people who will then help achieve an organization's goals the third is brand strength winning brands create an affinity an attachment with the customer either emotional or logical the apple brand has its super fans and there are lifelong devotees of brands like louis vuitton differentiation and customer attachment allow for premium pricing and potential gains in market share often such brands have a non-replicable heritage and have endured over time a brand is a promise an implicit guarantee of qualities or characteristics the promise needs to be honored consistently the brand power can be vulnerable when a fast-changing technology plays a large role in the benefits it offers look at nintendo for example it is a famous brand that owns video game icons like super mario yet superior innovation from competitors diminished the brand appeal the fourth is recurring revenue recurring revenues arise when an existing customer base buys additional services or products from a company the most powerful version arises when such obligations to pay for the service are locked in high degrees of recurring revenues increase the stability of a business and the predictability of its cash flows one example of recurring revenue is software companies in which the client pays a recurring value to the company to use the software the fifth is innovation dominance innovation dominance can facilitate both volume growth and pricing power companies that invest in tactics to defend and grow their business can build a virtuous cycle of growth more spending drives revenues at high gross margins that spins off more investable resources innovation must be profitable to make innovation dominance attractive not all innovation makes a business better in many industries companies must innovate constantly simply to defend their position when such innovation comes alongside declining margins a company is engaged in costly cannibalization not value creation to create value innovation must increase volume or induce customer switching from a company's less profitable to more profitable offerings like an expensive version of an existing product incremental innovation generally tends to produce more predictable revenue growth companies that have been able to improve customer benefits by a small increment annually for decades are more likely to keep doing so the third lesson is capital allocation a company can choose to allocate capital in one of five main ways expenditures for growth advertising and promotion research and development merger and acquisitions or distribution to shareholders through dividends or share buybacks capital allocation decisions can create or destroy value for shareholders let's check each one of these capital allocation possibilities the capex expenditure for growth is the money the company will invest to generate organic growth examples might include the construction of a new plant to increase production capacity or investment in new stores if the company can invest its earnings to grow with high returns this is the best capital allocation possible as it will result in a compound return the company can also invest in research and development or r d investments in research and development are the money spent on the development of new products or the improvements of the existing ones this can be a good thing as the new products can help the company to grow its earnings in the long term if a company has a good track record of generating returns on its r d outlay it's a great sign investment in advertising can also generate value for shareholders it can help to build strong brand power a company can also invest in merge and acquisitions an acquisition can either be a source of value creation or destruction an acquisition where the company is diversifying by expanding in new areas may be a risk because of the lack of expertise in that area as peter lynch said these diversifications can become a worsification there are also some contexts where acquisition can generate value consolidation of fragmented industries is often an appealing rationale for growth through acquisition also when a company with a good brand is acquired it can generate value by adding the brand to the company portfolio the last capital allocation is dividends and buybacks excess cash funds a company does not need to reinvest in the business or to seize attractive opportunities should be distributed to shareholders as dividends or share buybacks the fourth lesson is bottom-up versus top-down analytics quality investing is best conceived as a bottom-up exercise in the sense of focusing primarily on the company some investors use top-down analytics by looking at the broader environment considering the state of international trade the rate of inflation or the relative strengths of currencies in a quality investing context mistakes can arise from elevating top-down perspectives above bottom-up analysis one of the problems with the top-down perspective is weak conviction when an investment idea is based on the forces of macroeconomics it is far more difficult to have a conviction about a company or even an industry when adversity or surprise strikes for example when commodity prices fall or currencies reverse it can be harder to stand the thesis so when you focus on the business of the company you will have a better conviction of the company for the long run when you choose to invest in quality companies from the top down factors do not matter in the long run as the quality of the company will lead the company to survive and grow over time despite macroeconomics problems the fifth lesson is valuation and market pricing a quality investing strategy emphasizes quality first and valuation second many investors might agree that a specific company is great they just want them cheaper and wait until tomorrow when the price might decline the problem is that the day seldom comes if a company keeps delivering operationally its relative multiples rarely contract companies that are consistently able to deploy cash at high incremental rates of return often exceed earnings expectations over the long term so while the valuation premiums of such companies may reflect solid expected operational performance they often underestimate actual performance thus stock prices tend to undervalue quality companies for most of the past decade novo nordisk a pharmaceutical company that produces mainly diabetes products has had its shares pricey relative to its sector and the market despite this optically expensive multiple investing at almost any point during the decade would have been lucrative financial analysts routinely underestimated the earnings growth driven by novo's attractive and stable financial and corporate characteristics this is one of many examples that illustrates the rationality of prioritizing the analysis of corporate quality over price valuation the driver of long-term returns is earnings growth and quality companies with the characteristics that we saw earlier tend to grow their earnings in the future in the book warren buffett and the interpretation of financial statements we can check how warren buffett reads a financial statement and what he is looking for in a company you can check the top five lessons from this book by clicking on the card on the screen bye

Channel: The holder investor

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Keywords: Quality Investing, Quality Investing Owning The Best Companies For The Long Term, Lawrence A. Cunningham, Torkell T. Eide, Patrick Hargreaves, valuation, market pricing, top-down analysis, capital allocation, Warren Buffett, Investment Strategy, investing for beginners, stocks, moats, competitive advantages, Value investing, Charlie Munger, Investing in your 20s, Stock market, How to start investing, how to invest, how to invest in stocks, investing strategies, stock market

Id: X92j1smWsfY

Length: 10min 39sec (639 seconds)

Published: Sun May 15 2022