BAD QUALITY IS ALWAYS TOO EXPENSIVE
Whether it's furniture, chocolate or stocks, quality is often expensive... but worth it. On the other hand, poor quality is always too expensive.
Given the choice, it is better to buy a high-quality stock at a slightly overpriced price than a mediocre company trading at a low P/E (price/earnings ratio), especially when investing for the long term.
Charlie Munger puts it this way: “A great business at a fair price is superior to a fair business at a great price”.
The most interesting companies are mainly in LOW-CYCLICAL sectors such as consumer non-durable goods or healthcare/pharmaceuticals. These companies usually have a high cash flow and do not need to invest a lot of capital to maintain or expand their business. They have a competitive advantage, e.g. well-known brands (Nescafé) or the ability to increase prices without losing customers (Altria).
Predictability and consistency of results is also worth its weight in gold! (e.g. Hartmann IVF).
KEEPING THE BIG PICTURE IN VIEW
The PE of a stock means absolutely nothing when viewed in isolation. It is always necessary to compare this value to the PE that the stock deserves according to objective criteria. A stock with a PE of 30 but fantastic prospects (e.g. Partners Group) can be much more interesting than another with a PE of 15 (e.g. Oerlikon).
There are dozens of fundamental data points that can be analyzed for each company. It is essential to SIMPLIFY things as much as possible in order to keep the big picture. For my part, I use 5 to 6 main quantitative criteria that I am comfortable with and that give me some additional information.
In my analysis, I only use annual figures. Quarterly results of companies are just background noise. Quality companies change little from one year to the next.
We should also not hesitate to round off figures, be interested in orders of magnitude, focus on trends and not get lost in details.
Looking at a long-term chart (ideally at least 10 to 20 years) of the stock often gives a pretty good idea of the quality of the company. It mainly allows you to see whether it creates or destroys value over the long term and how it has weathered economic crises and recovered after a recession (resilience).
Looking at an intraday chart covered with technical indicators only serves to hypnotize, cloud the mind and make us miss the big picture (“the tree that hides the forest”).
LET’S TALK NUMBERS
I will now present you with the list of my criteria and then explain how each one is calculated and what it means. Note that these criteria are not valid for analyzing traditional banks and insurance companies, nor real estate stocks.
My 5 quantitative criteria:
- ROE
- Net profit margin
- % of equity
- Dividend
- Growth in turnover and net profit.
A SHOCKING EXAMPLE
To illustrate my point, I will use two companies with diametrically opposed results and fundamentals: EMS Chemie and Schaffner, which could also be called the beauty and the beast...
Let's start with Schaffner. This is a company active in electronic equipment. On its website, we can read in the news: "The Schaffner Group continues to broaden ecosine evo series, the new generation of passive harmonic filters with an evolutionary modular concept and unparalleled technology".
Wow! Honestly, I didn't understand anything, but it sounds really good and we think that we must be in the presence of a cutting-edge company with an extremely sexy profile! But what if all this was just smoke and mirrors, cheap perfume to cover the smell of manure?
As for EMS Chemie, it is a manufacturer of special chemicals and polymers. No sexy news on the website, a company at first glance very traditional lost in the canton of Grisons.
On a one-year chart, both companies have delivered a very nice performance of around 40%:
Schaffner
EMS Chemistry
Very convincing! So what should you buy: Schaffner or EMS Chemie?
Since I'm not really a fan of the short term, I then look at the performance of these two companies since their listing on the Swiss stock exchange:
Schaffner
EMS Chemistry
What!!! Schaffner is trading at the same price as it was 20 years ago! That dancing chart looks like my son playing yo-yo! While EMS Chemie has exploded by more than 3000% in 30 years!!! How is such a difference possible? What is causing such a gap between these 2 companies?
And if we now compare these companies based on my 5 criteria...
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I forgot a remark: Good companies stay focused on what they do well and avoid getting lost in diversifications that make no sense. Warren Buffett reminds us in the 1996 annual report that Coca-Cola had for example tried to diversify into shrimp farming (!!!) before coming to its senses:
“A far more serious problem occurs when the management of a great company gets sidetracked and neglects its wonderful base business while purchasing other businesses that are so-so or worse. When that happens, the surf ring of investors is often prolonged. Unfortunately, that is
precisely what transpired years ago at both Coke and Gillette. (Would you believe that a few decades back they were growing shrimp at Coke and exploring for oil at Gillette?) Loss of focus is what most worries Charlie and me when we contemplate investing in businesses that in general look outstanding”.
I 100% agree, both on the fact that it is better to buy a quality company a little expensive (rather than a super opportunity on a rotten stock) and on the fact that the best companies are those that focus on what they do well, with a small weakness for non-cyclical consumer goods. As P. Lynch also said, I must favor companies in sectors that are not very 'sexy' and whose business is easy to understand.
Indeed, reading Peter Lynch's "One Up in Wall Street" fundamentally changed my way of looking at companies. A company that sells noodles is generally a much better stock market investment than a high-tech start-up.
My favorite example in Switzerland is IVF Hartmann, a very small company that is of no interest to any financial analyst and sells totally unsexy products: latex gloves, adhesive bandages, disinfectants or, absolutely top notch: diapers for incontinent elderly people!!!
I have never seen such unglamorous, uninteresting, even taboo products. And yet: the action is a pure marvel…
A friend who already told me about it some time ago. I will certainly buy second-hand. In the same genre I bought Orior last week.
Orior operates with a low profit margin (around 5%) and both turnover and dividends are increasing only anemicly. Not a DGI, but a good pseudo-bond.
Hartmann is truly an incredible company, I had the opportunity once to be in contact with one of their representatives and I was blown away by their sales network, especially in the hospital sector. For example, major customers had told them that it was a shame that they did not sell toilet paper (and that they had to use another supplier just for this item), and bam, a few weeks later they had added toilet paper to their catalog and expanded their range according to customer needs. A hyper-responsive company and no unnecessary administrative burden.
Also a great solid stock that is growing nicely but surely, I would bet my life that it will bring in 10% of gains per year if you keep it for at least 5 to 10 years. The only downside is the very low dividend. Also pay attention to the low liquidity and wait for the spread to drop below 2% at the time of purchase. I think I will write an analysis on this gem one day.
With great pleasure!
I like Orior because it doesn't interest anyone and it's food. In the same genre I have Emmi and Bell who have already more than doubled my stake. I really have a weakness for the food sector, a primary need according to Maslov.
Thank you for these two articles and the enlightening comparison between EMS Chemie and Schaffner. I did not know IVF Hartmann. I have a PE of 30 which is a bit expensive, but I will go and look at this company in detail. I hope to discover other interesting Swiss companies (outside SMI) in the rest of the articles. And yes, the consumer discretionary sector is also one of my favorites; however, valuations are exaggerated these days.
You're right Jean@Louis, the current valuations are sporty. I feel like I'm crossing the Sahara with only one drinks stand on the horizon and a Touareg asking 10 francs for a simple glass of water...
It’s hard to find any more actions to recommend under these conditions. My current list has become as short as Donald Trump’s list of good deeds over the last 70 years…
There is IVF Hartmann, which I can definitely recommend with a clear conscience despite the relatively high price, because it is a really high-quality stock that also weathers stock market crises very well (or even profits from them).
There is also Burkhalter, Zug Estates, Partners Group and Titlis Bergbahnen… and that's about it! Partners seems optically very expensive but I do not agree with this point of view at all and I still see a very significant appreciation potential in the coming years.
Two articles on Partners and Titlis are in preparation (we have to keep busy with these rainy days).
Titlis seems to me to be the same kind of great stock as JFN and BVZN. I love this kind of business… Niche market, monopoly position. I already have JFN and BVZN, if I add Titlis it will only be one square missing to have the 4 railway squares of Monopoly
Unfortunately, you will have to stick to 3 boxes with your Dividenpoly… These are the only ski lift companies listed on the Swiss stock exchange. The others (Lenzerheide, Arosa, Davos Klosters, Engadin St. Moritz, Schilthorn, Pilatus,…) are only traded over-the-counter (BEKB). But you are not missing much, Jungfraubahnen, Titlis and BVZ being the only really interesting ones because they benefit from both the winter and summer seasons.
BVZ is far too expensive for me at the moment. Jungfrau is OK but I have a hard time imagining a potential of more than 10 to 15% in the coming years. Titlis has in theory the biggest upside potential, but also the most unknowns.
Hello Jerome,
I think you forgot one important thing that every investor thinks about when analyzing a stock.
This is the authenticity of the company. It is crucial that it maintains a guideline so that its customers recognize themselves or identify with it. If this is the case, they will be loyal to them and the creation of shareholder value will be affected.
The example of Coca Cola and shrimp shows that diversifying its activity outside its historical field can be prohibitive.
Sincerely.
Thanks for your comment Sovanna.
Indeed, the focus, the image that the company gives off (e.g. respectful of the environment or social conditions) or even the identification with a brand are important aspects and difficult to quantify. I will address these qualitative criteria later (I don't know if it is in part 5 or 6).
What do you think of the current price of EMS-CHEMIE, which had reached 700.- at the beginning of the year and already dropped below 600.- last April? Are we in a window of opportunity to buy?
Thank you for your views.
Yes, clearly! I had sold my EMS Chemie shares at around 685 because I found them grossly overvalued at the time and I bought some back today at 582.
The stock is still expensive, but given the qualities of the company, it is justified. The valuation is again in the historical average and the dividend of 3.2% is also interesting.