Wonderful Companies at Wonderful Prices: Is It Possible?
Many think that value investors can’t buy great businesses.
I’ve even fallen into this trap, thinking that I will never buy a long-term wonderful company if sticking to strict value criteria.
Why would the market ever price a great company at less than 10 EV/EBIT, for instance? Surely if you want to buy a great company, you have to pay up. Right?
Warren Buffett likes to say that it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price. Modern investors have taken this too far, in my opinion. They buy wonderful companies at any price.
I have been doing a lot of fresh thinking about this topic after looking at the dismal results of my portfolio over the last three years. I’ve re-read all of my posts and it’s often humiliating how wrong I got many things. The most glaring example is my mistake made in March by not buying many great businesses selling for wonderful prices because I was too frightened by the macro picture and the overvaluation of the broader market. I still sit on a lot of cash as I think through these things, and the market continues to rip higher.
Rather than participate in the madness, I went back and re-read the Buffett letters. I also re-read Buffettology and The Warren Buffett Way.
These books have led me to think about a question: Why can’t we have it all? Is it possible to buy a wonderful company at a wonderful price? Is it so crazy to try to do this?
And note I’m not talking about a wonderful price in the sense that you did a DCF with high growth rates to justify a high multiple.
A DCF is much like torture and torture is not effective. Usually, the victim will tell you whatever you want to hear to make the pain stop.
It’s not like 24, where Jack Bauer quickly extracts a confession, yells Damnit Chloe!, and stops the villain before the episode is over. In the real world, it doesn’t work. DCF’s are the same, in my opinion.
By the time you approach your spreadsheet to perform a DCF, chances are you are already in love with the company and will mess with that spreadsheet until it gives you want you want to hear.
I’m talking about actually statistically cheap. A low multiple, such as below EV/EBIT 10. Does that ever happen with a great company?
I decided to take a look at some great businesses & great performers over the last decade. Did they ever sell for wonderful prices?
I turns out that they all have, at one time or another.
A great example is Apple.
Apple is without a doubt a wonderful company. It has a 10 year median return on invested capital of 31%. Operating margins are usually above 25%, implying pricing power. Earnings per share have grown at a 25% clip over the last 10 years.
The stock price has reflected the growth & quality of the business, advancing at a 32% CAGR over the last decade.
In February of 2016, Apple got down to 8x EV/EBIT. All of this information was already known about the business, but the price was still cheap over doubts whether the business would continue delivering these results.
Did any value investors pounce on this opportunity? Did anyone actually use fundamental analysis to identify this opportunity?
Warren Buffett did. Berkshire began acquiring Apple in 2016 when it was at this crazy price. It was also written up in value investor’s club at the same time.
Mastercard is a wonderful company. Mastercard’s operating margin is typically astronomical, over 50%. They have a moat around payments and have benefited as our society becomes increasingly cash-less. Free cash flow has advanced at a 40% CAGR over the last decade.
Mastercard went below 10x EV/EBIT in 2009. It also dipped below 10x a few times in 2010 and 2011. It didn’t get beyond 15x (still reasonable for a company with that kind of moat & quality) until 2014.
Did any value investors pounce? Turns out they did. In 2010, it was written up in value investor’s club. It was also purchased by Randolph McDuff, a fascinating value investor who utilizes EV/EBITDA in valuation criteria. I read about in The Warren Buffetts Next Door. His blog can be read here. This is a good article about him from 2008 in which his Mastercard investment is discussed.
Domino’s is one of the best performing stocks of all time. Domino’s debuted on the public markets at the same time as Google. Shockingly, Domino’s outperformed. Since 2005, Domino’s has advanced at a 27% CAGR while Google has advanced at a 20% CAGR.
Over the last 10 years, Domino’s has grown free cash flow at a 17% CAGR. It has grown revenue at a 10% CAGR. Operating margins are consistently around 16-18%, a sign of a great business.
Shockingly, Domino’s – the stock that has outperformed Google – has traded for cheap multiples in the past. In 2011, Domino’s got down to an 8x EV/EBIT multiple. This is after they already adjusted their pizza recipe and after the stock already demonstrated excellence performance since their 2005 debut.
Did any value investor recognize this? Turns out that some did. Domino’s was written up in value investor’s club at this time.
It Is Possible
There are many other examples of this, particularly in the small cap space. I picked Domino’s, Mastercard, and Apple because they are mega cap stocks and everyone is already aware of their success. A truly efficient market would have never priced these widely followed wonderful companies below 10x EV/EBIT.
This all suggests to me that it is possible to have it all. Wonderful companies do sometimes sell for wonderful prices. Investors just need to be patient and move aggressively when these rare opportunities present themselves.
PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings. Read the full disclaimer.