How to Invest: Buying a Great Business at a Fair Price

Great investors often have one strong commonality: They look at stocks as a piece of a living, breathing business. But beyond that, they have many different ways to approach the game.

Even within our office here at The Motley Fool Singapore, we have investors who invest in vastly different ways (though it must be stressed that we all still look at stocks as a piece of a business) and yet achieve similarly good results.

Despite the myriad ways in which different investors use to describe their strategies, when it’s all said and done, it boils down to two reeds:

  • Buying a great business at a fair price, or
  • Buying a fair (or lousy) business at a great price

This article will be digging into what it means to buy greatness at a fair price and it is part of a two-part series which takes a closer look at the two aforementioned ways of approaching the art of fundamentals-based investing.

Identifying greatness

So, what makes for a great business?

Typically, such companies will need to have a huge addressable market – without a large market of customers ready to take up its products and/or services, there’d be no room for a company to grow.

But beyond the addressable market, a great business will also often have the ability to generate strong cash flows from its operations so that it can expand without having to raise capital externally on a frequent basis. Raising capital through the sale of new shares can dilute existing investors’ stakes while raising capital by borrowing money can increase the level of financial risks the firm’s taking on; both can be very unpalatable choices for an investor to stomach.

A great business would also often possess a competitive advantage that can protect its profits from competitors. This is also often known as an economic moat in the lexicon of the investing community.

Buying greatness

The stock market often does a decent job of figuring out the wheat from the chaff; as a result, great businesses are often not traded at prices which represent a significant discount to their intrinsic values. Investors would thus only be able to purchase a stake in great businesses at a fair valuation at best most of the time.

Staying with greatness

Once the investment’s made, it may make sense to stay invested for the long-term, a timeframe that’s measured in years or even decades. That’s because if the company’s able to grow for years on end, it can compound value for its investors over that same period.

That’s how investors in great companies can go on to earn multiples on their investment. Warren Buffett’s purchase of fizzy drinks giant The Coca-Cola Company is a great illustrative example.

Buffett, who’s one of the best investors in the world today, first started buying Coke’s shares in 1988. In that year, Coke was earning US$0.18 per share in profit. Fast-forward some 26 years to 2014, and we see Coke’s earnings per share jumping nine-fold to US$1.62. The solid profit growth has led to Coke’s share price gaining 1,667% from the start of 1988 to yesterday.

At the local front, companies like Vicom Limited (SGX: V01) and Raffles Medical Group Ltd (SGX: R01) might also be good examples of long-term compounders that have built great value for their investors.

Vicom and Raffles Medical's Earnings Per Share (EPS) Growth from 2004 to 2014

Source: S&P Capital IQ

In the chart just above, you can see how Vicom’s and Raffles Medical’s profits have grown steadily – and materially – over the past decade from 2004 to 2014. This has helped propel their share prices higher by 548% and 986%, respectively, since the start of 2005.

Parting ways with greatness

It’s not all just rainbows and sunshine when it comes to buying (and holding) great companies at fair prices though.

As this is a long-term strategy, you’d be reasonably sure that you’ve made a mistake with a company only after a long period of time. By then, your investment in the firm may already have dwindled in value significantly. That’s not to mention the opportunity costs that are involved with the investment.

Another disadvantage has to do with portfolio management. Buying and holding great companies at fair prices may leave you with a very concentrated portfolio after a number of years as a result of your best investment compounding at a much faster rate than the rest and hence making up a large portion of your portfolio. At that point, you may be sorely lacking diversification with your total wealth hinging on only a handful of companies.

Foolish Summary

That’s all I have for buying greatness at a fair price. For more on the other approach, check out here. There really is no right or wrong choice between the two as there are great investors who have succeeded with either way. It’s more important to stick with what suits your temperament the most.

There's a lot more to talk about when it comes to investing strategies and if you'd like to do so in person, you can come meet David Kuo and the rest of the Fool Singapore team on August 15! 

Please join us at Invest FAIR Singapore on 15 August. (Suntec Centre, Booth B-16). Come chat with us at our booth, and see our MAS-licensed Director, David Kuo, give his official SGX investor presentation.

You won't want to miss this! Add Invest FAIR Singapore to your calendar today.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies mentioned above.