A good company is not always a good investment
The strong emotions in the stock market are visible once again. How else can you explain that a company like Nvidia still increases its market capitalization by $200 billion after presenting its figures, while the valuation, to put it mildly, was not low?
Or in Belgium, Lotus Bakeries, despite already being 'priced for perfection', briefly rose to €9,410. Lotus is now trading (€700 cheaper) at 48.6 times the earnings of the last twelve months and 41.8 times the EV/EBIT. This while the growth over the last five years has been around 13%. Not exactly a tech stock that's going to explore the boundaries of the universe.
Both are great companies, you won't hear me argue about that, but are they still good investments today?
As a value investor, I'm always very focused on the company, or maybe it's because before I became a full-time investor, I was an entrepreneur. Maybe that's why I became a value investor.
Whichever it is, by always focusing heavily on the company, I sometimes lose sight of the fact that the majority of market participants do not see it that way at all. They see stocks as products to trade. Buying low and selling high is the game they play. They see the underlying company and the figures more as what determines the price of the stock. A bit like how oil reserves determine the oil price or how river water levels determine the rates of inland shipping.
That more oil is being consumed plays a secondary role, just as with shipping, the number of transports also comes second after the state of the rivers.
I can't do that. I can't see a stock as a trading product. I always have to know the companies, who runs them, their products, their market, growth potential, and so on.
The first thing I always try to do, to lighten my workload, is to try to determine whether a company is a good or a bad company.
I try to avoid investing in bad or less good companies. In the short term, the stock price may indeed be determined by emotions and news, but in the long term, good companies stand out and the stock price follows automatically.
But still, the so-called lesser companies sometimes get my attention. There are indeed good and bad companies, but there are no good or bad stocks. Shares of a good company cannot be interesting at all if the stock price is bad (i.e., way too expensive). Conversely, shares of a bad company can be interesting to buy if the stock price is good (i.e., very cheap).
An example of these are the so-called 'net-nets', as Benjamin Graham preferred to buy. Net-nets are stocks that trade cheaper than the value of their current assets (cash + other liquid assets + adjusted inventory + adjusted outstanding receivables), with all debts subtracted. In other words, you get buildings and other fixed assets 'for free'. If such a company were to be liquidated tomorrow, you would earn a nice profit. It might be a bad company, but potentially a nice opportunity with limited downside risk.
On the other end of the spectrum are the well-known tech stocks such as Amazon, Alphabet (Google), Microsoft, Meta (Facebook), Apple, and Nvidia. These are great companies with very strong operations, which may remain at the top of their markets for years to come with exceptional margins and decent growth rates. Again, it's not about the quality of the companies, just like with Lotus. The question is whether these stocks are still good investments at current prices.
Only time will tell, but for me, the ratio between risk and potential return is not correct. Even with these fantastic companies, things can go wrong. It's like someone driving a super-fast sports car at 150 mph on the highway (where allowed). If everything goes well, they'll reach their destination very quickly. However, a small stone on the road can have catastrophic consequences. As a value investor, you're not in such a flashy sports car, but in a reliable Volvo, driving calmly at 75 mph on the same highway. You have plenty of time to calmly avoid that stone. You may arrive later, but the chance of actually reaching your destination is greater, and your journey has been less stressful.
If you want to be a successful long-term investor, it's often more important to assess and try to limit your risk than to aim for exceptional situations where the risks are proportionate.
Hence also Buffett's golden rules:
don't lose money
don't forget rule no 1.
There are good and bad companies, but that doesn't make good or bad stocks. However, there are good and bad stock prices.