What is the value of "forever" companies

Value investing did not go through a great period. With tech and quality stocks outperforming us, it seems as if choosing cheap(er) companies was a mistake.

Personally, I always search for the most favorable combination of quality and price, as Greenblatt taught us with his Magic Formula. Although I prefer to delve deeper into companies rather than relying solely on such a formula. I avoid weak companies because the likelihood of them being a value trap is too high.

The highest possible quality, but at the right price, is what I seek. These companies form the core positions in my portfolio. In addition, I also buy solid and good companies that are simply too cheap, where we primarily count on multiple expansion. If I am not convinced of exceptional quality, I do not like to pay for growth.

I increasingly read that you should simply buy ETFs, dividend stocks, or quality companies and hold onto them forever. However, there is a significant focus on big tech and quality stocks.

Who can oppose to buying quality companies?

Who can oppose to buying quality companies? It will save a lot of headaches for many investors. I repeat once again that I am also an advocate of these quality companies and constantly seek them for our portfolio, but not at any price. If you pay too much for them, you are actually committing yourself to a lower return in advance.

However, I did have some considerations about valuing these highly qualitative companies. We define the value of a company as the value of the future cash flow that the company can generate for us, discounted to the present value.

In that cash flow, there is the dividend that they pay us as shareholders, any repurchase of own shares (if this occurs below fair value; if not, it is value-destructive), and also the money that is reinvested for growth. If it is a quality company that can achieve high returns and still grow, then we actually prefer it to reinvest that money as much as possible and pay out as little as possible.

These are the types of companies that Warren Buffett says his favorite period to hold is "forever." We share this sentiment with our quality companies in the portfolio and with the holdings.

What is the value of quality companies?

But if we really intend to hold onto these companies forever, what is the value of these companies to us as investors? Should we still determine the value based on the future cash flows for the company?

If we can never benefit from the capital gains of the shares resulting from retained cash flow because we never sell, does it really have value for us?

Or should we determine the value of these "forever" companies based on what we, as investors, extract from them, the dividends? Would the valuation of "forever" companies not be best determined using a dividend discount model?

The peculiar effect would be that, with this valuation, you would rate qualitative companies, that can grow through reinvestment, lower than companies that are at the end of their growth and pay out their cash.

It's therefore a reasoning that doesn't quite add up, but the question remains: what good is it for an investor to keep getting richer because the company’s value keeps increasing, but without selling, you can't take advantage of this increased wealth? Or if you have to sell at a time when the stock price is significantly below that increased value?

Not only building wealth anymore

Meanwhile, after many years of investing, I am no longer solely on the side of building wealth. As long as you are in the accumulation phase, the above issues don't bother you much, and a cheaper market is indeed a gift.

Why am I asking myself this question now? My wife and I bought a new house earlier this year, a beautiful home but 30 years old, so some renovations were needed. As an investor with no fixed income, borrowing from the bank was only possible for a small part. In other words, our previous home (which still had a mortgage) and my investments had to fund this new house and the changes. In short, the money had to come relatively unplanned out of the stock market.

I don't need to tell you that, in terms of timing, this is not a good period, especially now that small & midcap value (where I mostly invest alongside holdings and real estate) is really undervalued. I always maintain a cash buffer, but it was, of course, not earmarked for these expenses.

And then you look at certain things differently, namely, what is the value of 'forever' companies when the market goes against you just when you need the money?

This experience once again confirmed my belief that a healthy mix of quality and inexpensive companies is the way to structure my portfolio. The opportunity to occasionally take money off the table should not be underestimated. Additionally, it is sometimes easier to find three companies that each do +25% to +30% (successively) than one company that doubles in the same period. Why limit yourself to just one of both investments? In my opinion, both are value investing, buying something for less than its worth.