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It seems that there are a lot of investors around who follow people like Warren Buffett into companies that have strong economic franchises. Indeed, they often buy-in years after Warren has bought. This seems particularly true of well-known consumer brand companies, e.g. Coca-Cola or Kraft Heinz.
What they often forget to do is ask a simple question: What is the price, and does that price offer a good margin of safety?
So, when Warren bought the share was standing on price earnings ratio of say 15 – quite high for a value investor, but justified if good growth can be expected. He often buys at a time when some event or temporary poor trading period has lowered the price to provide a margin of safety.
But the would-be emulators pile in when times are good, and millions of investors think that these companies are great. Of course, the shares by then are trading on PERs of 30, 40 or more. All conception of margin of safety has evaporated. Do not expect exceptionally high returns from such knee-jerk copying.
Charlie Munger, the person who most influence Warren Buffett into buying into these excellent businesses at times when there share prices are low said recently
“The trouble is you will find, when you get into those good businesses in a place that’s picked over and analyzed…if it’s really a great business, it’s at least 25x earnings and maybe 30x or 35x or something. That makes it much harder because if something goes wrong, you can lose a lot of your investment.
“Of course, that’s what makes investment so difficult, the fact that good businesses don’t stay cheap. They’ve got to somehow recognize a good business before it’s recognizable as a good business. That’s very hard to do.
“Some people get good at it, but not many. 95% of the people who are America’s professional asset managers, I wouldn’t want working for me…I think it’s that hard. I think you need to be in the top 5% to have a reasonable chance. It’s very difficult.” (Charlie Munger at February 2023 meeting of Daily Journal)
Challenge for the day: Can you recognize a good business before it’s recognizable as a good business? Do you spend sufficient time and have sufficient tools?
Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk)
