Quality is Overrated

Nearly every investor's journey starts with Buffett and trickles down into Munger, who was once given credit for being the one to tell Buffett to buy "quality" companies. Over time, as the market has rewarded businesses that are growing and can be bought cheaply relative to their growth prospects, this has become the true north for investors. No longer are we thinking about what's cheap on an absolute basis, but rather, what is growing faster than what is being priced into a given stock and how an expanded multiple can make us money.

In my view, this is the wrong approach if your goal is to be a value investor. The idea of buying a quality business at a cheap price does not give you much of a margin of safety, especially when intangible assets are present. The implied margin of safety comes from making money even if earnings don't grow as much as you originally thought they would. To me, though, that's not much of a margin of safety. What happens if earnings are far worse than you projected? What happens if the business performs way outside of your projection of earnings and cash flows? What is your actual downside there?

Rather than play the guessing game with earnings, would you not rather know exactly what mid-cycle earnings are, rooted in a hard asset value? I would. In this way, you are not only setting yourself up to make money the second you buy a stock by buying far below asset value, but you are also anchoring your valuation knowing that important businesses operating in cyclical industries must earn their cost of capital and more to stay economically viable. So, if I buy an asset base for 50% of replacement value when the assets are only earning a 4-5% IRR, or even losing money, and I know there is a reason for a 12-15% required return over a 3-5 year period, that to me is attractive.

Everyone has to do what is comfortable and repeatable for them, and that is a critical part of long-term successful investing. However, do not get sucked into the idea that quality is the only way to win simply because it is the only thing that has been rewarded since 2007-2008.

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