Quality is Overrated

Nearly every investors journey starts with Buffet and trickles down into Munger who once was given credit for being the one to tell Buffet to buy "quality" companies. Over time as the market has rewarded the business that is growing and can be bought cheaply to growth prospects this has become the true north for investors. No longer are we thinking of what's cheap on an absolute basis but rather, what is growing faster than what is being priced into a given stock and how can an expanded multiple make me 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 provide for 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 forecasted. To me though, that's not much of a margin of safety. What happens if the earnings are far worse than you project, what happens if the business performs materially outside of your projection of earnings and cash flows? What is your actual downside there?

Rather than play the guessing game of earnings would you not rather know exactly what mid cycle earnings are that are rooted in a hard asset value? I would. In this way you are not only positioning yourself to make money the second you buy a stock by buying far below asset value but you are also anchoring your valuation knowing that critical businesses operating in cyclical industries must earn their cost of capital and more to remain economically viable. Therefore, 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 know there is a rationale for 12-15% required return profile over say 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 component to long term successful investing. However, do not get sucked into the idea that quality is the only way to win simply because that is the only thing that has been rewarded since 2007-2008.