Posted by kcchongnz > 2013-05-25 12:03 | Report Abuse

In search of excellent: Are good companies good investments? Many seasoned investors would have told you to invest in good companies and you will never go wrong. The core of the story is history backs you up; Public Bank, Nestle, GAB, Maybank, BAT etc. Well managed companies are also less risky. But is it really true that good companies are good investments? First of all how do we define good companies? This is important because many novice investors are confused what are the attributes of a good company; many of them falsely think that a good company is one its stock is going to be manipulated sky high by insiders and that everyone will profit from it. My criteria of a good company is a well-run company with good corporate governance; no unfair related party transactions, independent board of directors. A more measurable metric for good company is its financial performance; a durable business, constant growth in its business, a return on invested capital higher than the cost of capital, good cash flows and healthy balance sheet. More specifically the company must have sustainable future economic value added in its business. However, research has shown that investing in good companies is not a winning strategy. This is because the market has built into it these expectations. The biggest danger is that the firm will lose its luster over time and that the premium paid will dissipate. It is only when markets underestimate the value of firm quality that this strategy stands a chance of making excess returns. There is a strong tendency on the part of companies to move toward the average over time, or mean reversion. So what investors can do to profit from investing in good companies by: 1. Buy good companies that are not being recognized by the market as such. 2. Buy good companies when others throw because of overreaction to disappointing news even though the news may not have significant long-term value consequences. 3. Buy when the entire sectors or even markets may be marked down in response to bad news about a few companies in the sector or market. Screens for buying good companies can be as followed: 1. Return on invested capital (ROIC) > Weighted average cost of capital (WACC) 2. Price/Book < 2.0 3. Price Earnings ratio < 25 This is to avoid under-performance due to the usual high price of the stocks of good companies. Do you have your attributes of a good company? What are your screens for investing in a good company? What are the stocks from your screens?