Quality Investing

Quality, Quality, Quality

The great value investors, from Benjamin Graham to Warren Buffett, have understood and articulated that stock ownership is ultimately about business ownership. When you purchase shares of a stock, you own part of an actual company, not slips of paper.

Seeing yourself as part owner of a business instead of merely a generic shareholder changes your perspective. You're literally going into business with the company whose shares you own or whose options you trade.

Be honest now. Of all the stock and options positions you have ever held, what percentage consisted of truly high quality companies? How many were businesses you would be willing to own over an entire lifetime? If you're like the rest of us, most of the securities you've dealt with had more to do with recent stock performance than long term and incredibly sound business fundamentals.

It's not just momentum players or premium chasers who are guilty of settling for partnering with mediocre, and sometimes inferior, businesses. What frequently passes for prudent, long term, investing guidance—namely the need for diversification—is, in actuality, abysmal advice. Putting your money into mutual funds or ETFs and index funds consisting of dozens or even hundreds of stocks is a really efficient way to ensure lousy performance.

Blind investing is not quality investing. It's an abdication of your own entrepreneurial responsibilities and is suitable only for those with absolutely no aptitude or desire for real investing. [note: if you're reading this, you obviously possess both aptitude and desire.] Giving your money to a mutual fund manager whose performance is tracked on a quarterly basis guarantees that you're going to be part owner of a ton of average businesses as the fund "diversifies" and constantly turns over its positions.

So What's So Great About Quality Investing?

1. You're much less likely to go out of business
2. You're going to make a lot more money

Don't forget that the point of owning a business is to make a lot of money with limited effort on your part. You obviously can't do that if the company you own (or partly own) fails and becomes insolvent. And you can't do it if you're getting knocked around by your competitors or if you're in an industry where no one is making money (like Airlines about 95% of the time).

Of course, diversification through the ownership of countless mediocre/average companies protects you against the calamity of a crash in share price of any individual stock. But the only reason you would need that protection would be if you loaded up on trash companies to begin with. There's a weird, circular, false logic to diversifying through the purchase of a lot of unworthy securities. The securities are unworthy because they're issued by companies that are themselves unworthy.

Defining Quality Investing

• Benjamin Graham's classics, The Intelligent Investor and Security Analysis
• Warren Buffett's annual Berkshire Hathaway shareholder letters
• It's Earnings that Count by Hewitt Heiserman
• Rule #1 by Phil Town

• Morningstar.com
• The Motley Fool website

No single resource is definitive or infallible. As with everything in life, learn what you can, seek counsel, but then make your own choices. It matters less that you and I agree on the value and quality of a specific company than that we each have well-considered arguments to back up our opinions.

In a single, non-quantitative sentence, quality investing is investing in a business that consistently makes a lot of money and one that you're confident will continue to do so well into the future. And rather than trying to quantify that statement with a mathematical or financial formula, let me close instead by asking you two important and revealing questions:

1. Have you ever sat down and made a list of what you consider to be the twenty best (however you define that term), ten best, five best, and single best publicly traded businesses?
2. Would your stock selection process differ if, rather than simply typing in a ticker or option symbol into your online options broker's trading application, you were instead required to meet a $25,000 investment threshold, commit to ownership for at least five years, and submit a lengthy application for review?

Final Thoughts

Fortunately, that's where Leveraged Investing comes in, option trading strategies that can help us simulate successful value investing. That's right—instead of using options with a short term trader's mindset, we can use them to simulate great value investors who buy terrific businesses for less than what they're really worth.