Brandes is a investment management firm that follows the value investing philosophy. I found a hand out on their site that explains that a good company is not necessarily a good investment.
“One concept that value investors keep in mind is that a good companyis not necessarily the same as a good investment. An established firmwith high revenue levels and a stable, strong earnings record, forinstance, certainly sounds like a good company. But like any company,that firm only represents a good investment if it can be purchased at afavorable price.” The article gave the example of Cisco in the 2000s asa solid company, but was over-priced, $465 billion to be exact, which“dwarfed its $15 billion revenue and $2.5 billion net income”.
In this case, Cisco was a good company that turned out to be a rather bad investment. As of July 11, 2010, the market cap for Cisco stood at about $130 billion – still down 72% from its peak. I actually owned shares of Cisco in late 1999. I bought simply on the basis that I felt Cisco was the leader in the networking and internet router business. I had no idea about valuation and what it meant. Simply put, I was just speculating. In fact, I even had a 50% gain on my investment. However, I held on as I had heard that investing is “buy and hold” and investing is for the long term. I did not want to be considered a speculator by selling my investments so soon. Little did i realize that investing without doing any due diligence on the company as well as its valuation is also a form of speculation. “A fool and his money are soon parted”.
I can vouch for that. I sold my shares after two more years at a steep loss.
On the other hand, many good investments are not necessarily ‘good’ companies. They do not have the high sales and earnings growth, they could be down in the dumps ( Cyclical companies), they could be unloved due to temporary issues surrounding them be it legal, competitive, regulatory. These could well turn out to be excellent investments.
What one should remember is that buying shares of a company just because you know about the company or like its products is not enough. Investments usually are profitable when you pay less than what they are worth.
