The Importance of Price
When making an investment decision, particularly with stocks or equities, many investors often overlook one of the most important considerations: the price or valuation of a company.
"There's no investment idea that is so good that it can't be spoiled by too high an entry price." Howard Marks
When making an investment decision, particularly with stocks or equities, I find that many investors often overlook one of the most important considerations: the price or valuation of a company.
The allure of investing in high growth industries or innovative technologies can lead even the most rational investors down a dangerous path of paying over the odds for a business. At the time of writing, the so-called “Magnificent Seven” – Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, and Tesla - had a combined valuation that exceeded the aggregate value of the UK, Canadian, and Japanese stock markets. Much of this growth was fuelled by the market’s expectations of artificial intelligence (AI) developments in 2023.
Many of the companies within the Magnificent Seven may be positioned to benefit from AI and grow faster than contemporaries in more mature industries. But is there a price at which owning these companies doesn’t make sense? Or, to benefit from the boom in AI, should we throw caution to the wind and buy growth at any cost?
A look at the performance of a company that was once the largest in the world by stock market capitalisation, Cisco Systems (CSCO), offers some perspective. Once hailed as the “king of the internet”, Cisco had exceptional revenue and profit growth in the early 2000s. As a result, the company’s stock surged over 1,000 times from its initial listing price, peaking at $80 per share on 27th March 2000.
If you invested in Cisco at its peak on 27th March 2000 and held it to 25th January 2024, your return would be -6.26%. In contrast, an investor in an S&P 500 tracker (SPY, in this example) would have returned 393.67%.
This fate of Cisco’s stock price is an extreme example, but it provides a cautionary tale. There can be an asymmetry between the price paid and expected returns – paying a high price for a company can reduce expected returns and increase the potential for downside if that company fails to meet the market’s expectations. On the contrary, paying a low price for a company can increase the potential upside if that company beats expectations.
After all, in an efficient market, the price provides us with a fair, unbiased estimate of the present value of company’s future cash flows based on the information available to market participants. It’s difficult to know when a price is too high or too low, but there is an overwhelming amount of evidence supporting the notion that cheaper stocks outperform their more expensive counterparts over long periods. The pithy adage “buy low and sell high” is a timeless expression that remains relevant to investment decisions. Paying a lower price for a company can provide a crucial advantage and tilt the odds of outperformance in one's favour.
At MASECO, our portfolios emphasise allocating more of our clients’ capital to companies with robust balance sheets and strong growth fundamentals at reasonable prices. Without a crystal ball, we believe paying attention to price is paramount for managing risk and increasing the probability of outperformance.
1) The Book of Investing Wisdom: Commandments from Masters by Ashu Dutt for Howard Mark’s quote on price
2) Koyfin for performance of Cisco
3) Morningstar for history of Cisco’s share price (https://www.morningstar.co.uk/uk/news/243654/nvidia-2023-vs-cisco-1999-will-history-repeat.aspx)
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