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Friday, April 8, 2016

About Quality and Price in Stock Investing

Proponents of Efficient Market Theory (EMT) believe that it is impossible to 'beat the market' because prices of stocks (and other securities) discount all available information at any time due to the efficient dissemination of information in the stock market.

Most small investors would benefit by believing in EMT. Instead of losing their shirt trying to 'beat the market' by buying 'cheap' stocks in large quantities, they should just buy index funds or index ETFs from their monthly savings. The stock index will provide them long-term returns.

Hasn't Buffett become an investing legend by doing just the opposite? Isn't he the one who thinks that EMT is meant for academicians? Doesn't the stock market periodically mis-price stocks, allowing savvy investors to 'buy low and sell high'? Yes, to all three questions. 

You can get market-beating returns if you buy stocks of quality companies at fair prices, and sell them at a profit a few years later. But do you know which are 'quality companies' and what are 'fair prices' for their stocks?

Wikipedia provides the following definition of Quality Investing: "..an investment strategy based on a set of clearly defined fundamental criteria that seeks to identify companies with outstanding quality characteristics. The quality assessment is made based on soft (e.g. management credibility) and hard criteria (e.g. balance sheet stability)." 

In a recent article, Ben Johnson of Morningstar.com discussed 'The What, Why and How of Quality', where he makes the following remarks: "The importance of assessing the price paid for high-quality stocks cannot be understated. While quality matters, price arguably matters more."

Related Post

The Moneyball of Quality Investing


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