Good Stocks Vs. Good Businesses

By Sham Gad | January 11, 2010 AAA

Most investors make their mistakes not from picking bad stocks but instead from buying them at the wrong time. This is because many investors blindly assume that as long as the business they pick is a good business, then the underlying stock must be good too. Unfortunately, this fallacy is one that comes with an expensive price tag.

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My Favorite Businesses
I buy all books - and even other products today - from Amazon (Nasdaq:AMZN). No one can beat Amazon's prices or its excellent customer service. Unless you have to have a book immediately, one is almost guaranteed to save at least 30-40% by shopping Amazon instead of brick and mortar bookstores such as Barnes and Noble (NYSE:BKS).

One of my favorite places to eat is Chipotle Mexican Grill (NYSE:CMG), a fresh fast casual chain that serves some of best gourmet burritos around. I've visited lots of Chipotle locations during my travels and the stores are always packed. And like millions of other people all over the world, I use Google (Nasdaq:GOOG) and Yahoo (Nasdaq:YHOO) every single day. Yet I don't own a single share in any one of these companies.

One Word: Price
While I would welcome the opportunity to own them all, the single factor preventing me from buying them is price. The above companies are all fantastic businesses with amazing future growth potential. That outlook is no secret and as a result, the prices are above what I'm comfortable paying. Clearly, early 2009 would have been a great time to buy any of these names but since I was looking elsewhere I never gave them another look.

So while all of the above businesses are first rate companies, that doesn't mean they are first-rate investment candidates. The determinant, of course, is price. The price you pay for any investment will determine the value obtained. As much as I would love to own Chipotle at a P/E of 10, I realize that may never happen as long as the company is on the upward slope of its growth curve. While my approach to investing squarely qualifies me as a "value investor," my approach is to simply buy a good business trading below intrinsic value, thus giving me a margin of safety. However, growth too is part of a margin of safety and I am highly confident that names like Chipotle and Amazon will be making a lot more money years from now. And I would readily pay 15 times earnings for a company like Chipotle versus 10 times earnings for a company like McDonald's (NYSE:MCD).

Proper Discipline
In investing, discipline is everything, but you can't be so unyielding in discipline that you hold all companies to the same standard of value. In many cases, you may be better off paying a fair price for a great company than a great price for a fair one. At the same time, investors must always remember to keep their emotions in check when looking at great businesses trading at not-so-great prices. (For more, see The Characteristics Of A Successful Company.)

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