At Burgundy, we employ a value approach to managing our clients’ wealth. However, value has a broad spectrum of styles, ranging from deep value through quality value. The deep value (Ben Graham) approach aims to buy an ordinary company for a fraction of what it’s thought to be worth – a wonderful price for a fair business. Conversely, the quality value (Warren Buffett) approach strives to pay a fair price for a wonderful business. The latter is the philosophy embraced at Burgundy.
What is a quality business?
Simply put, a quality business has a competitive advantage that is very difficult for others to replicate. This advantage can come in many forms: a unique product, brand, or distribution model; superior intellectual capital; or, a low-cost structure. These advantages create barriers to entry and economic resilience, and often result in industry leadership and limited competition. Most importantly, they endow the business with the ability to earn economic rent.
Unfortunately, a great business does not necessarily make for a great company. Companies are often comprised of multiple business units, and they can range anywhere from lucrative to lousy. Often, what makes a truly great company is management’s ability to make wise capital allocation decisions, focusing on the lucrative businesses and ditching the lousy ones.
It is critical for management to make decisions that add the most value for shareholders. Of course, the decisions greatly depend on current circumstances and future prospects. It takes an experienced, competent and shareholder-focused management team to translate a great business into a great company.
What attracts Burgundy to quality companies?
At Burgundy, we look for quality companies because they have the ability to generate above-average returns on capital over the long term. That means above-average returns for shareholders.
Quality companies also tend to be more resilient to market cycle fluctuations. When economic downturns present themselves, quality companies not only tend to persevere, but are often presented with the opportunity to capitalize on their competitors’ misfortunes.
Quality companies help Burgundy to preserve clients’ capital when times are tough. When we are able to purchase a fraction of a company at a material discount to its intrinsic value, we get another layer of risk protection and a turbo boost to the capital compounding engine.
Why hasn’t everyone jumped on the quality bandwagon?
The truth is quality companies tend to exhibit unexciting qualities. They rarely offer the prospect of hitting the jackpot overnight. They make for dull cocktail party conversation. There’s no fancy quantitative model to “optimize the portfolio” or “target risk factor exposure.” It can take years for value to be realized. There’s just no glitz or glamour.
Despite all this, we are thrilled there’s very little glitz in quality companies. They are simple, steadfast machines that continue to truck along, consistently compounding capital over time.
Opportunities to own quality companies at fair prices present themselves to those who demonstrate the discipline to make rational decisions in irrational times. When others are fearful of adverse events, it allows long-term, disciplined investors to step in and buy $1.00 of intrinsic value for $0.70 or less. When competent management operates a company with a competitive advantage, a fist-sized $1.00 can snowball into something much larger with a long enough hill. While seemingly boring in a world of instant gratification, we find value investing to be very exciting, not to mention rewarding.