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Buying stocks: Quality or price?

Apr 20, 2009

A question perennially confronting investors out to invest in equity is - Does one buy shares in an extremely attractive and popular business at a high price? Or then does one buy shares in a fairly decent company at a very attractive price? Let’s turn to investing legend Benjamin Graham for his take on this question. His observation is that the popular opinion is always to go for the former rather than the latter. But doing so would only be instinctively, rather than logically right.

It is true that over a long period of time, observation and experience has shown that less money has been lost by the majority of investors by paying a high price for shares of the best regarded companies than by trying to achieve a higher profit by buying shares in companies that are considered less attractive.

But consider this analogy – If you were a novice with little or no knowledge of tennis and out to buy a tennis racquet, it would be wiser for you to purchase one that is of the best reputation/brand, even if that meant that you would be paying substantially higher price for it. That is because if you yourself did not have the requisite knowledge and skill to analyse and choose the different racquets available, your safety would lie in the fact that you are buying the most popular and well regarded brand.

However, if you were someone who has extensive knowledge of tennis and tennis racquets, you would be better off examining each and every racquet available in the market, and then may as well pick out one that might be of a relatively unknown brand and available at an attractive price, but nevertheless meets your personal quality standards and specific needs.

The above situation applies equally well when buying shares of companies. The lay investor would be better off confining himself to buying the best regarded companies. This should be his preference because of the greater amount of risk to him in venturing out to other directions.

But then an investor employing only such a strategy over the long term would indeed be sacrificing returns for safety, as one cannot expect to buy something at a high price and at the same time keep getting fabulous returns from it.

So, one idea for you could be to purchase shares of companies of the highest reputation at fair prices. And the other – to examine the quality of a group of companies in the minutest detail and then picking out the ones that might not yet be in the spotlight, but nonetheless, have fundamentals that are good enough and available at attractive prices so as to enable you to profit handsomely from them.

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