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Invest Like a Guru by Charlie Tian

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CHAPTER 5Buy Good Companies at Fair Prices

“Anything worth doing is worth doing slowly.”

—Mae West

In the previous two chapters, I examined the kinds of companies that qualify as the “good companies” we will buy and where to find them. But buying good companies itself does not guarantee good results. It works only if they are bought at fair prices. I have asserted that if you buy a good company, there is no risk of permanent loss of capital as long as its business continues to perform well and the company's value keeps growing. But any excess payment above the fair price will eat into your returns.

For example, riding the tide of the stock market bubble, Wal-Mart stock gained more than 500 percent in three years, to around $70 a share by the end of 1999. Then it took 12 years for anyone who bought Wal-Mart stock at the end of 1999 to break even. Even today, Wal-Mart is barely higher than it was 16 years ago. Wal-Mart certainly met the good-company requirement in 1999. It had been always profitable, had a ROIC in the mid-teens, and grew its earnings at double digits. But the problem was that the stock was overvalued. It had a P/E ratio of 60 at the end of 1999. Today, the P/E ratio of the stock is 16. Wal-Mart has quadrupled its earnings from 1999, but those who bought in 1999 have not benefited because they overpaid for the stock.

Another example is Coca-Cola. The stock was traded at $43 (split-adjusted) in the middle of 1998. After 18 years, today the stock is traded at below ...

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