{"id":477,"date":"2019-11-23T06:57:24","date_gmt":"2019-11-23T06:57:24","guid":{"rendered":"http:\/\/www.assetmultiplier.co.in\/blog\/?p=477"},"modified":"2019-11-23T06:57:27","modified_gmt":"2019-11-23T06:57:27","slug":"the-price-of-excellence","status":"publish","type":"post","link":"https:\/\/www.assetmultiplier.co.in\/blog\/2019\/11\/23\/the-price-of-excellence\/","title":{"rendered":"The Price of Excellence"},"content":{"rendered":"\n<p>Jon writes on his blog that some people happily pay a premium for quality. If you think a product \u2014 like iPhones, designer bags, or shoes \u2014 is higher quality, it might be worth paying more. Sometimes you actually get more than your money\u2019s worth. Other times, the premium is the cost of being associated with the logo. It\u2019s no different from stocks. Investors pay a premium for stocks labelled \u201cquality\u201d or \u201cexcellent.\u201d Sometimes, it\u2019s worth it.<\/p>\n\n\n\n<p>In 1987, Michelle Clayman tested the performance of so-called \u201cexcellent\u201d companies based on fundamentals relayed in the book\u00a0<a rel=\"noreferrer noopener\" href=\"https:\/\/www.amazon.com\/dp\/0446383902\/?tag=noveinve09-20\" target=\"_blank\">In Search of Excellence<\/a>. The book labelled 36 publicly traded companies as \u201cexcellent\u201d\u00a0based on specific fundamental criteria: asset growth, equity growth, return on capital, return on equity, return on sales, and price to book. At the same time, she tested 39 \u201cdisaster\u201d companies. These were the worst companies based on the same criteria. Over a five year period, the disaster companies beat the excellent companies handily! This result was repeated over studies conducted by Barry Banister over a longer period of time. <\/p>\n\n\n\n<p>Here\u2019s\nhow Clayman explained the unexpected results: Over time, company results have a tendency to&nbsp;regress to the mean\nas underlying economic&nbsp;forces attract new entrants to attractive\nmarkets&nbsp;and encourage participants to leave low-return&nbsp;businesses.\nBecause of this tendency, companies that have been \u201cgood\u201d performers in\nthe&nbsp;past may prove to be inferior investments,&nbsp;while \u201cpoor\u201d companies\nfrequently provide superior investment returns in the future. The&nbsp;\u201cgood\u201d\ncompanies underperform because the&nbsp;market overestimates their future\ngrowth and&nbsp;future return on equity and, as a result, accords&nbsp;the\nstocks overvalued price-to-book ratios; the&nbsp;converse is true of the \u201cpoor\u201d\ncompanies.<\/p>\n\n\n\n<p>Banister concluded that while financial \u201cexcellence\u201d is a laudable management achievement, he found that it tends to produce a high-priced stock with the potential for downward mean reversion. It is his view that a more rewarding investment strategy over time is the purchase of a portfolio of equities in financially solvent companies whose abysmal growth record of late has washed the last glimmer of hope out of the stock price. As the \u201cUn-Excellent\u201d companies revert to the mean, their stock performance is anything but average.<\/p>\n\n\n\n<p>Jon concludes that the market is a popularity contest driven by short-term thinking. Short-term thinking would suggest that great companies will continue to do great and poor companies will continue to do poorly and nothing will change that. The reality is far different. Poor companies may never become great or even good companies, but their fundamentals mean revert. The same happens to good (and most great) companies too. In the long run, the market reflects it in prices.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Jon writes on his blog that some people happily pay a premium for quality. If you think a product \u2014 like iPhones, designer bags, or shoes \u2014 is higher quality, it might be worth paying more. Sometimes you actually get more than your money\u2019s worth. Other times, the premium is the cost of being associated [&hellip;]<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1,74],"tags":[],"_links":{"self":[{"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/posts\/477"}],"collection":[{"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/comments?post=477"}],"version-history":[{"count":1,"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/posts\/477\/revisions"}],"predecessor-version":[{"id":478,"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/posts\/477\/revisions\/478"}],"wp:attachment":[{"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/media?parent=477"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/categories?post=477"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.assetmultiplier.co.in\/blog\/wp-json\/wp\/v2\/tags?post=477"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}