How to Buy Quality Companies at Bargain Prices


Warren Buffett emphasized buying quality companies rather than speculating about the direction of a stock price. Good companies are still good companies when times are bad. If you buy a good company and the price of its stock drops, that doesn’t signal any­thing more than a chance to pick up additional shares at a dis­count. Buffett says you should always understand the businesses in which you invest. The simpler, the better. Once you understand a business, you can make a judgment on the company’s quality. You should exercise the same scrutiny when buying shares in a company as you’d exercise when buying the company itself. In advice reminiscent of Fisher, Buffett told investors in a 1993 For­tune interview to “invest within your circle of competence. It’s not how big the circle is that counts, it’s how well you define the parameters.”

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Buying a quality business is vital to Buffett, far more vital l even than buying at a discount. After all, what’s the point of / buying something on sale if you’re getting junk? It won’t perform well in the long term, which leaves you one option: get lucky on a price runup and sell in the short term. Time helps wonder­ful businesses but destroys mediocre ones, which means you should be comfortable standing by your companies over time. Investors must evaluate companies on their individual merits before looking at stock prices.

For example, Buffett bought GEICO stock after it declined from $60 to $2. The company faced a possible bankruptcy and a growing number of class-action lawsuits from shareholders. The world thought the stock would end up worthless, but Buffett loaded up on it anyway, eventually owning half the company. Buying a stock that’s declined 96.5 percent is clearly a value move because by just about any measure it’s discounted. In GEICO’s case, Buffett found a great company at a colossal bargain.

But then there’s Coca-Cola. Buffett loved the soft drink from the time he bought and sold individual cans of it when he was five years old. He watched the company’s phenomenal growth over three decades and in 1986 made Cherry Coke the official bev­erage of Berkshire’s annual meetings. Yet he didn’t invest in Coca-Cola until 1988. The stock had risen over five-hundredfold since 1928 and over fivefold since 1982. To many it looked over­priced, but Buffett invested more than $1 billion. Buying a stock that’s risen fivefold in six years appears to be a growth move. In Buffett’s case, however, he saw Coca-Cola selling for well under its intrinsic value, so to him it was still a great company at bar­gain prices.

In each of these two investment decisions, Buffett wasn’t thinking value or growth. He wasn’t pondering hot tips on the street, because in both situations he acted against common con­sensus. He bought what he perceived to be quality businesses: GEICO when everybody thought it was dead, and Coca-Cola when everybody thought the opportunity had passed. The lesson we can take from this is that it is more important to buy solid, quality companies than it is to buy stocks at certain price levels. This is Buffett’s use of Graham’s margin of safety.

You should examine a business to determine its value, then look at the stock Price to see if it makes sense to buy now. It might, in which case you should. The price might decline after you buy, but that doesn’t matter. The fact remains that you bought a solid business at a fair price. After that, Buffett advises you to watch what’s on the playing field, not what’s on the scoreboard. A price decline is the market’s frenetic, short-term interpretation of the stock’s worth. Ignore it.

By now it should be clear that Buffett advocates buying quality companies at bargain prices, which is a blend of Graham and Fisher. Now, let’s delve deeper into Buffett’s definition of a quality company and a bargain price.

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About the Author: Marie Mayle is a contributor to the MegaHowTo team, writer, and entrepreneur based in California USA. She holds a degree in Business Administration. She loves to write about business and finance issues and how to tackle them.

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