Simplified, there are two pillars of successful investing:
- Buying good companies.
- Buying them at good prices.
Huge wins take place when you get both right. Near-certain losses occur when you get both wrong. Getting just one right can lead you either way. Sometimes great companies perform poorly because valuations are too high, and sometimes miserable companies produce extraordinary returns if starting valuations are low enough.
Two weeks ago, I sat down with Robert Arnott, CEO of Research Affiliates and one of the brightest minds in modern finance. He made a similar example with two popular companies: Apple (Nasdaq: AAPL) and Bank of America (NYSE: BAC). Have a look (transcript follows):
Robert Arnott: "Most people lack the discipline to do that kind of cool, collected contra trading because it's wildly uncomfortable.
Recently I've been using Apple versus B of A as an interesting example. Apple's beloved; everybody loves it. Everybody wants it in their portfolio. Practically everybody has it in their portfolio, and B of A is a much bigger company trading at much lower market cap. So is B of A going to be a more successful business than Apple? Highly doubtful. But you're already prepaying for that success in Apple's price. You're already prediscounting for disappointments in B of A, so I'd much rather own B of A than Apple."
Fool contributor Morgan Housel has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Bank of America. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.