For anyone who enjoyed the 2024 Paris Olympics, you may have noticed the absence of the popular sport of squash (played by an estimated 20 million people in over 185 countries). Squash is still not part of the Games, and one of the most contentious of the excluded sports, which also include cricket, bowling, netball, darts – and chess.
By Shaul Rosten, Redwheel UK Value & Income
Chess, unlike other ‘sports’, is regularly dismissed because it lacks the “physical exertion” that the International Olympic Committee demands. Despite the snub, watching competitive chess is popular – particularly the 3 minute ‘Blitz’ format.
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Blitz chess is an excellent framework for thinking about investment skill: you are not only required to make intelligent moves, but you also need to avoid running out of time. Having only one of those abilities is insufficient to assure success – and the same is true in investing.
Keep your eyes on the price
As we have noted in the past, investing requires the ability to (i) understand and quantify the economics of a business over time, and (ii) to fairly assess the value of that business today, what we term the “intrinsic value” of the company. It is only when you are confident in both the earnings stream of a business, and that the price today represents a material discount to the true intrinsic value of the business, that an investment is merited.
In our view, the main mistake being made by many investors today is not about the quality of the business, but the appropriateness of the price.
So far in 2024, many justifiably admired companies – across industries, geographies and sectors – have seen their valuations collapse, often leaving investors with zero total returns on a five-year basis.
How is it possible that so many truly great companies have delivered such poor outcomes to the investors?
Quality growth vs value
As with Blitz chess, investors need to be able to balance two skills simultaneously. With the companies in question, the issue was unlikely to be the quality of the business, but rather the quality of the business relative to the price paid, and relative to the expectations baked into those prices.
Avoiding the double punch
As well as mistakes on purchase price, investors have also made mistakes in assessing the quality of a business. Some have been lauded for years as perpetual growth machines, only to have stumbled, such as cosmetics giant Estée Lauder NYSE:EL. Despite being priced for prime growth over the past five years, the company has had to issue repeated profit warnings over the course of 2023 and 2024, with revenues for full year 2024 expected to be only 4% higher than those delivered in 2019; net income is forecast to be less than half of that earned five years ago. Not only did investors overpay – they also misread the quality of the enterprise.
This underscores the risk of paying high prices. Buying into a darling company, where everyone expects greatness, can deliver a devastating double punch if the business performs poorly.
Valuation matters
Like skinning cats, there is more than one way to lost money as an investor. One of these ways is to buy poor quality businesses, whose operation and balance sheet deteriorates, permanently impairing your capital. However, post the Great Financial Crisis – a crisis in which this sort of risk did indeed materialise – investors have perhaps focused too closely on that risk, forgetting, like a studious chess player who doesn’t check the clock, that there is something else they need to consider.
Today, as interest rates rise and as highly priced quality companies fail to deliver, we would encourage investors to remember: valuation matters.
