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Chapter 6. In Search of Excellence: Are Good Companies Good Investments?

Chapter 6. In Search of Excellence: Are Good Companies Good Investments?

Petra's Search for Excellence

Petra was an avid reader of management strategy books, and she was convinced that she had found a way to make money on stocks. After all, the strategy books she read often had case studies about the best-managed and the worst-managed companies and the skills (or lack thereof) of the managers in these firms. All she had to do was find the best-run companies in the market and put her money in them and the returns would surely follow. In a stroke of luck, Petra found a listing of the 20 best companies in the United States in Fortune Magazine and it was not long before she had all 20 stocks in her portfolio. As she bought the stocks, Petra did notice three things. One was that the stocks traded at lofty multiples of earnings relative to their competitors. The second was that these stocks were widely held by mutual funds and pension funds. The third was that equity research analysts expected these companies to continue to deliver high earnings growth in the future, which Petra took as a good sign.

A year later, Petra was disappointed. While most of the companies in her portfolio were still considered well run and well managed, the stocks had not done well. In fact, she found the market reacting negatively to what she considered good news from these companies; an increase in earnings of 25% was often categorized as bad news because investors were expecting a growth rate of 35%. Worse still, two of the companies in her portfolio fell off their pedestals when their managers were revealed as inept rather than superior. On these two stocks, Petra lost a lot of money. Having learned her lesson, Petra has decided to switch her portfolio to the 20 worst companies in the Unites States for next year.

Motto: When you are considered the best, very good is not good enough.


Buy companies with good products and good management and the investment returns will come. This is a story that you have heard over and over from impeccable sources. Warren Buffett, for instance, has been noted as saying that he buys businesses and not stocks. As with other investment stories, this one resonates because it is both intuitive and reasonable. After all, who can argue with the proposition that well-managed companies should be worth more than poorly managed firms? As you will see in this chapter, the story becomes much more complicated when you frame the question differently. Will you make more money investing in companies that are viewed as well-managed and good companies or in companies that have poor reputations? In this chapter, you will consider the answer and the precautions you need to take when putting this strategy into practice.


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