One of the strategies we employ is what we call Wide-Moat Growth, or forever quality value growth compounders. These are some of the greatest companies in the world, less than 1 percent of publicly traded companies.
Often these companies are fully priced, but occasionally there are opportunities after a period when the stock lagged the market or during a market correction — for example, in March 2020, when the pandemic started, most stocks were hit significantly, and during the Great Recession of 2008-2009. These are times when the market is very fearful, but these are also windows of opportunity.
Fear and uncertainly create volatility, which creates dislocations of value and unusual opportunities. When there are high levels of fear in the market, it goes down quickly, and this can be uncomfortable. We’ve never had a crash or correction we didn’t recover from. The stock market goes down faster than it goes up. However, it goes up longer than it goes down. In fact, throughout U.S. history, there has been an 88 percent chance the market will produce positive returns after five years; if you hold for 10 years, it’s roughly 97 percent.
We evaluate both quantitative and qualitative factors. We also ask, Is this a short-term or long-term problem? Is this a public relations (perceived) issue or a structural/operational issue? Are they getting painted with the same brush?
Warren Buffett coined the word “moat,” a business with competitive advantages. A company with a “wide moat” has substantial and sustainable competitive advantages. In many cases, these companies have a high return on invested capital. Characteristics of wide moat companies are:
- Cost advantages (Walmart)
- Brand recognition (Nike)
- Size advantages (Visa & Mastercard)
- Technology advantage (Google)
- Network effects (Facebook)
- High Switching costs (Software)
- Patents (Pharmaceuticals)
- Intellectual Property (Disney characters)
- Counter-positioning incumbents (Netflix vs. Blockbuster)
These are companies so wonderful you typically never want to sell them, keeping them through market corrections and recessions. And when there is a substantial price decline, instead of panicking, you can acquire more shares.
Visibility is the ability to foresee the competitive dynamics and have reasonable projections about future revenue and profits. Durability is the ability of the company to maintain satisfactory rates of revenue growth. These are the foundations of our criteria across all our strategies — and a wide moat increases visibility and durability.
We prefer to own companies that can continue to grow revenue and free cash flow at double-digit returns. This means that if you buy them at attractive valuation multiples, you can just hold them so long as they continue to grow at attractive rates.
But no matter how great the stock, it won’t outperform every year. In the public markets, volatility is the price you pay for outperformance. Google returned approximately 22.5 percent annually from 2009 to 2020 and underperformed the S&P 500 in five of those years. Amazon returned roughly 41 percent annually over that period and underperformed in four years. Netflix returned roughly 50 percent annually and underperformed in four years.
Owning a concentrated portfolio of the best companies can still lead to underperforming the S&P 500 in four to five out of 12 years. What matters is long-term returns, not consistency of returns. For high long-term returns, look for hypergrowth companies building a wide moat, or ones that have wide moats and attractive growth.
Umberto P. Fedeli is CEO of The Fedeli Group
