Building an Investment Philosophy
Investing is both an art and a science, demanding patience, and a deep understanding of the businesses we choose to invest in.
By Devon Walsh
With Todd Gray, a portfolio manager out of the Brattleboro Office, recently retiring and providing his investment pearls of wisdom in the previous newsletter, I thought it might be valuable to offer a perspective from someone newly entering the profession and still absorbing insights from those around him. Throughout my academic studies and my year of experience at the Trust Company of Vermont, I’ve come to realize that stock picking is not an exact science. However, certain key principles have resonated with me as I have shaped my own investment philosophy. I believe there are two main criteria that make an attractive equity investment: the stock is priced reasonably, and the company possesses sustainable, competitive advantages in its line of business.
Reasonable Pricing
When evaluating a company, we typically value the stock price as a multiple of income or cash flow, since companies often return excess cash to shareholders through dividends or share buybacks. For instance, if a company generates $5 billion in net cash flow and is worth $100 billion, we anticipate a 5% return assuming the company distributes all its cash flow to shareholders. 5% would be considered the company’s cashflow yield. However, while cash flow yields and multiples offer valuable insights for valuation, they aren’t the only factors affecting a stock’s worth. Even when we identify what we believe to be a mispriced stock, it may take months or even years for the market to correct itself.
Thus, successful investing often requires a long-term perspective. We must believe that the company has a strong market position, even if its price may not reflect that in the short term. As Warren Buffett, the Oracle of Omaha, wisely observed, “The market can remain irrational longer than you can remain solvent.” Price, while important, is only part of the equation; an equally, if not more, crucial aspect is identifying companies with sustainable competitive advantages.
Sustainable Competitive Advantages
Assessing a company’s sustainable competitive advantage—or “moat”— involves not only understanding its current market position but also evaluating its future prospects. A company’s moat represents its ability to fend off competitors and maintain its market share. For example, a mining company that controls the sole supply of a rare mineral would have a wide moat, as consumers would have no choice but to do business with them. However, it’s important to consider the durability of this moat—what happens if another company discovers the same mineral and offers it at a lower price? The key question is whether a company’s competitive advantage will endure over time.
One of the strongest competitive advantages we see today is called the network effect. This phenomenon occurs when a product becomes more valuable as more people use it, making it increasingly difficult for competitors to gain traction. Major tech companies like Microsoft, Google, and Meta (Facebook) are prime examples of firms benefiting from the network effect. The more users they attract, the stronger their market position becomes, as consumers grow accustomed to their platforms, and competitors struggle to break through. Companies with moats like these are well-positioned to maintain their dominance and represent long-term value, as they can capitalize on their strong market positions in the future.
Bringing It All Together
Ultimately, our goal is to choose companies that are reasonably priced and supported by a strong moat in the market. If we had to prioritize, a sustainable competitive advantage holds more weight, since market mispricing at least may eventually be corrected, while a strong moat is likely to persist. Warren Buffett himself evolved from seeking only cheap companies to realizing the value of paying a premium for a superior business. As he said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Investing is both an art and a science, demanding patience, and a deep understanding of the businesses we choose to invest in. While stock pricing is vital, it is the strength of a company’s moat—its sustainable competitive advantage—that ultimately determines its long-term success and value. By focusing on companies that are reasonably priced and have solid moats, we can remain confident in our investments, even in the face of short-term market volatility. As I continue my journey, Todd’s wisdom has been invaluable, and I’m excited to build on these insights to refine my own investment strategy.