What's Better for Investing, Quality or Price?

I've been reading and re-reading Warren Buffett's letters to his partnership from 1957-1970 and I've tried to absorb as much wisdom as possible from the Master.

One great example. In 1967 Buffett wrote his partners to discuss the differences between qualitative and quantitative investing and the relative merits of each. Since I can't improve upon Buffett's own words, here is an excerpt:

"The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors. At the one extreme, the analyst exclusively oriented to qualitative factors would say, "Buy the right company (with the right prospects, inherent industry conditions, management, etc.) and the price will take care of itself." On the other hand, the quantitative spokesperson would say, "Buy at the right price and the company (and stock) will take care of itself." As is so often the case the pleasant result in the securities world, money can be made with either approach. And, of course, any analyst combines the two to some extent - his (her) classification in either school would depend on the relative weight he (she) assigns to the various factors and not to his consideration of one group of factors to the exclusion of the other group."

About as succinctly as one can, Buffett has just described the never ending debate between price and quality and what is of paramount importance in investing. The story has long been told that Buffett learned to buy great businesses from Charlie Munger and from the Sea's Candy purchase in 1972. However here is Buffett describing the issue in detail almost 5 years earlier and in this letter he even acknowledges that his best investments have been made on qualitative factors primarily, and not primarily on a cheap price.

"... the really sensational ideas I have had over the years have been heavily weighted towards the qualitative side when I have had a "high-probability insight". This is what causes the cash register to really sing."

So perhaps the story about Buffett learning about quality from Sea's Candy is a bit overstating the case. Even in 1967 he acknowledged that buying higher quality businesses could lead to superior outcomes.

He balances his enthusiasm for qualitative factors with an acknowledgement that it can be easier and more predictable to rely on quantitative factors because no special insight into the business is required. Although, these statistical bargains have grown rarer and rarer over the years as there are more and more analysts combing over investments, and Buffett even acknowledged the dearth of good statistical bargains back in 1967. It seems simply relying on quantitative factors won't be good enough going forward either.

Where Buffett eventually lands with later investments in Sea's Candy, Coca Cola, and Apple, and where I believe we must look to invest, is on a combination of qualitative and quantitative factors. You need to have an insight about the business which although maybe not unique, is not recognized by the price quoted by the market. And while you don't need to find the extreme bargains of the "net-nets" that Buffett was buying in the 50s and 60s, you do have to buy at a sufficiently low price that there is a margin of safety built into your investment in case your insight into the company proves to be wrong.

Of course on the rare occasion you can find a high quality business which for one reason or another is trading far below what you think it's worth. When we find these very rare opportunities we need to act decisively to take advantage of them, because they don't come around very often. As Buffett has said, there are many ways to make money in investing, but this way works best for me.