Analytical: A vast segment of the investing community believes that investing in quality businesses is the ultimate recipe for investing success. The belief is that valuations matter less since premium valuations ascribed to quality companies is justified. However, reality is more nuanced than that.
For example, if you consider Nestle India's stock price movement over a 10-year period (January 2013 to December 2022), the stock quadrupled from 14,900 to over 20,000, with healthy compound annual growth rate (CAGR) returns of 15.1% (ex-dividends). The company's earnings growth happened at high return on capital employed, or ROCE, (10-year average ROCE of 56%) and valuations expanded to 90x trailing PER.
However, if we look at the stock's performance between March 2015 and March 2016, the stock fell approximately 31%; significantly higher than Sensex's 10% fall in the same period. This underperformance was primarily led by a sharp decline in earnings. Prolonged underperformance has also been seen in other quality companies in the past, i.e. HUL (January 2001-March 2010; April 2020-December 2022), Hero Moto (November 2015 to December 2022), Sun Pharma (July 2014 to December 2022), Symphony (November 2014 to December 2022), etc. What is common in these phases for the referred companies is growth slowed down and ROCES compressed.
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