Is It Smarter To Buy A Cheap Business Or A High Quality One?

Is it smarter to buy a cheap, lower quality business or a more expensive, but higher quality business? Particularly, I’m using Rona and Lowe’s as an example. I missed the opportunity to buy Rona. Was I right or wrong? I reflect on my inaction in this article.

Sometimes, investing is like this. You can miss out on opportunities. This time, I missed out on RONA Inc.’s (TSX:RON)(OTC:RONAF) 100% gain in a day after Lowe’s Companies, Inc. (NYSE:LOW) made another attempt to acquire it.

I checked out Rona as a potential investment just a month or so ago, but I passed on it because of its BB+ credit rating and multiple years of declining earnings from before. Now that I think about it, Rona experienced rising earnings in 2014 and 2015 so it seems like the business is turning around nicely. Of course, Lowe’s wouldn’t buy it if it wasn’t worth its bucks — rather C$24 per share (for a total of C$3.2 billion) as that’s the price Lowe’s is paying.

Lowe’s has been on my watch list for some time now. I’ve been waiting for an opportunity to buy its shares but it always seems to be expensive. Unfortunately, it now takes me 40% more to convert Canadian dollars to US dollars. So even though at one point, Lowe’s shares fell more than 9% during acquisition day, I still couldn’t bring myself to pull the trigger.

U.S. investors don’t have the foreign exchange problem, though. So, Lowe’s is more attractive after the pullback. It’s a high quality, high growth company after all. It has an S&P credit rating of A- and its earnings per share are expected to grow at an average rate of 16% in the foreseeable future.

In doing this exercise, my goal was to determine whether it was the right thing or not for me to have ignored Rona because it had a BB+ rating and I was focusing on building a higher quality portfolio.

In hindsight, my inaction was wrong of course, but there’s no way I could have even remotely guessed that Lowe’s would attempt to acquire Rona again (given that I didn’t know about its previous attempt). I simply stayed in my comfort zone as an investor. Even if I did buy Rona, I wonder if I could have held on until its value was realized.

I don’t think investors can go wrong by buying profitable businesses with a margin of safety whether they’re high quality or not. However, the lower quality a company is, the higher margin of safety you should wait for before investing.

This is primarily an excerpt from my Seeking Alpha article: Is It Smarter To Buy A Cheap Business Or A High Quality One? with some updates.

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Disclosure: At the time of writing, I didn’t own any stock mentioned in this article.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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