You might recognize the quote: “A great business at a fair price is superior to a fair business at a great price.” This quote marks a pivot point where Charlie Munger convinced Warren Buffett to evolve from his cigar butt philosophy to a more modern, quality-focused approach to value investing.
While this philosophy guides the normal purchases we make throughout our lives, a few times we're presented with a truly unique opportunity: to buy a great business at a great price. This is the essence of deep value, the kind of investment that can become a future multibagger. Recognizing this rare opportunity is the most important purchase you will ever make. When you find it, you should have the conviction to allocate a significant portion of your capital because you are so confident in your analysis.
When/why can we get great businesses for great prices?
Great businesses typically trade at high valuations because investors recognize their superior earnings power and growth potential. However, even the best companies can occasionally be found at very low valuations. This often occurs when there is a significant disconnect between market sentiment and the company's underlying fundamentals.
This disconnect is usually caused by a major controversy or temporary setback. The market tends to overreact to bad news, creating a buying opportunity for disciplined investors. To identify these moments, it's crucial to look past the headlines and focus on the business itself.
Ask yourself, is this company still making more money, and will they keep growing like this?
Meta 2022
Consider Meta in Sept. - Nov. 2022, they fell 76% and reached a commically low PE ratio of 12.9. This the PE ratio of old companies that barely outgrows inflation btw. Why?
The market's fear was focused on Mark Zuckerberg's intense commitment to the metaverse and its Reality Labs division. Investors saw this as a "black hole" for capital. Reality Labs reported operating losses of $10.2 billion in 2021 and a staggering $13.7 billion in 2022. The market, fed up with what it perceived as a reckless investment in a future it didn't believe in, and sold off its shares.
For a disciplined investor, this situation presented a powerful question: How much did these losses truly affect the company's bottom line? And what happens if they stop focusing on VR?
Despite the significant losses from Reality Labs, Meta still generated around $19 billion in free cash flow and $117 billion in total revenue in 2022. It became clear that a company consistently growing its revenue and EPS by more than 30% year-over-year should not be trading at a PE ratio of 13, a ratio significantly lower than the S&P 500's weighted average PE of 22 at the time.
Investors who recognized this misalignment between market sentiment and fundamental value, bought during this period, and held their positions have seen gains of 300-700%.
The most interesting part about this is that reality labs losses continued to make greater losses every year. The stock's recovery wasn't driven by a change in the company's spending habits, but by a shift in market sentiment as investors once again began to appreciate the strength of Meta's core business (Facebook, Instagram, and WhatsApp) once again.
Netflix 2022
Nov. 2021 - May 2022, Netflix faced more competitors than ever, they lost total amount subscribers for the first time (and only) ever, which happened in 2 quaters in a row. Disney shortly reached more total subscribers than Netflix, and they fell ~75% reaching a PE of 15.54, investors were saying that Netflix is dead and videos about the fall of Netflix were going viral. Again this company has grown their revenue >20% YOY and EPS even faster. This makes no sense.
This small moment in history (red ring) sent the stock to a 1/4 of the price.
Netflix even had a clear advantage that the market didn’t see. They had a profitable streaming platform, which no other company had. During the era of near-zero interest rates, Netflix borrowed heavily to build its streaming empire. This allowed the company to establish a very profitable business model and a vast content library before its competitors had even fully entered the race. By the time rivals like Disney and others launched their own streaming platforms, the cost of debt had risen significantly, making it far more expensive for them to finance the expansion of their content and infrastructure.
Netflix's head start gave it a powerful competitive moat, making its profitable platform a clear winner over competitors, and the market's obsession with subscriber churn overshadowed this reality.
If you bought here you would have made around 550% gains.
How do I find great businesses for great prices?
My opinion for this is to not go outside your circle of competence, it takes a lot of confidence to make a big buy a company that has fallen 75%, and even more will power to not sell when it drops 50% from your buying point.
If you look everywhere, then you would find more of these unique opertunities, but would you hold or even buy more when you lost half your investments? Would you start to doubt yourself because you don't really know the industry or the company?
I found and bought both Meta and Netflix during their downturns. Because both companies are in the tech sector, which is within my circle of competence, I was able to recognize the misalignment between the negative market sentiment and the businesses' underlying strength.
The only mistake I made was that A) I didn’t buy enough, my Netflix position was pretty small because I hoped for it to fall even more, and B) sold some of the positions too early, thinking they had reached their fair value.
These experiences reinforced a crucial lesson: once you have conviction in a business you truly understand, the most challenging part of the investment journey is not the initial purchase, but the discipline to hold your position.
What is great prices?
You could just use valuation ratios compared to the same company at an earlier time, or compare valuation ratios to other companies in the same industry. This will give you a vague idea, but not a precise fair value.
Determining the fair value of the company is trickier. I have a model for all positions in my portfolio that shows both an expected-case and worst-case valuation for Free Cash Flow (FCF) and Earnings Per Share (EPS), if you are interested in the process go to my other post.