Great companies to invest are like wonderful castles, surrounded by deep, dangerous moats where the leader inside is an honest and decent person. Preferably, the castle gets its strength from the genius inside; the moat is permanent and acts as a powerful deterrent to those considering an attack; and inside, the leader makes gold but doesn’t keep it all for himself

- Warren Buffett

Q = Quality of business X Quality of management

There are two aspects to Q: (1) Quality of business and (2) Quality of management. The relationship between the two is multiplicative and not additive. Thus, if one of the aspect is zero, Q will be equal to zero, no matter how high the other.

Quality is a subjective concept, and yet there are several objective indicators of the same, as listed below:


Quality of business

  • Economic Moat, i.e. sustained competitive advantage reflected in return ratios (RoE, RoCE) higher than cost of capital and also those of peers
  • Favourable competitive structure like monopoly or oligopoly
  • Secular and stable business, preferably consumer facing
  • Positive demand-supply situation

Quality of business

  • Competence
    • Sound business strategy
    • Excellence in execution
    • Rational dividend payout policy
  • Integrity
    • Honest and transparent
    • Concern for all stakeholders
  • Growth mindset
    • Long-range profit outlook
    • Efficient capital allocation including growth by acquisitions

Growth creates value only when it takes place within the limits of a strong and sustainable company franchise, and these are rare

- Professor Bruce Greenwald

in his book Value Investing: From Graham to Buffett and Beyond

G = Growth in earnings

In investing, there are two dimensions of growth: (1) Earnings growth and (2) Valuation growth. The G of QGLP addresses earnings growth, whereas the P(rice) takes care of the Valuation growth.

Earnings growth by itself doesn’t mean much. It adds value only when the company earns returns on capital higher than the cost of capital. Hence, growth is simply an amplifier: good when returns exceed the cost of capital, bad when returns are below the cost of capital, and neutral when returns equal the cost of capital.

In the final analysis, G (i.e. earnings growth in a company) is a quantitative reflection of Q (i.e. quality of business and management). G has four dimensions:

Quality of business

  1. Volume growth - a function of demand growth matched by company’s capacity to supply;
  2. Price growth - a function of company’s pricing power, which in turn is a function of the competitive landscape;
  3. Operating leverage - a function of the company’s operating cost structure; higher the fixed cost, lower the unit cost incidence on increased volumes, and higher the operating leverage;
  4. Financial leverage - a function of capital structure; higher the debtequity, higher the financial leverage and vice versa.

We like great companies with dominant positions, whose franchise are hard to duplicate and has tremendous staying power or some permanence to it.

- Warren Buffett

L = Longevity of quality and growth

Having established the present quality and earnings growth of the company, the next challenge to investors is assessing how long it can sustain both. In the context of longevity, competence of management is tested at two levels:
(1) Extending CAP, and
(2) Delaying growth slowdown.

Extending CAP: Competitive Advantage Period (CAP) is the time during which a company generates returns on investment that exceed its cost of capital. Competition eventually drives down returns to cost of capital, and sometimes even below it. However, a company with a great business and great management keeps extending its CAP, sustaining high return both for itself and its equity investors.

Delaying growth slowdown: Competent managements can delay growth slowdown by
(1) New streams of organic growth, and/or
(2) Inorganic growth via judicious acquisitions.

In the Bible, it says that love covers a multitude of sins. Well, in the investing field, price covers a multitude of mistakes. For human beings, there is no substitute for love. For investing there is no substitute for paying right price – absolutely none.


Outstanding Investor Digest, Apr-04

P = Price (i.e. Favourable valuation)

Growth in stock price is a multiplicative function of growth in earnings and growth in valuation. The simplest way to improve the odds of valuation growth is by ensuring favourable purchase price.

The price of a stock has to be seen in conjunction with the value it offers. Price is what we pay; value is what we get. Therefore, stock prices are attractive only when they are less than the value perceived in the stock

Few other measures of favourable purchase price

  • Discount to historical valuation bands – P/E, Price/Book
  • PEG Ratio (i.e. P÷E÷Earnings growth; the lower the better)
  • Discount to DCF value (Discounted Cash Flow) or Replacement cost
  • Low Payback ratio (i.e. Market cap/Expected profits of next 5 years)
  • High dividend yield
  • Absolute Market cap relative to the size of opportunity