A Slowing U.S. Economy and Trouble Spots Internationally Separate the Good Companies From the Great Ones.

“It’s far better to own a significant portion of the Hope diamond than 100% of a rhinestone.”

Warren Buffett, 1994 Annual Letter to Berkshire Hathaway Shareholders

For this latest quarterly message, we focus on a long-held Wasatch investment philosophy: Genuinely great companies are—as Warren Buffett wrote in 1994—“rare gems” that prevail regardless of political climates, economic conditions or market events. The same, of course, can be said of the world’s leading investors.

Twenty-five years ago, in his annual letter to Berkshire Hathaway shareholders, Buffett wrote: “If we identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.”

Buffett, who notched 30 years at Berkshire’s helm in 1994, cited a more than 23% compounded average annual return provided to shareholders since 1964—along with the “major shocks” he witnessed over the preceding three decades. The dissolution of the Soviet Union, the resignation of a U.S. president, the inordinate escalation of the Vietnam War and “Black Monday” (the one-day decline in the Dow Jones Industrial Average of -22.6%) were just some of the examples that Buffett relayed to his readers. Today, we know that not a single one of those episodes—or any global challenges that followed—made the slightest dent in Buffett’s investment principles. As he wrote in his 1994 shareholder letter, “nor did they render unsound the negotiated purchases of fine businesses at sensible prices.”

“GROW OR GO”

Buffett’s fundamental, bottom-up approach to identifying and deploying capital to best-in-class companies with disciplined management teams has been written about by a litany of journalists and stock-market commentators. Few, however, have undertaken an extensive quantitative study of corporate growth and survivorship that spans decades. Two researchers with consulting giant McKinsey & Company, Patrick Viguerie and Sven Smit, did just that in 2008, publishing, along with former McKinsey colleague Mehrdad Baghai, the Wiley business bestseller, The Granularity of Growth.

In 2015, Smit revisited the book’s central thesis with another McKinsey colleague, Yuval Atsmon, to determine if the book’s findings still held true. Smit and Atsmon built a brand-new proprietary database to track company fundamentals across S&P 500 Index constituents over the 30-year period from 1983 to 2013. The duo published their findings in a McKinsey research report entitled Why It’s Still a World of ‘Grow or Go.’ The report found:

  • For the three-decade period, nearly 60% of the S&P 500 companies that lagged their peers—in terms of growth and profit margins—were acquired. It was “grow or go,” and the majority of S&P 500 constituents were gone.
  • More than 75% of the S&P 500 constituents that generated top-line growth and maintained or improved margins outperformed the Index over the period.
  • 56% of the companies that grew slowly but also aggressively distributed cash to shareholders outperformed the Index.
  • Companies with deteriorating margins underperformed, even if these companies were still growing at a significant clip. Just 27% of this last group outperformed the Index.

What Smit and Atsmon concluded in 2015 after revisiting the core tenets of The Granularity of Growth was that “outperforming the competition remains possible in all industries, even in sluggish economic times.” They added that high-performing companies “continually seek the kind of growth that generates real and sustainable value.”