I recently overheard a conversation of two gentlemen discussing a home remodeling project. The younger of the two was explaining how he was preparing to paint a few rooms in his home. His wife was picking out colors and he was soon going to purchase the paint and begin his project. The older of the two men listened intently and besides jokingly saying 'have fun with that project,' gave only one piece of advice, 'buy the more expensive paint.'
This comment seemed to catch the younger man off guard and he responded to the advice with, 'but the more expensive paint is nearly double what the lower priced paint is, is it really worth the extra money?' That question was answered with a simple, 'just trust me, it is in the long run.'
If you have ever painted a room you know exactly what both men in this situation are thinking. The younger guy is confused because it's just paint, I am just trying to add some color to my walls and do I really need to spend the extra money. While the older, wiser, guy is trying to save the other from a headache, time and money due to possibly having to repaint the room again down the road.
I mean seriously, it's just paint, right? Yes and no. The more expensive paint will cover the wall better, not fade, not be marked up as easily, and will still look new for years down the road.
Paint is just one example of why it is worth paying up for a product. Vehicles, tools, appliances, electronics, flooring; the list of things in our lives that are worth paying up for quality products can go on and on. The point is, cheaper products or services are cheap at first, but will likely cost you more money over the long run because they breakdown and begin to show their flaws much sooner than their more expensive counterparts.
The same is true when it comes to investing.
One example of why this is true can be seen with oil and gas stocks. With current energy prices at depressed levels, the larger, stronger, better run energy producers have held up to low oil and gas prices better than the smaller players in the market. Two smaller, lower quality energy stocks which many investors considered to be 'good' buys just a few years ago because of their high growth potential, if oil and gas prices remained at current levels or went higher, were Chesapeake Energy (CHK) and Cheniere Energy (LNG).
If you google Chesapeake Energy buy 2013, or Cheniere Energy buy 2013 you will find article after article explaining why both of these companies are great buys; my favorite article mentions Chesapeake Energy as one of the best long-term investments. Nearly all of the articles or analyst's ratings during 2013 and early 2014 briefly discuss debt issues, but how higher gas prices in the future would help the companies.
Well, we now all obviously know that energy prices didn’t move higher and that debt has and will continue to be the downfall of these businesses. While the falling oil and gas prices hurt all companies in the industry during 2014-2015 and will continue to put a damper on companies if energy prices remain where they are today, the better run, more quality companies will be able to weather the storm. Which is not something we can currently say about the Chesapeake or Cheniere's of the world.
So how do you find quality companies in a sea of stocks? Sticking with the oil and gas industry, investors want to be looking for companies whom have reasonable debt levels compared to the size of their business, responsible management teams, positive profit and operating margins (despite low energy prices), reserve values based on low oil and gas prices, a decent credit rating, and history of proving they can weather potential storms, just to name a few.
My rule of thumb when looking for a quality business is one that I would have a hard time imagining the world without. When BP p.l.c. (BP) had its oil spill, the company was hammered by the market. Fee's and massive fines were handed down to the company in the billions. But, really at no point was the company in danger of going bankrupt. Even in the middle of the crisis, it was hard to image BP no longer existing. With oil and gas prices where they are today, the same can be said about Chevron (CVX), Exxon Mobil (XOM), Royal Dutch Shell, and a handful of the other top tiered oil and gas companies.
While the short sighted investor may believe organizations like Chesapeake or Cheniere's have greater growth potential than the much larger, more established, older companies in the industry, as the painter who buys the cheap paint will soon find out, quality is worth paying up for and is cheaper in the long run.
Disclosure: This contributor held no positions in the stocks mentioned at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.