Warren Buffet, Chairman of Berkshire Hathaway says, “It is best to invest in great companies at a fair price than a fair company at a great price.” That’s a pinnacle statement about Buffet’s investment style. So, to invest like Buffet, you need to know what features denote a great company.
Please read and reread the following carefully.
A great company has a competitive advantage. It has a consumer monopoly, and like a great fortress, has a moat preventing others from capitalizing on it. A competitive advantage is created by producing a unique product or service over a long period of time and being perceived as the leader in the field. Buffett refers to this as a “durable competitive advantage.”
Many of these great companies have been around for a hundred or more years. Coca Cola, one of his favorites, exemplifies this concept, as do several others. American Express and Wells Fargo have also been around for a century. (Interesting, the latter two were founded by the same people.)
So, on the flip side, let’s look at the stocks Buffett avoids. He really hates companies that are involved in something that is price sensitive. Automobile manufactures are a prime example. Most people don’t care if they have a Ford, GM, or Chrysler. They want a great deal, instead.
Because these companies must constantly fight to get a customer, they must constantly upgrade and improve their product by investing lots of money in new automobiles and their development. They are “commodities”, not bastions.
Let’s look at an example taken from Mary buffets book, The New Buffettology. Company A makes improvements in its manufacturing process that lowers its cost of production while increasing its profit margins. Companies B, C, and D lower their prices to compete with company A. And so company A must again adjust. It’s a vicious cycle.
There is a huge difference between the business that grows and requires lots of capital to do so and the business that grows and doesn’t require capital - says Buffett.
Companies like this are often cyclical. They do not have earnings that increase every year and so are unpredictable. These companies are best avoidable.
“I look for businesses in which I can predict what their going to look like in ten or fifteen years’ time. Take Wrigley’s chewing gum. I don’t think the internet is going to change how people chew gum,” says Buffett. And take Coca Cola. RC cola has been around for years, probably just as long, but it doesn’t have the same name brand recognition, nor will it ever. That’s a selective competitive advantage to Coca Cola.
Here are some simple questions you should ask when evaluating a company and deciding whether it is a great company:
- Do historical earnings show a strong, upward trend?
- Is there little or no debt?
- Is there a high rate of return on shareowner’s equity
- Are returned earnings used appropriately?
- Is the company free to adjust prices as costs increase?
This helps me decide. In other words, good companies make scads of money (as shown by good cash flow and high Return on equity). They have good management, and invest wisely.
Then, after analyzing them, talking to investor relations, etc. I produce a graph with the help of the Canadian Shareowners Association. In the next few installments, I’ll tell you more about this.
Disclaimer:
This publication contains the opinions and ideas of its author. It is not a recommendation to purchase or sell securities of any of the companies or investments herein discussed. It is written and read with the understanding the author and publisher are not engaged in rendering legal, accounting, investment or other professional services. Laws vary from state to state, and country to country and if the reader needs expert financial or other assistance or legal advice, a competent professional should be consulted.
Although every attempt is made to verify the information found above, neither the authors nor the publisher can guarantee the accuracy of the information contained within. The authors and publisher specifically disclaim any responsibility for any liability, loss or risk, professional or otherwise, which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents above.
Recommended Reading
- Buffetology
- The Buffetology Workbook
- The New Buffetology
