Warren Buffett selling $US900 million worth of Walmart stock last week was of startling news to the business world. Warren is one of the most influential figures in the investment sector due to his successful track record over the past 60 years.
I have been following Warren’s journey since I was in my early 20s in the quest to understand the stock market, investment strategies and the art of business. My favourite book about Warren called “Buffettology,” written by Mary Buffett an ex-daughter-in-law, provides valuable clues on his thought process and investment methods.
Some of these clues are below:
IDENTIFY EXCELLENT BUSINESS
The key to Warren’s good fortune is that he knows how to identify excellent business. He does this by dividing the business world into two categories:
- Commodity-Type Business
A business that sells a product whose price is the single most important motivating factor in the buyer’s decision due to a plethora of competition in the marketplace.
An example is a petrol station such as Shell, which has many competitors like BP, Caltex, Hi Tec Oil and Liberty Oil. These companies are all selling the same product, being fuel, and the only way a consumer will buy from them [besides convenience] is price.
2. Consumer Monopoly
A brand-name product or a key service that consumers believe offers superior advantages over the competition.
An example of a brand-name product is Coca-Cola, a drink that you can buy anywhere in the world today. You will find Coca-Cola in the village shops of Fiji to the corporate offices of Australia, in restaurants, cinemas, bars, petrol stations … the list is endless. It is such a popular drink that businesses have no choice but to sell it or they risk losing sales.
A key service is getting across a toll bridge for instance. If you need to get to the other side of a toll bridge, you can either walk, take a boat or swim across the river. However, many of us choose to drive over the bridge and pay the toll. Since there is no choice but to pay the toll, this service then has consumer monopoly over the bridge.
9 QUESTIONS TO ASK BEFORE INVESTING
Warren, more often than not, will invest in a consumer monopoly business. To further determine that the company is an excellent business, he will ask the following nine questions:
- Does the Business Have An Identifiable Consumer Monopoly?
This will either be a brand name that is sold all around the world like Coca-Cola. Or a key service which a consumer would rely on such as a toll bridge.
- Are the Earnings of the Company Strong and Showing An Upward Trend?
Earnings of a company can either be a solid upward growth or erratic trend. An upward trend indicates a company whose management performs a good and steady job in running the company.
- Is the Company Conservatively Financed?
These companies usually have little to no debt on their books. However, it may incur long term debt to acquire another company for example.
- Does the Business Consistently Earn a High Rate of Return on Shareholder’s Equity?
Investors buy shares in businesses to make money. Therefore, consistent high returns on shareholders’ equity can produce great wealth for shareholders.
- Does the Business Get to Retain its Earnings?
In other words, can a business reinvest their surplus earnings to expand their business enterprises after all the bills, debts and dividends have been paid out? If so, then shareholders can benefit from the company’s growth long-term.
- How Much Does the Business Spend on Maintaining Current Operations?
If a business is reinvesting their surplus income into maintaining equipment or replenishing tools as opposed to expanding the business, then there is little money left over to increase the shareholder’s fortune.
- Is the Company Free to Reinvest Retained Earnings in New Business Opportunities, Expansion of Operations or Share Repurchases?
Warren’s preference is to invest in cash cows, which are very profitable businesses that require little in further research and development or equipment and tool replacement.
- Is the Company Free to Adjust Prices to Inflation?
Inflation causes prices to rise. The excellent business or a consumer monopoly has the freedom to increase the prices of its products right along inflation without it experiencing a decline in sales.
- Will the Value Added by Retained Earnings Increase the Market Value of the Company?
A wise investor like Warren knows that over the long-term, the market will adjust the stock’s price to reflect the real value of the business.
Warren favours consumer monopoly businesses, which is usually a brand-name like Coca-Cola or key service like a toll bridge. They usually have superior advantages over the competition.
Additionally, the management of the business must possess the ability to expand the enterprise with its surplus earnings as opposed to maintaining equipment or replacing tools.
Excellent businesses are also conservatively financed and will have the freedom to adjust its prices with inflation.
“The investor of today does not profit from yesterday’s growth,” Warren Buffett, investor extraordinaire.
So there you have it, some gems to assist in your business endeavours. And to help you along should you explore the world of investing into a company like Warren Buffett.
Disclaimer: The content within is general or publicly available information only. Speak with your accountant or financial adviser for advice on various investment options.