6 2
T H E W A R R E N B U F F E T T W AY
that have guided his decisions. If we extract these tenets and spread them
out
for a closer look, we see that they naturally group themselves into
four categories:
1.
Business tenets.
Three basic characteristics of the business itself
2.
Management tenets.
Three important qualities that senior man-
agers must display
3.
Financial tenets.
Four critical f inancial decisions that the com-
pany must maintain
4.
Value tenets.
Two interrelated guidelines about purchase price
Not all of Buffett’s acquisitions will display all the tenets, but taken
as a group, these tenets constitute the core of his investment approach.
They can also serve as guideposts for all investors. In this chapter, we
look at the f irst group—the characteristics of the business—and study
how some of Buffett’s investment decisions ref lect those tenets.
For Buffett, stocks are an abstraction.
3
He does not think in terms of
market
theories, macroeconomic concepts, or sector trends. Rather, he
makes investment decisions based only on how a business operates. He
believes that if people choose an investment for superficial reasons instead
of business fundamentals, they are more likely to be scared away at the
first sign of trouble, in all likelihood losing money in the process. Buffett
concentrates on learning all he can about the business under considera-
tion, focusing on three main areas:
1. Is the business simple and understandable?
2. Does the business have a consistent operating history?
3. Does the business have favorable long-term prospects?
I want to be in businesses so good even a dummy can make
money.
2
W
ARREN
B
UFFETT
, 1988
I n v e s t i n g G u i d e l i n e s : B u s i n e s s Te n e t s
6 3
A S I M P L E A N D U N D E R S TA N D A B L E B U S I N E S S
In Buffett’s view, investors’ financial success is correlated to the degree
in which they understand their investment.
This understanding is a dis-
tinguishing trait that separates investors with a business orientation from
most hit-and-run investors, people who merely buy shares of stock. It is
critical to the buy-or-don’t-buy decision for this reason: In the final
analysis, after all their research, investors must feel convinced that the
business they are buying into will perform well over time. They must
have some confidence in their estimate of its future earnings, and that has
a great deal to do with how well they understand its business fundamen-
tals. Predicting the future is always tricky; it becomes enormously more
difficult in an arena you know nothing about.
Over
the years, Buffett has owned a vast array of businesses: a gas
station; a farm implementation business; textile companies; a major re-
tailer; banks; insurance companies; advertising agencies; aluminum and
cement companies; newspapers; oil, mineral, and mining companies;
food, beverage, and tobacco companies; television and cable companies.
Some of these companies he controlled, and in others he was or is a mi-
nority shareholder. But in all cases, he was
or is acutely aware of how
these businesses operate. He understands the revenues, expenses, cash
f low, labor relations, pricing f lexibility, and capital allocation needs of
every single one of Berkshire’s holdings.
Buffett is able to maintain a high level of knowledge about Berk-
shire’s businesses because he purposely limits his selections to companies
that are within his area of financial and intellectual understanding. He
calls it his “circle of competence.” His logic is compelling: If you own a
company (either fully or some of its shares) in an industry you do not un-
derstand, it is impossible to accurately interpret developments and there-
fore impossible to make wise decisions. “Invest within your circle of
competence,” he counsels. “It’s not how
big the circle is that counts, it’s
how well you define the parameters.”
4
Critics have argued that Buffett’s self-imposed restrictions exclude
him from industries that offer the greatest investment potential, such as
technology. His response: Investment success is not a matter of how
much you know but how realistically you define what you don’t know.
“An investor needs to do very few things right as long as he or she avoids
6 4
T H E W A R R E N B U F F E T T W AY
big mistakes.”
5
Producing above-average results, Buffett has learned,
often comes from doing ordinary things. The key is to do those things
exceptionally well.
Coca-Cola Company
The business of Coca-Cola is relatively simple. The company purchases
commodity inputs and combines them
to manufacture a concentrate
that is sold to bottlers. The bottlers then combine the concentrate with
other ingredients and sell the f inished product to retail outlets including
minimarts, supermarkets, and vending machines. The company also
provides soft drink syrups to fountain retailers, who sell soft drinks to
consumers in cups and glasses.
The company’s name brand products include Coca-Cola, Diet
Coke, Sprite, PiBB Xtra, Mello Yello, Fanta soft drinks, Tab, Dasani,
and Fresca. The company’s beverages also include Hi-C brand fruit
drinks, Minute Maid orange juice, Powerade, and Nestea.
The company
owns 45 percent of Coca-Cola Enterprises, the largest bottler in the
United States, and 35 percent of Coca-Cola Amatil, an Australian bot-
tler that has interests not only in Australia but also in New Zealand and
Eastern Europe.
The strength of Coca-Cola is not only its name-brand products but
also its unmatched worldwide distribution system. Today, international
sales of Coca-Cola products account for 69 percent of the company’s
net sales and 80 percent of its prof its. In addition to Coca-Cola Amatil,
the company has equity interests in bottlers located in Mexico, South
America, Southeast Asia, Taiwan, Hong Kong, and China.
The
Washington Post Company
Buffett’s grandfather once owned and edited the
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