A letter a day!

A letter a day!

Letter #61 2007

Key learning’s :

1. A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low- cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success.

2. If a business requires a superstar to produce good results, the business itself cannot be considered great.

“A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.”

3. Always look for long term competitive advantage in a stable industry . If it comes with a rapid growth , it’s a great. But even if it comes without any organic growth, such business can be rewarding.

4. The growing businesses have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments.
   A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment.

5. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.

“The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt. Twice”

6. Do not measure the progress of your investments by what their market prices do during any given year. Rather, evaluate their performance by the two methods.

1)The first test is improvement in earnings.
2) The second test, more subjective, is whether their “moats” – a metaphor for the superiorities they possess that make life difficult for their competitors – have widened during the year.