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Lessons from Warren Buffett - LVIII

Oct 22, 2008

In the previous article based on Buffett's 2006 letter to shareholders, we covered his tribute to a fellow value investor Walter Schloss whereby he discussed the latter's value investing based investment strategy and how he (Schloss) had beaten the markets by a huge margin over a long investment horizon.

Let us now move to the letter from the year 2007 i.e., his most recent letter to the shareholders of Berkshire Hathaway and see the investment wisdom on offer therein.

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The Three Gs
Let us suppose that you are planning to lock away the surplus money with you in a bank savings account and three different banks approach you with three different offers:

  1. The first bank takes a one time deposit and pays you a very attractive interest rate, which will continue to increase as years pass by;
  2. The second bank pays a decent interest rate but also asks you to increase your yearly deposits at a fixed rate, which will also bear a decent interest rate; and
  3. The third banks pays you a very poor interest rate and also asks you to increase your deposits at a high rate, which in turn yield the same poor interest rate.

It is difficult to imagine a depositor choosing any other sequence than the one mentioned above if asked to rank his preferences. However, while investing in companies, the very same depositor fumbles quite often. He ends up investing in firms that exhibit the characteristics of deposit schemes similar to options b) and c) listed above.

Warren Buffett has mentioned that virtually all the businesses could be classified on the basis of three characteristics mentioned above and he has gone on to name these businesses as Good, Great and Gruesome. Needless to say businesses of the 'Great' kind are what excite him the most and he tends to avoid the businesses labeled 'Gruesome'.

Let us see what he has to say on the characteristics of each of these businesses:

The golden words
On 'Great' businesses, Buffett says, "Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There's no rule that you have to invest money where you've earned it. Indeed, it's often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return."

Furthermore, Buffett likens 'Good' businesses to industries like the utilities where the companies will earn a lot more 10 years from now but will also have to invest a substantial amount to achieve the same. The returns though are likely to be satisfactory.

Let us now move on to businesses that Buffett has labeled as 'Gruesome' and he proffers the following view on them. He says, "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."

Indeed, if investors stick to 'Great' and 'Good' businesses in their investment lifetimes and buy them at attractive prices, they are unlikely to end up poor.

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24 Responses to "Lessons from Warren Buffett - LVIII"

V.Vijayamohan

Nov 10, 2013

The concept is Simple but effective - just like many other concepts of warren Buffet. In the Indian context, my own assessment is Private Banking sector, Pharma (Export oriented) sector, and IT sectors are Great. FMCG, Telecom are good. Airlines is Gruesome. Iron and steel, Power Generation and Infrastructure sectors could become good or even great - if a Government which 'decides and allows' is ruling the country - not otherwise.

Like (1)

YPS AMETA

Jan 6, 2013

Sir,

Earnings on an Investment depends on the decision where to invest and how long to invest but selecting the business/company where to invest is a critical question. This has answered and suggested in Lessons from wannen buffet are true experiences and useful for every one.

Thanks a Lot,

Like (1)

thalapati

Oct 5, 2012

please mail the lessons form warren buffet thanks

Like (1)

J Makwana

Sep 10, 2012

It is pleasure with benefit to have knowledge when we read something from the great Warren Buffet... I request you to Mail me directly all the articles related to him, particularly, "Lessons from Warren Buffet "..THANKS..

Like (1)

Ramesh Gadapa

Jul 4, 2011

Dear Sir,

Lessons from Warren Buffet is very interesting & eye opening.
I shall be highly obliged if you send all of "Lessons from Warren Buffet" to my mail id.
Thanking You,
Ramesh Gadapa
Mumbai

Like (1)

John Mathai

May 16, 2011

Dear Sir,

Lessons from Warren Buffet is very interesting & eye opening.

I would like to have full set of lessons right from Lesson 1. i shall be highly obliged if you can send the same in my mail.

Thanking you,

John Mathai
Mumbai

Like (1)

salim morbiwala

Apr 2, 2010

Dear Sir,

Thanks For The Lessons from Warren Buffet If We understand it well surely will become smart investor and earn good profit

regards

Like (1)

ajay

Mar 27, 2010

Dear Sir,
Please send all of "Lessons from Warren Buffet" to my mail id its very interesting and useful for future developement for every individua
Thanks

Like (1)

J.ARUN

Mar 26, 2010

its very interesting and useful ......

J.ARUN
BHOJAN CAPITAL.
OOTY,TAMILNADU,INDIA.

Like (1)

Prakash Bendale

Sep 27, 2009

Dear Sir,
Please send all of "Lessons from Warren Buffet" to my mail id its very interesting and useful for future developement for every individual
Thanks

Like (1)
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