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The Equitymaster Research Digest

What Is a Good Business?
Aug 10, 2016

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Let's turn back the clock. Think of the first time you bought a stock. How did it feel? Did you get lucky?

I don't know what your respective answers will be to these questions... But your first stock was likely a speculative bet.

Why do I say this? Because it's very unlikely that someone buying their first stock will know how to analyse a business.

I didn't.

When I bought my first stocks in early 2006 (ITC and Cipla), I was not working with Equitymaster, and I had no idea why I bought them.

I just knew that these stocks were going up...and that they could go up more!

By sheer luck, I made some short-term profits.

Does this ring a bell?

Relax. I'm not criticising anyone. This is normal.

But 'normal' is not the same as 'correct'.

Over time, we gain knowledge and experience. Our stock-picking skills improve. We learn to separate the stock from the business. We learn to ask the right questions.

Not...

'What is a good stock?'

Rather...

'What is a good business?'

Thankfully, we don't have to struggle to find the answer to that question. Warren Buffett did the work for us.

No kidding. In his 2007 letter to shareholders, he explained the three types of businesses: the great, the good, and the gruesome.

Great businesses are easy to understand. They earn huge return on capital. They grow at a steady pace. They don't need much capital to grow. They pay out large dividends. They're tough to compete with.

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