Part: 1, 2, 3, 4, 5, 6
Part 2 of this series continues where part 1 left off. Warren continues to talk about the qualities of character which matter most. If there is any confusion, try to find someone to short. Someone who you have to pay 10% of their earnings all of their life. You'd pick the person that is habitually late or constantly cutting corners.
The people with the highest IQs are not the best people. It's the high IQ people that are efficient that you want. It's the qualities of character that make an enormous difference.
Question 1: It sounds like Charlie Munger's and Warren Buffett's analysis are very much back of the envelop. Could you tell us about the financial analysis you would do on The Coca-Cola Company or the Nebraska Furniture Mart.
Answer: Those are two excellent examples. A woman named Rose started and owned Nebraska Furniture Mart. She is an amazing woman that put a lot of people out of business. In 1996 Warren expected Revenues of $230 million. And Nebraska Furniture Mart will probably have pre-tax earnings of $23 million. She came the the US as an immigrant and could not speak English. She started the store with $500. And the punch line is that she can't read or write. The thing is, she can tell you the yardage of a room and give you a quote in a matter of seconds. Point is, she is smart but not due to her education. She knows how to run the business, she is dedicated and she runs her business well. It's a simple thesis and that is all that is needed. When Berkshire bought the Nebraska Furniture mart, it cost $1400 in legal fees and the agreement was only one page long. He knew that anything Rose said was true. No digging to verify her statements were required.
The point of all this is that Warren stayed in his circle of competence. Not to mention that it is a wonderful example of character as previously discussed. Warren can understand some simple businesses but he can not understand any complex businesses. The size of the circle is not important, knowing where the perimeter is, is important. Having a large circle with a fuzzy edge is not as good as a small circle with a well defined perimeter.
Regarding Coke. Coke provides 750 million 8 ounce servings a day. Per capita consumption going up all over the world 110 years after the company was founded. It has 47% of all soft drink consumption outside of the US and 41% in the US. Is Coke a durable product? Yes (according to Buffett). Is Coke universal? Yes. Is there a competent management? Yes. Warren quotes Peter Lynch here. “Go for a business that any idiot can run – because sooner or later, any idiot is probably going to run it.” - Peter Lynch
Any good investment idea can be summarized in one paragraph.
Question 2: When is it time to sell a business?
Answer: The answer to the question regarding a truly great business is never. To sell off something really wonderful because the price looks a little high is almost always a mistake. It's rare that it makes sense if you really believe that the long term economics of the business are is terrific.
From recent history, Warren Buffett bought and sold Petro China. When he sold it, he said that when he sold, he figured it was overvalued by 100%. Without getting into a discussion of Petro China's quality, it's clear that Buffett will sell a grossly overvalued business if it makes sense to sell it.
With tech stocks, people try to jump from flower to flower because Warren believes that there is no long term durability. With tech, you have to jump from winner to winner because there are no permanent winners.
With Gillette (now owned by Proctor & Gamble (ticker: PG)), you have a product. 20-21 billion razor blades are sold per year in 1996. 30% of them are Gillette. But 60% by value are Gillette's. He goes on to say that “When something has been around as long as shaving, and you find a company that has that kind of both innovative power in terms of building new razors all the time plus the distribution power and the position in peoples minds. For an item that costs only $20 a year. Here is something you use every day. I hope you do it every day(crowd laughs). And for $20 per year, you get a terrific shaving experience. Men are not inclined to shift around a lot, you know, when they get that kind of situation.” Given the price of the product and the like of the product, the consumers will remain loyal.
Gillette is an example that is similar to Coke. The product is not going to change a lot. It's easy to sleep at night owning Gillette knowing that 2.5 billion males with hair growing as they sleep. No one at Gillette has trouble sleeping.
That is the beauty of business. You don't need to be right on DuPont, Oracle or Microsoft all of the time. You only need to be right one time a year.
With investments there is no such thing as a called strike. You can stand there at the plate and be very rich. You will think about every decision and when you decide to do something, you will do it on a big scale.
Buying businesses on Wall Street is so easy that the very ease with which it can be done causes people to do things that don't make sense (frequent trading). Most fortunes have been made on one or very few securities that have been held for very long times and where the buyer understood the business.
Part: 1, 2, 3, 4, 5, 6