One of my favorite bloggers, Richard Beddard, read my post on talking to management and pointed me to a post he wrote on the subject back in 2008.
Richard’s post is definitely worth a read.
In it, he mentions Peter Lynch. Lynch wrote two of the best books on investing – One Up on Wall Street and Beating the Street. Lynch he doesn’t get enough credit for those books from value investors. I’ve got both books up on my shelf right next to Phil Fisher’s Common Stocks and Uncommon Profits.
Peter Lynch and Phil Fisher have a lot in common with Warren Buffett. I think their biggest similarity is their focus on competitive advantages. They may not all talk about moats. But they're all looking for them. They're all thinking not just like investors but like businessman. And that sets them apart from some value investors.
Lynch's books and Fisher's books are definitely worth reading.
If you’re looking for common sense advice on how to pick stocks, these are the 5 books to read:
1. The Intelligent Investor
2. One Up On Wall Street
3. Beating the Street
4. You Can Be a Stock Market Genius
5. Common Stocks and Uncommon Profits
Now, Richard Beddard and Peter Lynch really show me up here – as does Phil Fisher, but more on him later – since they both talk so much sense about talking to management. Yet, I basically said: “Don’t.”
I get a lot of emails from people asking what kind of questions they should ask management. And I hear from people who’ve already talked to management. Sometimes these are people who don’t know more about the stock then I do. You need enough background to ask intelligent questions. So don’t rush into talking to management.
Before talking to any company's management, read:
1. Richard Beddard’s post
2. Peter Lynch’s One Up on Wall Street and Beating the Street
3. Phil Fisher’s Common Stocks and Uncommon Profits
Lynch and Fisher were both very good at this kind of thing. And I don’t think most value investors naturally work the way those two did.
Fisher said he does not approach management in the early stages of researching a company.
Instead he:
“(tries) to see…every key customer, supplier, competitor, ex-employee, or scientist in a related field that I know or whom I can approach through mutual friends.”
Now you’re probably thinking: “Well, good for Phil Fisher. But I don’t know anybody like that.”
Chances are you do. Take me for instance. Let’s put aside friends. Since I write about stocks, I know a lot of helpful people you might not.
Instead I’ll just go through my extended family.
I know investment bankers and retail brokers, bank tellers, booksellers, people who work in insurance, people who work on websites, people who lay cable, teachers, shop owners, construction workers, lawyers, accountants, auto workers, meat packers, delivery truck drivers, restaurant owners, company directors, people who work for non-profits, people who work in law enforcement, and…
And that’s just family. If you add friends and folks I talk with because of my blog– we’re starting to get a pretty big list.
The best information you can get out of any conversation is how the business works. The next best information you can get is how one competitor stacks up against the others.
In many cases, you don’t need to talk to management to get that information.
Saying I talked to the CEO sounds more impressive than saying I talked to the manager of their Springfield store. But who is the better source of competitive information?
Obviously, customers make great information sources. After all, companies spend big bucks studying their own customers.
Why shouldn’t investors study customers too?
It’s also really easy to talk to customers. Because the questions you want to ask and the questions customers want to answer usually line up real nice.
Now for a hypothetical…
Let’s pretend I go to the same restaurant every weekday morning for breakfast. I do. So this isn’t all that hypothetical yet. Now let’s say I’m studying a stock like Sysco (SYY, Financial), American Express (AXP, Financial), or Intuit (INTU, Financial).
How can the restaurant owner be helpful in this situation?
Well, if the owner is a customer of Sysco, American Express, or Intuit he probably made a choice about using that product.
Ask him why he made that choice. He’ll be happy to tell you. Listen to the reason he gives. That’s often going to be the company’s competitive advantage.
It will also be a reality check on what matters and what doesn’t.
The truth is that investors, analysts, and executives overthink things. They think a great many things matter about a company’s products. They think a company’s competitive advantages are some impossibly hard to quantify amalgam of its people, its culture, its R&D, its…
No.
If you actually talk to a customer, the whole decision usually boils down to something as simple as: they carry the widest selection. I can get all the stuff I need from one place. It’s convenient.
If you read about how Warren Buffett applied Phil Fisher’s scuttlebutt approach, you’ll notice something interesting.
He tried to understand the business. Really understand the business. When Buffett was interested in advertising stocks, he asked his advertising friends about the advertising business. He learned everything he could about insurance. He stood behind the counter at an Omaha restaurant and watched as people used their American Express cards.
He wasn’t looking for inside information. He wasn’t looking for an edge. He wasn’t checking channels. He wasn’t trying to figure out what this month’s comps looked like.
He was just trying to find the connection between people’s behavior and what he was seeing in the financial statements.
You can often tell a good business from a bad business just by reading the financial statements. But you may not be able to tell whether that high return on capital or that fat profit margin is sustainable. You may not understand why a certain store is doing more sales per square foot until you walk the store floor yourself.
I don’t think doing that kind of research is necessarily dangerous. But I think it’s important for investors to understand how to weigh the information they get.
A lot of investors seem to think open source intelligence is somehow less valuable than information they get from top management. The most important information about a company is going to be found in their annual reports and in publicly visible stuff like their stores and products.
If I want to understand Barnes & Noble (BKS, Financial) or Richard wants to understand Games Workshop, the first step is usually going to be walking in the door.
That seems obvious, but not everybody does it.
A recent example for me is Delegat’s. It’s a New Zealand wine company.
Guess what I did as soon as I finished reading the annual report?
I went to my local wine superstore – yes, I have one of those – and I tried to find a bottle of Oyster Bay wine myself without any help from the staff.
How visible was it? How many bottles were they displaying? How was it priced compared to other New Zealand wines? What did it look like? What other label would people most likely confuse it with? In other words, what was the closest substitute? What was the mindshare?
And, yes, I bought a bottle and drank it. But, frankly, whether I liked the wine or not was never going to be the deciding factor in whether I bought the stock or not.
I just wanted to see what customers see when they go searching for the product.
For most investors, the scuttlebutt approach is going to work best if you start with the customer. You want to figure out what their problem is. How do they decide?
Be an objective observer. Really listen to what you’re hearing. Don’t try to force some competitive theory on the situation.
I’ve read a lot of books on competition. I can’t recommend any of them.
There’s a book called Hidden Champions of the 21st Century. It’s not about competition exactly. It’s about companies – mostly from German speaking countries – that dominate very small market niches.
You’ll learn more useful stuff about competitive forces from that one little book than from all the books on competition you hear people quoting from.
I’ve never been overwhelmed by what economists have written about competition. Maybe it’s good. Maybe it’s bad. It’s usually not very practical. I can’t apply the stuff they talk about. And I’m not sure I can tell – or they can tell – how much sense they’re talking.
I’m not arguing whether the work they’re doing is good or bad for the science of economics. I’m just saying most of what economists write about for each other to on the topic of competition doesn’t offer a framework investors can profitably apply.
If you have access to academic journals, I’d read the papers published in a business history journal rather than an economics journal. And don’t limit yourself to recent papers. Research methods – and faddish frameworks – change pretty fast in the academic world. So, a great paper on cigarette pricing written in the 1950s and discussing prices in the early 1900s is not going to look the same as a paper on the same subject written in 2010. The history may be the same. But the interpretation will differ depending on what decade the research was done in.
Most of the well-known work in these areas is broad. And that’s rarely useful for investors. Stories about individual companies – or oligopolies – are the most useful.
Of course, there have been bestsellers like Built to Last and Good to Great that are worth reading.
Do they have flaws?
Sure. Plenty of them.
But they’ll give you a sample of some companies that were once pretty good businesses. The first book, Built to Last, suffers from how the companies were selected. The authors didn’t pick companies just because they did really, really well for their shareholders. And that’s really what we want to read about. A good antidote to the big company bias in these books is reading them alongside Hidden Champions of the 21st Century.
Looking at companies from Warren Buffett’s past is also a good idea.
How did Walt Disney (DIS, Financial) stock do since Buffett first bought the company’s shares in his partnership days? How about American Express? GEICO? The Washington Post (WPO, Financial)?
The best sources for information about Buffett’s views of competitive advantages are his lectures to students and Alice Schroeder’s biography.
Buffett said Tom Murphy was the best manager he knew. Well, Tom Murphy did an hour long interview with Charlie Rose back in 1995. You can watch that.
And you can look long and hard for anything written about Capital Cities.
For example, you can search newspaper archives using the internet. Access to the full historical archives often costs something. But it’s available in a lot of different ways. The Wall Street Journal, New York Times, and the company’s hometown paper probably wrote about them at some point.
You can also screen for stocks that have averaged – say – a 20% return on equity over the last 10 years. For example, if you use Sharelockholmes – the best tool for screening stocks in the United Kingdom – to find stocks with a 20% average ROE over the last 10 years and a Z-Score of 3 or greater (to eliminate those that are just highly leveraged), you end up with 57 stocks.
They range in size from a $15 million market cap to a $75 billion market cap.
Most of the businesses have little in common other than their ability to earn high returns on equity.
The basic idea here is to be curious. Hunt down good companies and study them. Try to understand why some businesses are so good while most are so mediocre.
Do you think it has something to do with management or culture or some competitive advantage that can be duplicated in other industries?
The important thing is to stop settling for explaining away any high return business using the competitive advantages you see listed in textbooks.
Any business – of any size – that earns high returns on tangible capital year after year is a business worthy of studying.
So start studying those real world examples instead of reading about competitive theory.
That’s what Warren Buffett did. He got his education from buying both great businesses and lousy businesses. He learned he liked the great businesses better. And he starting finding ways to identify them from afar.
You can learn to do the same.
Again, I’d suggest starting your study of competitive advantages in the real world by looking at: Warren Buffett’s past investments, Peter Lynch’s books, Phil Fisher’s book, and Hidden Champions of the 21st Century.
Follow Geoff at Gannon On Investing
Richard’s post is definitely worth a read.
In it, he mentions Peter Lynch. Lynch wrote two of the best books on investing – One Up on Wall Street and Beating the Street. Lynch he doesn’t get enough credit for those books from value investors. I’ve got both books up on my shelf right next to Phil Fisher’s Common Stocks and Uncommon Profits.
Peter Lynch and Phil Fisher have a lot in common with Warren Buffett. I think their biggest similarity is their focus on competitive advantages. They may not all talk about moats. But they're all looking for them. They're all thinking not just like investors but like businessman. And that sets them apart from some value investors.
Lynch's books and Fisher's books are definitely worth reading.
If you’re looking for common sense advice on how to pick stocks, these are the 5 books to read:
1. The Intelligent Investor
2. One Up On Wall Street
3. Beating the Street
4. You Can Be a Stock Market Genius
5. Common Stocks and Uncommon Profits
Now, Richard Beddard and Peter Lynch really show me up here – as does Phil Fisher, but more on him later – since they both talk so much sense about talking to management. Yet, I basically said: “Don’t.”
I get a lot of emails from people asking what kind of questions they should ask management. And I hear from people who’ve already talked to management. Sometimes these are people who don’t know more about the stock then I do. You need enough background to ask intelligent questions. So don’t rush into talking to management.
Before talking to any company's management, read:
1. Richard Beddard’s post
2. Peter Lynch’s One Up on Wall Street and Beating the Street
3. Phil Fisher’s Common Stocks and Uncommon Profits
Lynch and Fisher were both very good at this kind of thing. And I don’t think most value investors naturally work the way those two did.
Fisher said he does not approach management in the early stages of researching a company.
Instead he:
“(tries) to see…every key customer, supplier, competitor, ex-employee, or scientist in a related field that I know or whom I can approach through mutual friends.”
Now you’re probably thinking: “Well, good for Phil Fisher. But I don’t know anybody like that.”
Chances are you do. Take me for instance. Let’s put aside friends. Since I write about stocks, I know a lot of helpful people you might not.
Instead I’ll just go through my extended family.
I know investment bankers and retail brokers, bank tellers, booksellers, people who work in insurance, people who work on websites, people who lay cable, teachers, shop owners, construction workers, lawyers, accountants, auto workers, meat packers, delivery truck drivers, restaurant owners, company directors, people who work for non-profits, people who work in law enforcement, and…
And that’s just family. If you add friends and folks I talk with because of my blog– we’re starting to get a pretty big list.
The best information you can get out of any conversation is how the business works. The next best information you can get is how one competitor stacks up against the others.
In many cases, you don’t need to talk to management to get that information.
Saying I talked to the CEO sounds more impressive than saying I talked to the manager of their Springfield store. But who is the better source of competitive information?
Obviously, customers make great information sources. After all, companies spend big bucks studying their own customers.
Why shouldn’t investors study customers too?
It’s also really easy to talk to customers. Because the questions you want to ask and the questions customers want to answer usually line up real nice.
Now for a hypothetical…
Let’s pretend I go to the same restaurant every weekday morning for breakfast. I do. So this isn’t all that hypothetical yet. Now let’s say I’m studying a stock like Sysco (SYY, Financial), American Express (AXP, Financial), or Intuit (INTU, Financial).
How can the restaurant owner be helpful in this situation?
Well, if the owner is a customer of Sysco, American Express, or Intuit he probably made a choice about using that product.
Ask him why he made that choice. He’ll be happy to tell you. Listen to the reason he gives. That’s often going to be the company’s competitive advantage.
It will also be a reality check on what matters and what doesn’t.
The truth is that investors, analysts, and executives overthink things. They think a great many things matter about a company’s products. They think a company’s competitive advantages are some impossibly hard to quantify amalgam of its people, its culture, its R&D, its…
No.
If you actually talk to a customer, the whole decision usually boils down to something as simple as: they carry the widest selection. I can get all the stuff I need from one place. It’s convenient.
If you read about how Warren Buffett applied Phil Fisher’s scuttlebutt approach, you’ll notice something interesting.
He tried to understand the business. Really understand the business. When Buffett was interested in advertising stocks, he asked his advertising friends about the advertising business. He learned everything he could about insurance. He stood behind the counter at an Omaha restaurant and watched as people used their American Express cards.
He wasn’t looking for inside information. He wasn’t looking for an edge. He wasn’t checking channels. He wasn’t trying to figure out what this month’s comps looked like.
He was just trying to find the connection between people’s behavior and what he was seeing in the financial statements.
You can often tell a good business from a bad business just by reading the financial statements. But you may not be able to tell whether that high return on capital or that fat profit margin is sustainable. You may not understand why a certain store is doing more sales per square foot until you walk the store floor yourself.
I don’t think doing that kind of research is necessarily dangerous. But I think it’s important for investors to understand how to weigh the information they get.
A lot of investors seem to think open source intelligence is somehow less valuable than information they get from top management. The most important information about a company is going to be found in their annual reports and in publicly visible stuff like their stores and products.
If I want to understand Barnes & Noble (BKS, Financial) or Richard wants to understand Games Workshop, the first step is usually going to be walking in the door.
That seems obvious, but not everybody does it.
A recent example for me is Delegat’s. It’s a New Zealand wine company.
Guess what I did as soon as I finished reading the annual report?
I went to my local wine superstore – yes, I have one of those – and I tried to find a bottle of Oyster Bay wine myself without any help from the staff.
How visible was it? How many bottles were they displaying? How was it priced compared to other New Zealand wines? What did it look like? What other label would people most likely confuse it with? In other words, what was the closest substitute? What was the mindshare?
And, yes, I bought a bottle and drank it. But, frankly, whether I liked the wine or not was never going to be the deciding factor in whether I bought the stock or not.
I just wanted to see what customers see when they go searching for the product.
For most investors, the scuttlebutt approach is going to work best if you start with the customer. You want to figure out what their problem is. How do they decide?
Be an objective observer. Really listen to what you’re hearing. Don’t try to force some competitive theory on the situation.
I’ve read a lot of books on competition. I can’t recommend any of them.
There’s a book called Hidden Champions of the 21st Century. It’s not about competition exactly. It’s about companies – mostly from German speaking countries – that dominate very small market niches.
You’ll learn more useful stuff about competitive forces from that one little book than from all the books on competition you hear people quoting from.
I’ve never been overwhelmed by what economists have written about competition. Maybe it’s good. Maybe it’s bad. It’s usually not very practical. I can’t apply the stuff they talk about. And I’m not sure I can tell – or they can tell – how much sense they’re talking.
I’m not arguing whether the work they’re doing is good or bad for the science of economics. I’m just saying most of what economists write about for each other to on the topic of competition doesn’t offer a framework investors can profitably apply.
If you have access to academic journals, I’d read the papers published in a business history journal rather than an economics journal. And don’t limit yourself to recent papers. Research methods – and faddish frameworks – change pretty fast in the academic world. So, a great paper on cigarette pricing written in the 1950s and discussing prices in the early 1900s is not going to look the same as a paper on the same subject written in 2010. The history may be the same. But the interpretation will differ depending on what decade the research was done in.
Most of the well-known work in these areas is broad. And that’s rarely useful for investors. Stories about individual companies – or oligopolies – are the most useful.
Of course, there have been bestsellers like Built to Last and Good to Great that are worth reading.
Do they have flaws?
Sure. Plenty of them.
But they’ll give you a sample of some companies that were once pretty good businesses. The first book, Built to Last, suffers from how the companies were selected. The authors didn’t pick companies just because they did really, really well for their shareholders. And that’s really what we want to read about. A good antidote to the big company bias in these books is reading them alongside Hidden Champions of the 21st Century.
Looking at companies from Warren Buffett’s past is also a good idea.
How did Walt Disney (DIS, Financial) stock do since Buffett first bought the company’s shares in his partnership days? How about American Express? GEICO? The Washington Post (WPO, Financial)?
The best sources for information about Buffett’s views of competitive advantages are his lectures to students and Alice Schroeder’s biography.
Buffett said Tom Murphy was the best manager he knew. Well, Tom Murphy did an hour long interview with Charlie Rose back in 1995. You can watch that.
And you can look long and hard for anything written about Capital Cities.
For example, you can search newspaper archives using the internet. Access to the full historical archives often costs something. But it’s available in a lot of different ways. The Wall Street Journal, New York Times, and the company’s hometown paper probably wrote about them at some point.
You can also screen for stocks that have averaged – say – a 20% return on equity over the last 10 years. For example, if you use Sharelockholmes – the best tool for screening stocks in the United Kingdom – to find stocks with a 20% average ROE over the last 10 years and a Z-Score of 3 or greater (to eliminate those that are just highly leveraged), you end up with 57 stocks.
They range in size from a $15 million market cap to a $75 billion market cap.
Most of the businesses have little in common other than their ability to earn high returns on equity.
The basic idea here is to be curious. Hunt down good companies and study them. Try to understand why some businesses are so good while most are so mediocre.
Do you think it has something to do with management or culture or some competitive advantage that can be duplicated in other industries?
The important thing is to stop settling for explaining away any high return business using the competitive advantages you see listed in textbooks.
Any business – of any size – that earns high returns on tangible capital year after year is a business worthy of studying.
So start studying those real world examples instead of reading about competitive theory.
That’s what Warren Buffett did. He got his education from buying both great businesses and lousy businesses. He learned he liked the great businesses better. And he starting finding ways to identify them from afar.
You can learn to do the same.
Again, I’d suggest starting your study of competitive advantages in the real world by looking at: Warren Buffett’s past investments, Peter Lynch’s books, Phil Fisher’s book, and Hidden Champions of the 21st Century.
Follow Geoff at Gannon On Investing
