Analyzing and breaking down investment ideas is an integral part of improving one's process. It is something Charlie Munger (Trades, Portfolio) recommends investors do regularly to understand how they made mistakes and where they went wrong.
One of the easiest ways to learn from investment mistakes is to review the investment decisions of others. This can help overcome the psychological biases that come with examining one's own investment positions. A highly educational case study is the so-called "inevitables" that Warren Buffett (Trades, Portfolio) outlined back in the 90's.
The inevitables
A couple of decades ago, Buffett spoke about the companies that he called the "inevitables" in his annual report. These were companies that had highly predictable business models, so much so that Buffett dubbed their success inevitable because it was so easy to predict their cash flows.
Buffett picked out Coca-Cola (KO, Financial) and Gillette as two examples of these inevitable business models. At Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) 1997 annual meeting, one shareholder wanted to know if McDonald's (MCD, Financial) fit into the same bracket. In response, Buffett stated that he did not believe the fast-food company had the same qualities:
"I would say that in the food business, you would never get the total certainty of dominance that you would get in products like Coca-Cola and Gillette. People move around in the food business, from where they eat, from - they may favor McDonald's but they will go to different places at different times. And somebody starts shaving with a Gillette Sensor Plus is very unlikely to go elsewhere, in my view. So they do not - you just - you never would get in the food business, in my judgment, quite the inevitability that you would get in the soft drink business with a Coca-Cola."
He went on to add:
"You'll never get it again in the soft drink business. I mean, it took a hundred - I guess it'd be 1886, so it'd be about 111 years to get to the point where they are. And the infrastructure's incredible, and - so I wouldn't put it quite in the same class, in terms of inevitability."
Two and a half decades on, McDonald's has had more time to prove its worth. The company certainly has a bigger, more ingrained footprint today than it did in 1997.
However, I think it is more important to highlight the market share loss Gillette has suffered over the past decade. Between 2010 and 2018, the company's share of the U.S. razor market fell from 70% to 54%. Upstarts like Harry's and Dollar Shave Club have chipped away at its market dominance by offering cheaper products, while others have swooped in with more expensive but better-quality products.
Gillette has not turned out to be the inevitable company Buffett believed it would be in 1997. There are a couple of things to consider here. Just because the company has lost market share does not necessarily mean it will be a bad investment. What's more, Gillette's business model remains intact. The high-margin recurring revenue business model Buffett was attracted to still exists.
Meanwhile, with regards to McDonald's, the restaurant industry still suffers from the challenges the Oracle of Omaha outlined in 1997. Consumers have a vast amount of choice when it comes to eating out, and turnover in the restaurant industry is extremely high.
Despite these drawbacks, McDonald's has clearly carved out a niche in its market, and it does have a high level of brand loyalty. Considering Gillette's market share losses over the past decade, it does not appear to have the same level of brand loyalty.
I am not going to say Buffett made a mistake in his appraisal of McDonald's and Gillette in 1997. His observations were correct at the time. However, I think it is essential to acknowledge that the business environment is constantly changing. Just because a company was successful in 1997 does not mean it will still be 20 years later, even if the business model that brought it success in the past remains the same. Investors need to analyze continually and break down their ideas to make sure they don't fall into this trap.
