In part one of this mini-series, we looked at a particularly illuminating Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) shareholder letter from 1996. In it, Warren Buffett (Trades, Portfolio) explained why he prefers inactivity to activity, and why diversification for the sake of diversification is a foolish strategy.
In part two, we will look at another part of that same letter, in which the Oracle of Omaha outlineed the characteristics of the kinds of businesses that he and his partner Charlie Munger (Trades, Portfolio) like to invest in. He also discusses the concept of an "inevitable" business — that is, a company that is destined for success.
Invest in boring
From the letter:
“In studying the investments we have made in both subsidiary companies and common stocks, you will see that we favor businesses and industries unlikely to experience major change. The reason for that is simple: Making either type of purchase, we are searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twenty years from now. A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek.
I should emphasize that, as citizens, Charlie and I welcome change: Fresh ideas, new products, innovative processes and the like cause our country's standard of living to rise, and that's clearly good. As investors, however, our reaction to a fermenting industry is much like our attitude toward space exploration: we applaud the endeavor but prefer to skip the ride.”
Notice how at odds this is with a lot of financial commentary. One need only to flick on any financial channel to be bombarded with news of the latest explosive tech stock or eagerly awaited IPO. Yet the greatest investor of all time prefers to stay away from such turbulent waters.
The easiest way to make money is to avoid going broke, and that’s why Berkshire has typically steered clear of the growth stories of the 21st century. This approach has brought clearly positive results: Buffett only began purchasing Apple (APPL) in the first quarter of 2016, at a time when many thought that he had missed the boat on this particular investment. But he wasn’t interested in Apple as a growth stock in the rapidly evolving mobile phone market of the early 2010s; he became interested in it when it had already established overwhelming market dominance. He waited until the industry became boring.
The inevitables
“Companies such as Coca-Cola and Gillette might well be labeled 'The Inevitables.' Forecasters may differ a bit in their predictions of exactly how much soft drink or shaving-equipment business these companies will be doing in ten or twenty years. Nor is our talk of inevitability meant to play down the vital work that these companies must continue to carry out, in such areas as manufacturing, distribution, packaging and product innovation. In the end, however, no sensible observer - not even these companies' most vigorous competitors, assuming they are assessing the matter honestly - questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime. Indeed, their dominance will probably strengthen. Both companies have significantly expanded their already huge shares of market during the past ten years, and all signs point to their repeating that performance in the next decade
Obviously many companies in high-tech businesses or embryonic industries will grow much faster in percentage terms than will The Inevitables. But I would rather be certain of a good result than hopeful of a great one.”
It has been almost 23 years since this letter was written, and both brands have continued their global dominance — Coca-Cola (KO, Financial) as an independent entity and Gillette as a subsidiary of Procter & Gamble (PG, Financial). Incidentally, Berkshire Hathaway still has a considerable stake in Coca-Cola, and acquired shares of P&G when that company acquired Gillette, booking a $5 billion paper profit on the deal. Buffett later sold his P&G shares to acquire Duracell, another incredibly strong brand, from P&G.
For the greater part of his career, Warren Buffett (Trades, Portfolio) has sought out opportunities to buy global brands at discount prices. He doesn’t buy the upstart newcomer with growth potential — he goes right to the big dogs that he feels certain will still control sizeable market share in 10 or even 20 years' time. So far, this has been a winning strategy.
Disclosure: The author owns no stocks mentioned.
Read more here:Ă‚
Warren Buffett’s Guide to Intelligent Investing, Part 1Â
Warren Buffett on Cigar Butts and the Institutional ImperativeÂ
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