Retail is a tough business. One of the reasons why it is so hard to be successful in the sector is that it has virtually no barriers to entry. Anyone who has enough money can start a shop or produce their own clothing line.
There are some exceptions to this rule, but for every one company that has carved out a reputation for itself as a retail giant, I'm willing to bet there are at least 100 failed enterprises.
Considering the nature of the retail industry, I'm always surprised when I read about Warren Buffett (Trades, Portfolio)'s investments in the sector. Buffett has only made a handful of retail investments over the past few decades, one of which turned out to be one of his most costly mistakes of all time (Dexter Shoe). The others have worked out reasonably well.
Buffett on retail
The most well-known of Buffett retail sector bets is Nebraska Furniture Mart. Buffett famously bought this business off its owner, "Mrs. B," with a one-page contract after spending only a few hours considering the offer.
Another acquisition was R.C. Willey Home Furnishings. Buffett bought this business in 1995, and went on to describe why he made the deal in his Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual letter to shareholders that year:
"R.C. Willey is an amazing story. Bill took over the business from his father-in-law in 1954 when sales were about $250,000. From this tiny base, Bill employed Mae West's philosophy: "It's not what you've got it's what you do with what you've got." Aided by his brother, Sheldon, Bill has built the company to its 1995 sales volume of $257 million, and it now accounts for over 50% of the furniture business in Utah."
As the Oracle of Omaha went on to explain, both R.C. Willey and Nebraska Furniture Mart operated in a similar line of business, selling appliances, electronics, carpets and furniture. Willey had a much bigger footprint than its peer, with six major stores at the time of the acquisition compared to Nebraska's one.
As Buffett said in his letter, "retailing is a tough business."
He went on to add, "During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy."
The reason why so many retailers fail to stay at the top of their game is that they are involved in a constant shooting match. "A retailer must stay smart, day after day," Buffett said.
Nebraska and R.C. Willey had managed to stay ahead of the competition because they had incredibly smart managers at the helm. As Buffett explained in his letter:
"In contrast to this have-to-be-smart-every-day business, there is what I call the have-to-be-smart-once business. For example, if you were smart enough to buy a network TV station very early in the game, you could put in a shiftless and backward nephew to run things, and the business would still do well for decades. You'd do far better, of course, if you put in Tom Murphy, but you could stay comfortably in the black without him. For a retailer, hiring that nephew would be an express ticket to bankruptcy."
"The two retailing businesses we purchased this year are blessed with terrific managers who love to compete and have done so successfully for decades. Like the CEOs of our other operating units, they will operate autonomously: We want them to feel that the businesses they run are theirs."
Picking retail stocks is not an easy game, but this advice from the Oracle of Omaha could help you make the right decisions when it comes to picking future winners.
Disclosure: I own shares of Berkshire Hathaway.Â
Read more here:
- Warren Buffet: Everyone Wants an Easy Investing System
- Buffett's Views on How to Prepare for a Recession
- Warren Buffett: Figuring out the Durability of a Business
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