Having just recently returned from the Berkshire Hathaway annual shareholders meeting – a lifelong dream fulfilled; I was reminded of one of Warren Buffett’s key principles. Investing in great businesses.
It sounds simple but in today’s fast moving, online world, where a huge amount of data is at our fingertips, there is a tendency to get bogged down in the numbers when choosing an investment.
Ratios and statistics such as the ‘PE (price/earnings) ratio’ and ‘return on equity’ have become popular in recent times. This sort of data can be important, but a great set of numbers is not worth anything if the business model is wrong.
A business can post a great set of results, achieve record profits, but if the business operates in a market that is declining or offers a product that will no longer be needed in the future then these results will not be sustainable.
It’s said that Buffett does not invest in businesses he doesn’t understand and if you look at the Berkshire Hathaway portfolio this definitely looks true. It is full of companies with easy-to-understand business models and he even admitted during the recent annual shareholders meeting that he knows nothing about Artificial Intelligence.
Here at Minerva Money Management, whilst we are looking for investments in different markets to what Buffett would normally be comfortable in, we do apply the same principles of picking great businesses first and foremost.
We believe there are some key soft facts you can work through in order to determine whether you have found a good business such as:
Understanding the business – Are you clear on what the business does? Can you explain it in simple terms? Do you know what is going on in that market and what future prospects look like?
Popularity of the business – Is it easy to see with your own eyes how popular the business is? Take the company Apple for example. Their products are all around you and I imagine most of your friends would rather sell their car before giving up their iPhone.
Moat – Does the business have a moat? Something that protects its market share meaning it is very hard for new entrants in the market to compete.
Owners with skin in the game – Do the founders still run the business and do they still hold a large proportion of the shares? This usually means the vision is strong and the people running the company are incentivised for it to succeed.
Only once these soft facts are determined should you decide whether to move on to the hard facts.
Don’t get me wrong, the hard facts are certainly important, you don’t want to overpay for a business. It can take some businesses many years to become profitable.
Debt can be a huge drain on company resources and can sometimes destroy the best businesses.
Profit figures can be misleading so it always good to check the free cash flow to see if a company really is making money.
At the end of the day investing really can be quite simple. Think of yourself as a business owner. When choosing stocks, don’t think of it as a stock, think of the business. Do you want to own that business?
I think it’s appropriate for the great man to have the final say…..
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
Carl Roberts, Director
If you want to learn more about this topic, please find the link.
More information about our fund the YFS Intelligent Wealth Fund can be found here: Hargreaves Lansdown or AJ Bell
Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
