Buy businesses with long-term visibility the Warren Buffett way
One effective way of finding good companies is to ask whether their product or service will undergo any change over the next 10 years
By Research Desk | Oct 3, 2018
Investors who have come to the market in the last 10 years have seen it go only up. Many of them do not think about the long-term demand for a company's products and its impact on stock returns. Here we explore the relation between long-term visibility of a company's product or service and how it affects the returns you can expect.
The world's greatest investor Warren Buffett takes a long hard look at where a company will be 5 to 10 years from today. We show you how you can improve your stock returns if you follow Buffett.
Buffett gives a lot of weightage to businesses that are stable and have been doing the same thing for decades. His rationale is that such businesses develop a franchise over decades of operations. Here is Buffett explaining why this is important.
'Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago. That is no argument for managerial complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But a business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns.'
What we have to train ourselves as investors is to look out how a company is going to do five or 10 years ahead. You want it to be continuing to do the same thing again and again.
'There are all kinds of important subjects that Charlie and I, we don't know anything about, and therefore we don't think about them. So we have - our view about what the world will look like over the next ten years in business or competitive situations, we're just no good.
We do think we know something about what Coca-Cola's going to look like in ten years, or what Gillette's going to look like in ten years, or what Disney's going to look like in ten years, or what some of our operating subsidiaries are going to look like in ten years.
We care a lot about that. We think a lot about that. We want to be right about that. If we're right about that, the other things get to be - you know, they're less important. And if we started focusing on those, we would miss a lot of big things.
I've used this example before, but Coca-Cola went public in, I think, it was 1919. And the first year one share cost $40. The first year it went down a little over 50 percent. At the end of the year, it was down to $19. There were some problems with bottler contracts. There's problems with sugar. Various kinds of problems. If you'd had perfect foresight, you would have seen the world's greatest depression staring you in the face, when the social order even got questioned. You would have seen World War II. You would have seen atomic bombs and hydrogen bombs. You would have seen all kinds of things. And you could always find a reason to postpone why you should buy that share of Coca-Cola.
But the important thing wasn't to see that. The important thing was to see they were going to be selling a billion eight-ounce servings of beverages a day this year. Or some large number. And that the person who could make people happy a billion times a day around the globe ought to make a few bucks off doing it. And so that $40, which went down to $19, I think with dividends reinvested, has to be well over $5 million now. And if you developed a view on these other subjects that in any way forestalled you acting on this more important, specific narrow view about the future of the company, you would have missed a great ride. So that's the kind of thing we focus on.'
Avoid businesses that a smartphone can destroy
Technology is a disruptive force. It has destroyed the fortunes of many varied industries. Here is Buffett talking of the effect of technology and the damage it can do to some industries.
'If something comes in where there's a technological component that's of significance, or where we think the future technology could hurt the business as it presently exists, we look at, you know, we look at that as something to worry about.'
Here are some businesses destroyed by smartphones. Some are struggling to remain alive.
1. GPS location devices
3. Book publishers
4. File cabinet manufacturers
6. Music CD and DVD players
7. Digital cameras
8. Handheld video games
10. Travel agents
11. Brick and mortar book stores
12. Traditional taxis
13. Banks physical branches
15. Real estate brokers
Remember, avoid companies selling products that can one day become an app.
The problem with tech companies
Many Indian tech companies that do basic back-office work are susceptible to any innovation that can render their services obsolete. Automation has started doing that today. These tech firms will have to move up to doing something that cannot be easily replicated by robots or software. Here's Buffett talking about the risks to software companies compared to those selling simpler products.
'I am not going to be able to figure what the moat is going to look like for Oracle, Lotus or Microsoft ten years from now. Gates is the best businessman I have ever run into and they have a hell of a position, but I really don't know what that business is going to look like ten years from now. I certainly don't know what his competitors will look like ten years from now. I know what the chewing business will look like ten years from now. The Internet is not going to change how we chew gum and nothing much else is going to change how we chew gum. There will be lots of new products. Is Spearmint or Juicy Fruit going to evaporate? It isn't going to happen. You give me a billion dollars and tell me to go into the chewing gum business and try to make a real dent in Wrigley's. I can't do it. That is how I think about businesses. I say to myself, give me a billion dollars and how much can I hurt the guy? Give me $10 billion dollars and how much can I hurt Coca-Cola around the world? I can't do it. Those are good businesses.'
How to look at stocks?
In today's world of 'click to buy and sell' many investors confuse investing with trading. 'Buy today, sell tomorrow' is a big selling jingle for one big brokerage. This is exactly what you should never do with stocks. If you have done your homework and have not fallen prey to a 'hot stock' at crazy valuations, you should not be looking at an exit price. Buffett explains.
'I don't want to buy any stock where if they close the NYSE tomorrow for five years, I won't be happy owning it. I buy a farm and I don't get a quote on it for five years and I am happy if the farm does OK. I buy an apartment house and don't get a quote on it for five years, I am happy if the apartment house produces the returns that I expect. People buy a stock and they look at the price next morning and they decide to see if they are doing well or not doing well. It is crazy. They are buying a piece of the business. That is what Graham - the most fundamental part of what he taught me. You are not buying a stock, you are buying part ownership in a business. You will do well if the business does well, if you didn't pay a totally silly price. That is what it is all about.'
Remember Buffett is not saying you bury your head in the sand after you buy a stock. Follow the major news, the big developments, the ups-and-downs, but don't trade in the stocks you bought for the long term. The table lists out Indian companies that have been doing the same thing over and over again for more than 100 years.