Buffett's Five Business Lessons

Mar 30, 2016 -

What by Buffett's standards is a good business?

A good business according to Warren Buffett is a business that earns a high rate of return on tangible assets. The very best businesses are one that earn high rates of return on tangible assets and grows. You can turn a good business into a bad investment buy buying at too high of a price.

Buffett's statements above eludes to businesses that do not require a lot of capital investment such as the Van Tuyl Automotive car dealership business he purchased in 2014. Whereby in the dealership business, you can lease the real estate, arrange the floor plan, and sell a lot of volume with narrow margins and still manage a high return on capital. Years ago car dealerships were many and across the U.S. there were about 30,000. Now that amount is a little more than half and on average each dealer does greater volume than ever before. However, I will say that his investment in BNSF Railway is quite the opposite and is a highly capital intensive business.

Are the big banks good business and are they still as good of a business prior to the 2008 crisis?

Banks earn on assets not on their net worth. Since 2008, the government now requires banks to have more net worth for each dollar of asset. Meaning that their earnings on net worth will go down. Banks are required to have more net worth than before to make the "same" amount of money. In general, they are great business because they can borrow money cheaply. Think of your deposits sitting in a Wells Fargo or Bank of America checking or savings account. What interest rates are those paying out? More than likely it is something of the tune of less than 0.10% annual percentage yield. Banks turn around and lend that money out at interest rates at least 20 to 30 times that.

"Keep the business if you expect the company to do well in the future versus the price now compared to other opportunities you might think you know equally well."

In 2014, Buffett still believed that most stocks were being priced at a range of reasonableness. There has only been five times in Buffett's lifetime that he recalls whereby businesses were either priced too expensive or very cheap. There is no way to pinpoint exactly where those peaks and troughs are, but he believe he can make a call on either end of the spectrum every 5-10 years. Overall, buy good businesses at reasonable prices and you'll make money.

Another piece of advice? Buy stock in a business so good that an idiot can run it because one day an idiot will. Forget about what is happening in the United States about the Fed and economy. In the long-run the American system works and unleashes human potential, which will bring value to the economy. Buy a business because of what is happening in the business not because of what you think political effects have on the business or doesn't have on the business.

When do you throw in the towel on an investment or business?

If you have a bad manager with bad results, you can sometimes change the manager and get good results. But if you have a bad business and a good manager, most of the time you can't get better with a better manager. Some businesses are just plain tough and the bad economics almost always trumps good management.

Buffett loves it when the things they buy go down in value. When you go to the grocery store and find something cheaper today than yesterday you are elated. But for some reason with a stock people tend to hold on to it and sell when it gets to what they paid for it. People have a tendency to justify holding on to positions. The stocks don't care when you bought them for. You are nothing to the stock, but the stock is everything to you.

How do you know when to sell a stock or rearrange your portfolio?

When you get can more for your money somewhere else. Prices change constantly and valuations shift daily. Today, you can rearrange your business empire at virtually no cost. But people can use that to a disadvantage as well by trading too much. Keep the business if you expect the company to do well in the future versus the price now compared to other opportunities you might think you know equally well.
Copyright © 2007- StockKevin. Disclaimer. All Rights Reserved.