I started interviewing entrepreneurs and business owners to explore a wide variety of businesses, and then use that information to help identify what kind of business I would want to run. Ultimately, this led me to a way of analyzing companies that is remarkably similar to what Warren Buffett does (or professes to). Like Buffett, though maybe for different reasons, I need something that is incredibly resilient, that tolerates mistakes, and that will let me learn on the fly without going broke. I want what Buffett would call, “A Wonderful Business.”
To clarify what makes a business “Wonderful,” I went through my guests’ businesses one by one, listed out their strengths and weaknesses, and a put together a list of traits that struck me as highly attractive. For a wonderful business, you want a few of these (and other traits I missed) in spades. Likewise, you should try your hardest to avoid businesses whose traits conflict with those on this list.
- Customers Pre-Pay, preferably far in advance
- Recurring Revenue
- Can finance with OPM, minimal personal risk
- Differentiated Value Proposition, no true competition
- Minimal Cyclicality
- Fragmented Customer-Base
- Product is Small Percentage of Customer Budget
- Consumer Preferences are Stable, Preferably Nostalgic
- Industry Growing Faster than GDP
- Low Inventory Risk
- Product is Important to Customer
- Low Cost Producer
- Minimal, or Very Consistent Capex Requirements
What it came down to was that these 13 factors triangulate (tridecalate?) on 1 concept, Predictability. The ability to make money year in, and year out without having to deal with competition, pricing pressure, changing inventories, fickle customers, economic sensitivity, and pushing around working capital. Now I’m not saying “only dumb people run these kinds of businesses.” I’m saying, you want to seek out situations where it doesn’t take a genius to run it successfully. You want to use your genius to help grow it, not to keep a crappy business afloat. You want your business to be able to stand on it’s own without you dumping 70-80 hours a week into it. You want to be sailing with the breeze at your back, not struggling to stay afloat. Do you see what I mean? I’m no longer “copying” Buffett, I’m channeling him.
Meb Faber’s recent guest John Reese would, I think, back me up on this. He reached a similar conclusion regarding predictability, that I did a while ago when I first wrote this post. He said that Buffett’s preferred investment is one with a history of extremely stable earnings growth, priced such that it would net him an annual return in the low-teens over the next ten years. But you don’t need to be a quant to get inside Buffett’s head, you can get to the same conclusion by thinking like the owner and operator of a business.
This is where the worlds of business and investing converge (hence the Warren Buffett angle). When I think about companies I want to invest in, I look for the factors I described above, and I think about it through this lens, “do the people running this company (the operators) have a strong enough position that they can focus on growing this company, or are they entrenched in a bloody, WWI-style battle for no-man’s land?” Pricing wars, unpredictable investments in machinery, the need to stay cutting edge on R+D, and changing customer preferences are all things I want to avoid because they increase risk and difficulty. Very few people, I think, are smart enough and energetic enough to be able to fight these battles while simultaneously growing their business. So for me, the intelligent thing to do with these kinds of situations is to toss them in Buffett’s “too hard” bucket. #circleofcompetence
Throughout this exercise, I kept thinking about Buffett’s line, “I am a better investor because I am a businessman, and I am a better businessman because I am an investor.” Having actually engaged with this process, his words are more true to me now than ever.