WARREN BUFFETT’S LETTER – 2007

Warren Buffett’s Letter 2007

Businesses – The Great, the Good and the Gruesome

One of the concepts which are essential to understanding making an investment and value to the business.

WB 2007 01

Many of us focus on the story builds for a particular business and make a hope investing rather than focusing on the actual reality. I always quote- “Stories are for kids, not for investors.” We need to focus on the ability of the company for creating access return on invested capital (Access return means higher than the cost of capital) and that should be sustainable for a longer period of time.

WB 2007 02

Mr.Buffett has always put a huge emphasis on the business which has a moat and earns consistently higher return compared to the cost of capital.

WB 2007 03

See’s Candy as an example of Great business

WB 2007 04

Indian Companies example for Great business

One of the two-wheeler and commercial vehicle manufacturing company

Eicher 01Eicher 02Eicher 03Eicher 04

One of the FMCG Company

HUL 01

HUL 02HUL 03HUL 04

One of the Assets Management Company

HDFC AMC 01HDFC AMC 02HDFC AMC 03HDFC AMC 04

Here, the company does not require to make a huge investment to earn more money. Float itself take care of the major requirement of the invested capital. Many a time float covers working capital as well as fixed assets requirement. Due to such nature, Profit earns from operation majorly gets to the investment and cash so that investment and cash to the company is compound which also provides benefits to the business.

Good Business

WB 2007 05

Good business which does not have float available with the business or least float available with business, company has to invest money which they earn from profit, and sometimes little external funding also requires.

Indian Companies example for Good business

One of the company from tableware industry

La Opala 01La Opala 02La Opala 03La Opala 04

One of the pharma company

Ajanta Pharma 01Ajanta Pharma 02Ajanta Pharma 03Ajanta Pharma 04

One of the Tea manufacturing company

Goodricke 01Goodricke 02Goodricke 03Goodricke 04

Gruesome Business

WB 2007 06

A gruesome business which does not have float available with the business, company has to invest money which they earn from profit, and also external funding requires to earn little profitability, sustaining the business or further growth. Here, huge capital is required to run a business.

Mr.Buffett has quoted an example of U.S. Air, He acquired a preference share of the company in the year 1989 and sold at the year 1998 with a huge gain. After that company gone for bankruptcy for the twice. The airline business is a cyclical business, huge dependence on the prices of crude oil and during the year 1998-99, crude oil prices were at the bottom (near to the price at the year 1988). So that profitability gets improved for the year 1998-99 and after that crude has never come back to those price level, which has affected to the profitability of the company.

Indian Companies example for gruesome business    

One of the telecom company of India

Idea 01Idea 02Idea 03

One of the logistics company

Snowman 01Snowman 02Snowman 03

One of the steel manufacturing company

Jindal Steel 01Jindal Steel 02Jindal Steel 03

WB 2007 07

We have to use a different valuation matrix for each category of the businesses and cannot provide a similar valuation to each category of businesses. We cannot give the same value to pour water and to dirty water. Yes, it is true that we can make process and pour dirty water but for that, we need to bring more capital and many a times, few qualities of water will be lost during the process of dirty water to pour water.

WB 2007 08

We have to sell out our position into the cyclical business at the proper time or else we stuck with the business.

WB 2007 09

Indian company’s example

For how to enter to the cyclical businesses, kindly visit – WARREN BUFFETT’S LETTER – 1987

Now, for taking an exit from cyclical businesses – When margin approaching towards a previous high margin, we should start to exit from a cyclical business. We need to track the price of the commodities as well as quarterly operating margins.

Sugar companies

Balram ExitBalram Exit 01

EID Exit 01EID Exit 02

Cement Company

JK Cement Exit 01JK Cement Exit 02

Warren Buffett’s Letters 1957 – 2012

Pat Dorsey Moats

On 17th January 2016, I got an opportunity to address one group of investors. I am so thankful to all my friends who provided me such an opportunity.

Investor Philosophy – Pat Dorsey

This presentation (Click here Pat Dorsey) based on what I learned from Pat Dorsey and about his philosophy.

S1

S2

Company A earns High profit / High Return on Capital that attracts many players to the same industry; which resulted in a higher level of competitions. Higher competitions affect to the margins of the company A and continuously increasing competition affects to the earnings of the company A. and if company A doesn’t have any Competitive Advantage then the business of company A can be in problem.

S3

So the question is what is the competitive advantage?

S4

Now, let me explain with a simple example that how USP helps.

S5

Above all are benefits of having a strong USP of Rajinikanth. Now, compare these benefits to the business class.

S6

So before understanding, what is the competitive advantage? I explain what can not be a competitive advantage?

If a company cannot able to raise the price of the products/services then we should understand that there is an absence of competitive advantage. (Eg.: – ITC Ltd. – Budget imposes the duty on cigarette but company easily able to pass those costs to the customers and that’s the reason for the survival of the company in adverse situations.)

S7

We can easily able to recall brands. Meggie is becoming synonyms for noodles, Fevicol becomes synonyms for adhesive, and Colgate is becoming synonyms for toothpaste.

Also, the company which has the ability to change consumer behavior that Amazon has done (From traditional bookstore to online bookstore).

S8

Patents & Licenses can be useful for protecting the interest of business (not considering strong moats because after the expiry of patents other companies also can able to register it and licenses can fall in the compliance risk).

S9

Any psychological barrier or any cost associated with a switch from using current product/service to other product/service.

S10

As the addition of new users make the network more and more strong and replicating such model becomes very difficult.

S11

Low-cost producer compares to other players in the same industry.

S12

Wide and strong moat resulted in the long-term Return on Capital generation and if absent of moat not able to provide long-term Return on Capital to the business.

S13

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S15

Bad managers destroy business for own enjoyment and ambitions.

S16

Now, what to select and what to avoid is up to us. If we able to select good business with the good manager then wealth creation become more effective. That is like the good horse with the good jockey that can able to win a race.

For more details, Kindly check — Part 1 , Part 2

Inspired by — Pat Dorsey Moats

Disclaimer: This is not a recommendation to Buy-Sell-Hold. And I am not a SEBI registered analyst.

I am really grateful to – Mr. Neeraj Marathe Sir, Prof. Sanjay Bakshi Sir, and Mr. Vishal Khandelwal Sir.

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