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Moats, Not Castles: Warren Buffett's Enduring Investment Strategy

By sagebytes —

Warren Buffett's Investment Best Practices

Distilled from Berkshire Hathaway 2007 Annual Letter

The Ideal Business: What Buffett Looks For

  1. Understandable business model - Invest only in what you can comprehend
  2. Favorable long-term economics - Seek companies with enduring competitive advantages
  3. Trustworthy and capable management - Quality leadership is non-negotiable
  4. Sensible price - Even great businesses can be poor investments at excessive valuations

The Concept of "Moats"

  • Successful businesses need enduring protective moats to defend against competition
  • Powerful moats include:
    • Being the low-cost producer (GEICO, Costco)
    • Possessing powerful worldwide brands (Coca-Cola, Gillette, American Express)
  • Avoid industries with rapid and continuous change - moats that need constant rebuilding eventually fail
  • A business dependent on a "superstar" manager is not truly great

The Three Types of Businesses

  1. The Great: High returns on capital with minimal reinvestment needs (See's Candy)
    • Creates "ever-increasing streams of earnings with virtually no major capital requirements"
    • Allows profits to be deployed elsewhere for additional growth
  2. The Good: Solid returns but requiring significant capital reinvestment (FlightSafety)
    • Must continuously reinvest earnings to maintain growth
    • Can be satisfactory investments but offer less flexibility with capital
  3. The Gruesome: Fast growth, high capital needs, poor returns (Airlines)
    • "The worst sort of business grows rapidly, requires significant capital, then earns little or no money"
    • Avoid businesses where growth actually destroys value

Investment Philosophy

  • Focus on the long-term business performance, not short-term market movements
  • Measure investments by two tests:
    1. Improvement in earnings (adjusting for industry conditions)
    2. Whether competitive advantages ("moats") have widened during the year
  • Patience pays - Sometimes the best investments take time to develop
  • Learn from mistakes - Buffett openly discusses his investment errors (Dexter Shoes) to emphasize learning

Risk Management

  • Be willing to make concentrated investments in high-conviction ideas
  • Maintain reserves and financial strength to capitalize on opportunities
  • Avoid businesses requiring constant innovation to stay competitive
  • Be cautious of accounting tricks and management teams that focus on short-term earnings

Final Wisdom

"It's better to have a part interest in the Hope Diamond than to own all of a rhinestone."

"Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding."