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The Three Investment Categories: Why Buffett Favors Productive Assets

By sagebytes —

Warren Buffett's Investment Best Practices

From the 2011 Berkshire Hathaway Annual Letter

The True Definition of Investing

"Investing is forgoing consumption now in order to have the ability to consume more at a later date."

Investment Principles

Intrinsic Value Over Market Fluctuations

  • Judge investments by their capacity to deliver real returns, not by short-term price movements
  • Price fluctuations can create opportunities when assets are undervalued
  • A non-fluctuating asset can still be laden with risk

Three Categories of Investments and Their Merits

  1. Currency-based investments (cash, bonds, deposits)
    • Often falsely considered "safe" but vulnerable to inflation
    • Since 1965, the dollar has lost 86% of its purchasing power
    • Only useful for liquidity needs or when mispriced opportunities arise
  2. Non-productive assets (gold, collectibles)
    • Rely on someone else paying more in the future
    • Create no value; depend on "greater fool" theory
    • Bubble-prone when rising prices attract bandwagon investors
  3. Productive assets (businesses, farms, real estate) ✓
    • Buffett's preferred category
    • Produce goods and services people will always need
    • Can maintain purchasing power during inflation
    • Best when they require minimal additional capital investment
    • Examples: See's Candy, Coca-Cola, IBM, well-managed businesses

Business Acquisition Criteria

  • Look for businesses with excellent economics and trustworthy management
  • Focus on long-term economics (10-20 year outlook)
  • Value businesses conservatively
  • Seek companies with enduring competitive advantages

Share Repurchases - Two Essential Conditions

  1. The company must have ample funds for operational and liquidity needs
  2. The stock must be selling at a material discount to intrinsic business value
    • "What is smart at one price is dumb at another"

On Business Ownership and Stock Prices

  • As a long-term net buyer of stocks, you benefit when prices fall
  • Lower prices allow companies (and you) to acquire more shares
  • Focus on the long-term earning power of businesses, not short-term price movements

Succession Planning

  • Essential for long-term business success
  • Identify the next generation of leaders before they're needed

Key Attributes of Successful Businesses

  • Ability to earn solid returns without requiring significant new capital
  • Strong management with independent thinking
  • Disciplined approach to underwriting/pricing (in insurance)
  • Focus on building enduring competitive advantages

Final Wisdom

"Metaphorically, good businesses are commercial 'cows' that live for centuries and give ever greater quantities of 'milk' to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk."