"Investing is putting out money to be sure of getting more money back at an appropriate rate. And to do that, you have to understand the business."
In part three of this lecture, Warren talks about what constitutes a great company. He begins by briefly stating that one should take a job one loves, then describes what he looks for in businesses he buys. This is the basic approach to investment analysis by Warren Buffett and is the foundation upon which he begins choosing businesses for the long term.
These are some of the main points of part 3 of this lecture:
1. Only do work you would enjoy.
Take a job, that if you were independently wealthy, you would take. You will get a lot more out of it and will enjoy it more.
If you think you will be happier making 2X instead of X, you are making a mistake. You ought to find something you like and you will get in trouble if you think that making 10X or 20X is the answer to everything in life because then you will do things like borrow money when you shouldn't or cut corners on things your employers want you to cut corners on. It does not make any sense; you would not like it when you look back on it.
2. Warren Buffett's business criteria
What makes companies you like?
i. Go for businesses you understand.
ii. Simple businesses, but not easy businesses.
iii. Business must have a moat.
iv. Honest, hard-working and able management.
v. Good current and future economics.
Buffett goes on to discuss the idea of a moat being the competitive advantage of the company. He uses the example of car insurance. Insurers compete on service and price; since most of the insurers offer similar products, the price is what he must compete on. Therefore he must be the low-cost provider. Therefore, GEICO is the low-cost provider in this industry and therefore, he owns it.
A lot of emphasis is put on the moat. He mentions to the MBA students that the one request he has for his managers is to widen the moats of their respective businesses, that is, strengthen their competitive advantages; throw in alligators and crocodiles and snakes.
Moats can come across through patents, quality of product, service, cost or real estate location.
4. Buy a business you understand
If he is not able to tell what a business will be like 10+ years from now, he is not going to buy it.
I would not buy any stock, if they closed the stock exchange tomorrow for 5 years, I won't be happy owning it.
You're buying a piece of business.
You're not buying a stock; you're buying into a business and once the business does well, you will do well.
If I were teaching a class in business school and on the final exam, I would pass out information on an Internet company and tell the students to value it. Anyone that gave me an answer would flunk. You can't do it.
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery