Value Investing

The Warren Buffett Series – Businesses you Know

By Master Class Invest

The Buffett Series explores some of the interesting and timeless investment concepts discussed by Mr. Buffett in his annual Berkshire letters. Over the years I’ve found there isn’t a lot that Mr. Buffett and his partner Mr. Munger haven’t worked out when it comes to investing. I am constantly discovering hidden investment gems, new ways of thinking about businesses and the investment process.

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With permission

This Series contains ten short essays on concepts that have featured in Mr. Buffett's annual letters since the early 1980's. It's amazing how timeless and universal they are. This short essay touches on the concept of "Businesses you Know".

In his 1994 letter, Buffett outlines why it can be profitable to revisit companies you know well. In investing it's important to understand the businesses you are investing in, know the limitations of your knowledge and stick within your circle of competence.

"Before looking at new investments, we consider adding to old ones. If a business is attractive enough to buy once, it may well pay to repeat the process. We would love to increase our economic interest in See's or Scott Fetzer, but we haven't found a way to add to a 100% holding. In the stock market, however, an investor frequently gets the chance to increase his economic interest in businesses he knows and likes. Last year we went that direction by enlarging our holdings in Coca-Cola and American Express.

Our history with American Express goes way back and, in fact, fits the pattern of my pulling current investment decisions out of past associations. In 1951, for example, GEICO shares comprised 70% of my personal portfolio and GEICO was also the first stock I sold - I was then 20 - as a security salesman (the sale was 100 shares to my Aunt Alice who, bless her, would have bought anything I suggested). Twenty-five years later, Berkshire purchased a major stake in GEICO at the time it was threatened with insolvency. In another instance, that of the Washington Post, about half of my initial investment funds came from delivering the paper in the 1940's. Three decades later Berkshire purchased a large position in the company two years after it went public. As for Coca-Cola, my first business venture - this was in the 1930's - was buying a six-pack of Coke for 25 cents and selling each bottle for 5 cents. It took only fifty years before I finally got it: The real money was in the syrup.

My American Express history includes a couple of episodes: In the mid-1960's, just after the stock was battered by the company's infamous salad-oil scandal, we put about 40% of Buffett Partnership Ltd.'s capital into the stock - the largest investment the partnership had ever made. I should add that this commitment gave us over 5% ownership in Amex at a cost of $13 million. As I write this, we own just under 10%, which has cost us $1.36 billion. (Amex earned $12.5 million in 1964 and $1.4 billion in 1994.)

My history with Amex's IDS unit, which today contributes about a third of the earnings of the company, goes back even further. I first purchased stock in IDS in 1953 when it was growing rapidly and selling at a price-earnings ratio of only 3. (There was a lot of low-hanging fruit in those days.) I even produced a long report - do I ever write a short one? - on the company that I sold for $1 through an ad in the Wall Street Journal.

Obviously American Express and IDS (recently renamed American Express Financial Advisors) are far different operations today from what they were then. Nevertheless, I find that a long-term familiarity with a company and its products is often helpful in evaluating it."

Get The Full Warren Buffett Series in PDF

Get the entire 10-part series on Warren Buffett in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Buffett recognised that dealing with companys he had a history with and could understand provided an edge.   Given Buffett's distaste for change, it's likely it also gave him some level of confidence in the sustainability of the business model, thereby also reducing risk.  Buffett has always been a big believer in sticking within his circle of competence.  Revisiting company's within that circle has proved to be a successful investing strategy over the last 50+ years.

"In his fifty years of practice, Buffett added one more principle; through unremitting hard work over a long period, investors can build up their own circle of competence.  This can give them a deeper understanding than others of a company or industry, and allow them to make better judgements of future performance.  Your unique strength lies within this circle" Li Lu