Saturday, October 18, 2008

The New Buffettology: Chp 11: Where Warren Discovers Companies with Hidden Wealth

There are several categories in which investors can find companies with durable competitive advantages. The first category includes businesses that fulfill a repetitive consumer need. Ideally, the products that these companies sell to consumers are used quickly and have brand appeal. Examples from this category include brand name fast-food restaurants, pharmaceutical companies with patent protection, brand name foods and beverages, brand name household products and brand name clothing businesses. An example here is Warren's purchase of Gilette and Coca Cola.

The second category includes advertising businesses that provide a service which manufacturers must continuously use. Warren thinks of advertising companies as advertising toll bridges that connect consumers to suppliers. This can include business such as advertising agencies, radio stations, television networks, newspaper publishers, magazine publishers etc. Warren bought Knight Ridders Newspapers in 1977 when the P/E ratio for this company was around 9.

The third category includes businesses that provide a repetitive consumer service that are always in demand. Businesses involved in pest control, tax filing, rental services and information services serve as examples. Warren purchased Dun & Bradsteet, an informational service company which serves as an example of this business category.

The final category includes low-cost producers of products that most people purchase at some point in their lives. Businesses that sell furniture, insurance, household wares and jewelry are a few typical examples of business types in this category. Warren purchased Nebraska Furniture Mart, Borsheim's, Furniture Brands International and Geico, which all belong to this business category. These companies create a barrier to entry by being the low-cost producers. Low cost retailers usually have cheap retail space (typically they have purchased their land many years ago) and can get significant discounts by making bulk purchases and then pass these savings on to the customers. By keeping profit margins relatively low, it keeps new competitors out, and allows the companies to get significant profits via volume of sales.

Within these business categories, look for companies that have demand preference for their products and services with limited competition.

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