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  • Writer's pictureDaywey Chen

Before you invest, you need to know how to spot a great business

According to Warren Buffet, the world is divided into 2 kinds of businesses: 1. Great businesses and 2.Everything else... So what are the attributes of a good business?

This article's ideas are drawn from a recent book that I have read "Invest like Warren Buffet" by Matthew R. Kratter. I will share about the attributes of a great business and the attributes of not-so-great business from Warren Buffet's perspective.

The book begin by first providing an example of what a not-so great business looks like. Think about "Staples", Do you ever get excited of going to purchase a Stapler tomorrow" Do you go online, using hours and hours of your time enjoying the search for the best stapler ? Do you keep constant track of when the stapler 2.0 is going to be released, and can't wait to be first to share it with your friends on Facebook? Probably not. You probably care most about where is the most convenient place that you can get the stapler at and is it at the cheapest price.

Staples are commodities. Many companies make them but non of them stand out. If you don't believe it, please name the brand of your Stapler out. How about hearing about Stapler brands like SwingLine, Advantus, PaperPro, Max or Rapid? The chance are very unlikely.

The book points out that business that are very price competitive. The manufacturer that can produce the product at the cheapest price is likely to gain the most market share are probably not the best business that you can invest in.

In general, if the business has very little brand recognition, and no pricing power then its probably in the category of everything else but a great business.

Some other examples of price competitive business includes

+ Semiconductor company

+ Gas and oil company

+ Steel producers

+ Producers of corn, wheat, rice

+ Stations

So what defines a great business to invest in ? Well the opposite of whats has been described above. Take example the company Apple. Apple outsource most of its manufacturing, and choose to focus on the technology, design and marketing. Great business usually has excellent brand recognition and are very powerful in their market price. For example, Disney land. Over the years Disney land has increased the price of their theme park tickets dramatically. However, you take your kids to Disney anyways. Why? because how can you say no to your kids for letting them see Micky Mouse. Other the other hand you would choose your airline tickets carefully, with the same flight plan, you would want to choose the lowest airline tickets possible.

Another attribute of a good business according to Warren Buffet is that the business has to be simple

What does it mean by the business needs to simple? Simple means you need to understand the product of the business. You need to be able to understand what the business does and hot it makes money. Therefore, every person's definition of Simple is different. For instance you may be very familiar with the Technology sector but not familiar with the medical sector, making the technology business simple for you. Some people have purchased the Apple stock and has gotten quite wealthy by purchasing the Apple stock right after they got their first Ipod.

Great business often occupies a significant slice of the consumer mind share

For instance, when you think of fast food you think of McDonald, KFC, Burger King. When you think of sporting goods you think of Nike, Addias, Under Armour. These are example of brands that have occupy a significant slice of the consumer mind share.

A great business sells product or services that never go out of style and requires very little updating

Take Coca Cola example, it is a carbonated beverage fifty years ago, and it is still an carbonated beverage today. Nothing significant has changed about the product. Very little R&D cost needs to go into the product, the product could be sold on the market forever again and again and not be impacted by other similar and fresher products. On the other hand the semiconductor industry must reinvest most of its profits into R&D to produce the next faster chip. Therefore the most of the profits does not end up in the investor's pocket.

Lastly, business that are good for investing are usually ones where the consumer needs to purchase the product or service over again and again

For instance most people would only purchase a mortgage once in a lifetime. However, will purchase razor blades, fast food, coffee, toothpastes continuously. Frequency matters! Other business like Facebook, Twitter, Linkedin, Google has an high frequency. However blog post on information sharing pregnancy tips, pluming techniques has a much lower user frequency.

In summary, as described by Warren Buffet that great business always has a "moat". Just as a medieval acste used a moat to passively define itself from its enemies. A great business will have a durable competitive advantage like a moat that protects it from its competitors.

Source: "Invest like Warren Buffet" by Matthew R. Kratter

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