Question from a reader
There seem to be two courses of action in trying to apply the lessons learned via your website to improve your skill as an investor. The first is to do an in-depth study of a single company, its industry and its competitors. The second option is to read as many 10-Ks as possible and do quick and dirty valuation similar to those found in, say, Greenblatt Class #5.
Which option do you see as more valuable? Am I missing a third way?
Great question and I will elaborate more as this blog develops.
Mario Gabelli advises students to pick one industry and study that thoroughly then after 3 to 4 months move on to another industry. Buffett started by pawing his way through Moody’s manuals and Value-Line to find cheap asset stocks like cigar butts. Munger influenced Buffett with Sees Candy to look at high quality businesses.
After you have read the obligatory required materials like Buffett’s shareholder letters, his Buffett Partnership letters, Margin of Safety, The Intelligent Investor, the Greenblatt books and lecture notes, you need to build from there. My interest and suggestion would be to find 6 to 8 compounding machines which can be bought at a discount. If you can find a few high return on capital companies that are able to redeploy that capital for several years at high rates, you will have outstanding returns. These companies are rare that is why you must be patient to find them and to hold them. But you must know what to look for. You should become an expert in how companies develop and maintain competitive advantages. This will help you in searching for great investments and give you confidence to hold them for a while.
For example, if you understand regional (geographic) economies of scale you could focus on service companies like waste hauling and disposal or rock aggregates or health care providers and notice if they dominate their particular regions. Do you see high returns on capital? Study these companies and wait for them to go on sale. Rather than wait for blow-ups and disasters to study companies, find the best emerging companies you can find, study them regardless of price then wait for your opportunity.
Take a look at the last case study on charlie479. He epitomizes what I am talking about. Read broadly and deeply about businesses—10-Ks but books and autobiographies too. As you learn more about competitive advantages you will see connections in other businesses. You will see companies losing their advantages but look for companies that are successfully entering against incumbents. Look at niche companies that can dominate smaller markets. Read, read and read.
Next week I will post the best company analysis in the world done by Charlie Munger. If you can learn how he views business problems then you will grasp what is most important in business analysis.
You can buy cheap assets in special situations where management restructures the debt or assets and you get a nice bump up in price, then you must redeploy your capital like a merchant into another asset play. This can be profitable and relatively low risk but the big money is made sitting on fantastic businesses that are compounding at high rates. I would focus there. Few investors study competitive advantages–I mean become an expert at spotting and understanding great companies.
Fire away with more questions.