Friday, September 22, 2006

Simple lesson from Warren Buffett

Imagine you are a sprinter, looking for an edge in your race and Adidas has invented a shoe that can shave a second off your 100-metre run. The shoe is at a bargain price of $150. How many race can you win owning to this great technology invention? 5? 10? Or all the race that you enter?

The answer is ZERO, NONE. Yes, you are not reading wrongly. ZERO is screaming. The reason is very simple. All the rest of the runners are wearing the same pair of shoes. You can bet that all others can easily fork out the $150.

So what has this got to do with investing or Mr. Buffett for the matter? Now, we shall look back in history. The Berkshire Hathaway today is a full-fledged holding investment business for all the businesses that they own. Back in the 1960s when Buffett acquires Berkshire, it was then in the fabric mill business. Then the operating business managers at Berkshire would bring to Buffett's table with well-conceived plans for upgrading of processes, machinery and things you name it. These would on paper at least, save the plant a lot of time and cost of production, which means bigger potential profits for the company. But before long, Buffett realized that such capital expenditures were a waste. These advances were also available to the other mill plants out there. So with everyone else being able to generate the same cost and time savings, and passing them to the customers to boost sales, the only beneficiary will be the customers.

By realizing how to best allocate his capital in the best way, Berkshire turns into an investment-driven company and the rest like they say, is history.

The lesson here is multi-proned.

Firstly, never throw good money after bad money. Let's say if you make a bad investment, never throw good (fresh) fund after the bad funds (which is the bad innvestment made).

Secondly, being able to distinguish the things of all th competitors of the business which you are thinking to acquire are doing. If you can tell that the things which your potential targeted business is doing is something which all the rest are doing, then most likely, they are not having any durable competitive edge.

Thirdly, look for business which has a durable competitive edge.

Last but not least, a great business at a fair price is always better than a fair business at a great price.

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