Thursday, October 05, 2006
Understanding a business model
As most investors will proclaim, they understand the business that they own. The idea behind understanding is really very deep and diverse. Just how deep an investor understands, it is essential to always ask "Why."
Some investor confuses short term with long term interest in understanding a business. Most important in understanding a business is to be able to tell its performance in the the long road down the lane. No doubt, everyone hope to earn more profit in the short term. But when the short term and long term interest conflict, the long term interest must takes precedence at short term pain.
Knowing the competitive edge of a business has, is of utmost importance. When that is determined, the next most important question is to ask "How durable is this edge?." These are all long term goals that a business must answer. When the long term competitive edge of a business improves as a result of some painful or unnoticeable actions, that is "widening the moat." And doing so is essential if you want to have the kind of business a decade or more from now.
If management plays the short-term game in order to meet the short-term earnings targets as dictated by none other than Wall Street, bad decisions can be expected when a promise to make the numbers turn to making up the numbers. Consequently, the moat gets thiner, customer service and brand strength deteriorates. Then when this happens, no amount of subsequent brillance will overcome the damage that has been inflicted.
So in understanding a business, "an ounce of prevention is worth more than a pound of cure." should be the way to understanding it.