Nine Questions to Determine If a Business is Truly an Excellent One

When we think of investing in great businesses we normally try to put on a famous investor’s hat to go with our line of thinking.  Maybe it helps us make better decisions, or maybe, it’s just fun to pretend like we’re Warren Buffett and we’re making investing decisions that will alter the course of history.

I have found that it is easier break this part of the analysis into a series of questions.  Warren Buffett uses a similar approach when he is trying to determine the presence of the consumer monopoly, exceptional business economics, and shareholder-oriented management.

Let’s ask the following questions:

1. Does the business have an identifiable consumer monopoly? 
2. Are the earnings of the company strong and showing an upward trend?
3. Is the company conservatively financed?
4. Does the business consistently earn a high rate of return on shareholder’s equity?
5. Does the business get to retain its earnings?
6. How much does the business have to spend on maintaining current operations?
7. Is the company free to invest retained earnings in new business opportunities, expansion of operations, or share repurchases?  How good a job does the management do at this?
8. Is the company free to adjust prices to inflation?
9. Will the value added by retained earnings increase the market value of the company?

These nine thoughts should spark revelation.  Kind of like trying to figure out if your blind date is a hopeful for the altar.  Ever been married?  Been to college?  Has a good job?  Does he or she snore?

We should do the same thing when we allocate capital to investment. 

As Warren says, “it is better that one act like a Catholic and marry for life.”

Avoid Forecasting - Learn to Recognize What's Happening Around You

Many people will try to see what they want to see and not necessarily what is actually going on.  Don't fall into that trap.  Be aware of indicators that suggest things may change, but do not get into forecasting.  The greatest investor of them all, Warren Buffett, has saying, "Forecasting tells you how much about the forecaster and nothing about the future!"

If the year 2008 told you anything, it should have told you that there is no such thing as an ever-growing economy.  If you believed that real estate properties will continue to rise because "they're not making more Real Estate," then please read the book, Extraordinary Popular Delusions and the Madness of Crowds (Mackay, 1980), and you'll see that hype existed long before our current "economic recovery," all the previous economies before that and will continue to exist well into future economies!

Ultimately, company values will depend on their financial performance in the long term.  Sure, there are wild short-term swings and great opportunities in the immediate term.  Sure, there were some amazing opportunities during the early part of 2009 (bargain basement prices abound!).  CAM Trading participated in those crazy days too.  But, eventually when the market wakes up, guess what happens to those synthetic prices?  History repeats itself time and again, especially where the stock market is concerned.