Investing requires the understanding of a few common components that determine the differences between businesses. These components are competitive advantage, management, cash, and margin of safety. All of these components are measurable. In other words they can be measured against other businesses or the industry the business you are evaluating operates under. Here are my simple definitions of each.
Competitive advantage is the ability to measure one businesses ability to out sell or out service it’s competitors. This can also be referred to as a businesses moat.
Management is the measurement or analysis of the businesses current operators or overseers and their past history, beliefs, and share holder friendliness.
Cash is simply the businesses ability to make money. How fast are they growing their revenue streams, what are their margins of profit, how much cash are they burning, and how much cash do they have in the bank.
Margin of safety is at what price can a person or entity invest in the business with the understanding that the price of purchase is producing a good value versus the actual worth of the business. In other words if the business was sold today would you get your money back at the price you paid.
In my opinion there is another component in investing which is the most important component required within investing and is something that is difficult to measure. It is a businesses durability. Does the business sell products or services that you as an investor definitely can say will exist ten years in the future. Having the ability or vision to predict this is very important. If the business can’t make money for at least ten years into the future you as an investor put your money at high risk. A business has to make money to survive, and if there is a doubt that it can not sell it’s products or services for at least ten years from now then it won’t be able to endure any economical, political, or business cycles that may occur while invested. As an investor in a business you have to be in a position where you know that investing or adding to your investment at a potential low price will be a good decision, and you can’t do that if you have any doubt that what the business makes or sells won’t have relevance to the consumer in the future.
The ability to determine a businesses durability coupled with the common components of competitive advantage, management, cash, and a margin of safety is the biggest piece of the puzzle and what determines the superstar investors from the average. Investors like Buffett and Munger that have a keener sense of how to determine durability to consistently grow and find successful investments. As the two of them often refer it is more important to pay a fair price for a good investment than it is to pay a good price for a fair investment. This isn’t to say that there won’t be times of mistakes or failures. Even the greatest investors have their moments of failures. When investing there will be potential candidates that might fit the four common components above, but measuring it’s durability may be questionable. All businesses have life cycles, and if they don’t reinvent themselves they will endure failure at some point due to consumers changing their choices or competition making them irrelevant.
Being able to have a good sense of the future is as much a skill as it is common sense. As an example Buffett and Munger were able to see through the challenges of American Express’s soybean scandal in 1963, and realize that the American Express card wasn’t going away and had a future with comsumers. A good example of durability. The same goes with Buffett and Munger’s ability to capitalize on Coca-Cola and See’s Candies. Munger and Buffett aren’t perfect by any means and have made mistakes as well, but their mistakes with durability have been smaller and less apparent than their wins due to their keen sense of envisioning what will have a place and exist in the future.