Recently, some Hong Kong stock and real estate stock markets have experienced a decline in value, making it difficult for investors deeply trapped to escape a tragic fate. Real estate companies around the world have a high leverage attribute, and high leverage businesses are inherently fragile. If they are careless, their net assets will be wiped out and their market value will gradually return to zero. During the 2008 financial crisis and the sharp decline in Hong Kong real estate stocks, this vulnerability was fully demonstrated.
Some people say that at the moment of buying, the outcome is actually determined. For example, the unchanging industry, strong pricing power, extremely high entry barriers, strong financial strength, and so on, these characteristics intersect with each other, endowing the companies Buffett invests in with strong anti vulnerability, making it difficult for these companies to break through difficulties even at the most unfavorable times and face losses.
In Buffett's screening system, highly leveraged and heavily capitalized railway and energy companies belong to public utilities, which require stable cash flow; Highly leveraged banks and insurance companies require excellent managers.
If one cannot comprehensively and correctly consider factors such as the capital structure, business sustainability, and management of a business, blindly concentrating bets is dangerous. Any business, over time, will inevitably encounter unexpected events. Only good businesses with anti vulnerability attributes can withstand the ups and downs. Even if an accident occurs, it will not trigger a shareholder catastrophe!
Investing in heavy capital enterprises with public utility attributes
Buffett also invests in businesses with high leverage and heavy capital attributes, such as railways, energy, and finance, but Buffett only invests in utilities with stable cash flow and financial stocks with excellent management.
Although railway and energy companies belong to industries with high capital expenditures and high debt ratios, Buffett had already figured out that these companies have stable cash flows, which cover high debt risks. These subsidiaries can not only operate smoothly on their own, but also bring about 10% annual compound income to Berkshire. Although this type of business may not be considered a great business, it is also a good business. For Berkshire, which is now a large company, such highly leveraged companies with sustained profitability have investment value.
When evaluating the 2008 financial crisis, Buffett once said that in the past two years, the tragic losses of just the four largest financial institutions have caused shareholders to lose a total of $500 billion in wealth. This is not a problem for shareholders, but shareholders have borne the losses.
Buffett said that banking is not our preference. Due to the 20:1 leverage of the banking industry, both the advantages and disadvantages of management are amplified. We are not interested in buying a poorly managed bank at a "cheap" price. On the contrary, we are only interested in buying a well managed bank at a reasonable price.
When it comes to real estate stocks, Munger once said at the 1994 Daily Journal shareholders' meeting, "Large blocks of land, even in prime locations, will allow developers to enter vertically and come out horizontally. Occasionally, some people can make big money, but that's a minority. Overall, real estate is a difficult business to do
Munger said that when Alcoa bought the Century City plot in western Los Angeles, it was a prime location with a land price of only over $50 per square meter. Unfortunately, despite the cheap price, buying such a piece of land coincided with the most prosperous period in Southern California. After many years of development and deducting interest costs, Alcoa did not make much money.
Munger also gave an example, "We also have a piece of land in Siko, which costs only $10 per square meter and is located adjacent to the coastline of Santa Barbara. We got this land many years ago and didn't make much money
Investing in unchanging industries
In a letter to shareholders in 1994, Buffett said, "I must cite the story of Fortune magazine in 1938. It is difficult to find a company that can rival Coca Cola in terms of scale and sales, and its products have not changed for ten years. It has been 55 years now, and Coca Cola's production line has expanded a lot, but this sentence still provides a good description of the company
In fact, 30 years have passed since Buffett's 1994 letter to shareholders, and the phrase from Fortune Magazine still serves as a good description of Coca Cola Company. People may not reinvent traditional products such as Coca Cola, hamburgers, candy, Oreo, and oatmeal. They belong to enterprises with a "first mover advantage", and the longer they have existed in the past, the deeper their impression in people's minds, and the longer they will survive in the future.
Technical companies such as Kodak and Polaroid were once at their peak, but due to the impact of technological updates and iterations, these companies withdrew from the market. In industries with a "latecomer advantage" attribute, the emerging advanced technology destroyed the shareholder value of the original leading companies. No wonder Buffett said that our attitude towards industries that are rapidly expanding and changing due to fermentation is similar to our attitude towards space exploration; We will applaud and welcome, but we will not participate in it.
The key to investment is not to evaluate how an industry affects society or its growth rate, but to determine the sustainability of a company's competitive advantage. Companies that have gained competitive advantages in unchanging industries will largely remain leading companies in the future, while today's leaders in changing industries are likely to be overturned in the future.
Investors need to remember the ancient wisdom - if something is destined not to last, it will eventually perish; To be first in a car rally, one must complete the entire race.
Investing in companies with pricing power
Whether it's Apple, Coca Cola, or Xishi Candy, they all have pricing power, and even a slight increase in product prices will not lead to a decrease in their market share.
This type of company has outstanding financial characteristics, often with rolling cash flow in its business, with a wealth of cash on its books, and enviable gross and net profit margins. Even if the macro environment is not good, it can withstand the impact of depression. The company's return on equity has always been at the top level among listed companies.
About half of Bafite's position is focused on investing in Apple. In the 2022 annual report, Apple's gross profit margin was as high as 43.31%, net profit margin was as high as 25.31%, return on equity was 175.46%, and operating cash flow was RMB 122.1 billion. Apple not only has outstanding financial characteristics, but also has a long-term psychological share in consumer minds.
A business with pricing power is a good business, and its high gross and net profit margins can absorb the adverse effects of macroeconomic downturn and management errors. As Munger said, when I was young, I used to work as a lawyer in a mining company. The boss of the mining company was a kind old man who told me, "Charlie, good mines are not afraid of poor management." Good business has some management problems and mistakes, but good business is still good business.
When deciding to invest in a company, if investors use the financial indicators of a long-term excellent company as the benchmark, the impulse to blindly invest will be greatly suppressed. The net asset profitability of a company without financial leverage is the best guide for evaluating its financial attractiveness. Once investors incorporate the standards of good business into their investment system, investment becomes cautious and self-disciplined. Why overestimate a company with thin profits, no cash at all, and constantly asking for money from the market?
Investing in energy companies with declining production but consistently increasing profits
Munger once said that the oil and gas industry is different from other businesses. In most industries, the scale of business is increasing and production increases over time, while the oil and gas industry is not. Taking Exxon as an example, its production has decreased by two-thirds compared to the past, but the rate of increase in crude oil prices has exceeded its rate of decline in production, although Exxon's production has been declining, But its profits have been on the rise.
The oil and gas companies that Buffett invests in have resource scarcity. Senior investors in energy companies believe that oil and gas companies are different from other commodity companies. The less oil and gas resources are used, the more they are burned and gasified as fuel, while other commodities exist in a material form after production and can be turned into renewable resources.