I’m interested in emulating Warren Buffett in finding “first-class businesses with first-class management”. These are generally businesses with one or both of:
- A unique competitive advantage.
- Excellent management.
Here are businesses on my watch list.
Businesses with advantages from scale
Normally scale is a disadvantage. In Berkshire Hathaway’s case, “size is an anchor on performance”. In rare cases however, scale is an advantage.
Express Scripts – Scale allows unusual negotiating power with retail pharmacy networks.
DaVita – Scale leads to negotiating power and localized monopolies. If DaVita owns all the local dialysis doctors and clinics, they effectively have a monopoly because dialysis patients do not want to travel several hours to a dialysis clinic on a continual basis. With the local market locked up, DaVita can price gouge the private insurance companies and cut corners on Medicare patients in clinics with few/no private patients. Unfortunately for DaVita (and fortunately for dialysis patients), regulators are blocking DaVita’s growth.
Google – On the expenses side, R&D costs benefit from scale. On the revenue side, scale also helps. Advertisers spend more time optimizing their Google campaigns than other advertising platforms. Google’s search share is >=90% and drives at least 9X the clicks as its next competitor (Yahoo/Bing). As a result, advertisers bid higher and pay more for Google clicks.
LKQ – This company salvages parts from old vehicles and resells them to auto shops. I believe their deep inventory makes them attractive as auto shops can easily go to them to find specific parts at low prices.
Amazon – I think that online retailing is an industry that benefits from economies of scale and massive volume. It leads to better negotiating power with suppliers, lower IT/R&D costs, and the ability to save money on shipping by bundling multiple items into a single order. Jeff Bezos is also an incredible CEO that’s focused on the long run.
Intel, TSMC, Samsung – These are the largest semiconductor manufacturers in their niches. Being the largest has the advantage of lower costs. However, I am not a fan of the semiconductor manufacturing industry. Competition is cutthroat and extreme. I’m not sure if the advantage of being big offsets the terrible economics of the industry.
Businesses with strong brands
COH – Coach handbags
LVMH – This conglomerate is a collection of top brands (e.g. Louis Vuitton). It also owns Sephora, which is an incredibly well-run cosmetics retailer.
JSDA – This former Wall Street darling is currently poorly run and loses money. As a customer, I believe that Jones Soda has a valuable brand. I also think that not every stock with a moat makes money for shareholders.
Businesses with network effects
Some things stay entrenched once they reach wide acceptance. For example, the QWERTY keyboard is a terrible keyboard layout that slows down users and is difficult to learn. Yet it remains the most popular keyboard layout in the world.
CME – Industrial users of commodity futures are less likely to use competing exchanges due to liquidity and hassle in physical delivery.
MSFT – Microsoft almost has a very dominant position in operating systems. The software ecosystem (games, other software) surrounding Windows is a huge, unfair advantage. However, Office is Microsoft’s other cash cow and doesn’t have the same special advantage. I think that much of Microsoft’s success should be attributed to Bill Gates, who is arguably the best tech CEO in the business.
EBAY – Buyers prefer an auction website/platform with lots of sellers and vice versa. That’s obvious. On the payments side, Paypal has seen virtually all of its competitors die due to losses from fraud. Developing the business processes and technology to combat fraud seems to be a major barrier to entry.
V and MA – These are technology companies in the payment processing business. Historically, these companies have been incredibly resilient against competitors. The “chicken and egg” problem tends to lead to entrenchment. Consumers are less likely to sign up unless there are many merchants which accept that form of payment. Merchants are less likely to sign up unless many of their customers request it.
Sirius XM – Sirius effectively operates in a oligopoly with terrestrial radio broadcasters, although it is the only broadcaster with a subscription model (terrestrial broadcasters are generally supported by advertising). Sirius can negotiate lower rates for content due to its scale. However, technology is rapidly changing for Sirius. Eventually it will compete against audio content streamed over wireless Internet connections.
Cable companies – Cable companies are regulated monopolies with no competition from other cable companies. They do however compete with other technologies (e.g. phone / IPTV, satellite, etc.). As larger cable operators have more negotiating power with content providers, there is an incentive for the cable industry to consolidate. In the past however, governments have prevented them from becoming too big. The industry as a whole is undergoing technological change and may see continued earnings growth from offering high-speed Internet. According to Malone, cable is the most cost-effective means of delivering high-speed Internet (better than fibre optic and phone lines).
Growth industries without cutthroat competition
Not all growth industries are good for shareholders. For whatever reason, some industries continually exhibit poor economics (e.g. semiconductor manufacturing). Currently, I think that online advertising and online shopping are good growth industries that don’t exhibit extreme competition. However, these industries will likely be dominated by the largest companies as most segments benefit from scale.
FB – Facebook creates a lot of value for many of its advertisers. While I’m skeptical of many of the Dot-Bomb 2.0s because they don’t make profits, Facebook does make profits and has very strong cash flow. Facebook’s accounting hides much of their profit.
Excellent asset allocators
Warren Buffett – He’s a legend and still not widely imitated. Few copy his style of using insurance float as leverage. Few copy his style of buying first-class businesses with first-class management. Few copy his style of buying entire private businesses. He has a deep understanding of various industries. Just as importantly, he stays away from things that he doesn’t understand and has made very few investing mistakes.
Charlie Munger (DJCO) – Daily Journal is a publisher that’s partly an investment holding company managed by Munger.
John Malone (various Liberty companies) – John Malone is an expert in the cable industry and one of America’s richest people. I’ve covered him in a series of blog posts.
Excellent managers – operators
Brian Dalton (Altius Minerals) – The best mining CEO in the field. He has made a lot of money from prospect generation and from flipping royalties. While he has made a few very smart investments, he has avoided major losses and has avoided dumb projects (unlike the rest of the mining sector). He is brilliant partly because he has avoided unnecessary exposure to building mines, operating mines, and owning mining equity.
Thomas Peterffy (IBKR) – Interactive Brokers is part market maker and part brokerage. I think that Peterffy has integrity and a laser-like focus on value creation, something that is sorely lacking in the financial industry. For example, he blasts his industry peers in this insightful speech. As a retail customer of IB, it’s obvious to me that their operations are far more efficient than TD Waterhouse, Etrade, iTrade, etc. IB doesn’t have a human being call you regarding corporate actions as the process is automated. Their order execution is generally far, far superior to Etrade (Etrade skims money from its customers, or routes orders to other companies that do). However, I’m not sure if market making or financial brokerage are great industries to be in right now.
William Erbey and William Sherpo (ASPS) – Sherpo, Altisource’s CEO, has generated impressive growth in the mortgage servicing field.
Christine Day (Lululemon) – Lululemon’s return on invested capital is incredible (over 50% by my calculation) and among the highest in the retail industry. While she is leaving Lululemon, it will be interesting to see where she turns up next.
Gregory Sandfort (TSCO) – Tractor Supply is competing very effectively against Wal-Mart, succeeding in locations where Wal-Mart has closed.
Bob Sasser (DLTR), Larry Rossy (DOL.TO) – Both dollar store CEOs are excellent. Rossy/Dollarama has higher returns on capital.
John McCarvel (Crocs) – Shoe retailer with high returns on capital.
Carol Meyrowitz (TJX) – Very good retailer.
EDIT: Stanley Ma (MTY.TO) – The “king of the food courts”.
Companies not on my radar
I don’t follow these companies because I don’t understand their industries very well.
IBM – Gerstner states in his book that IBM’s only competitive advantage is its ability to integrate different products into a working solution, and that it was far ahead of its competitors in that area.
MCO – Moody’s bond ratings benefits from network effects. Buffett is selling, presumably because bad ratings during the subprime crisis has hurt Moody’s credibility and therefore the value of its service.
Railroads – I don’t understand them very well, though Buffett does. The railroad business seems to be somewhat like a natural oligopoly (with some monopoly routes), with competition against other modes of transportation. So, they have lots of stable cash flow. There may be some upside from rising oil prices and advances in technology.
Lawrence Ellison (ORCL) – I don’t really understand enterprise software.
Michael Pearson (VRX) – The John Malone of pharma???
Glenn Chamandy (Gildan) – Is textiles a bad business? It doesn’t matter because this company has delivered incredible returns for shareholders.
Stericycle (SRCL) – This company helps other companies dispose medical waste. It seems like an industry where scale is an advantage.
*Disclosure: I own the stocks of many of the companies listed above.