Also, for years Buffett and Munger have discussed their basicinvesting filters or checklist: Is it a good business?Does it have a durable competitive advantage?Does it have capable, honest management?Is it available at a good price? The idea of investing checklists took on renewed interest as aresult of the recent financial crisis as bloodied investors didpost-mortems on their dismal performance and searched for tools andinsights that might help them do better going forward. One sourceof insight was an article by Atul Gawande inThe NewYorker, “The Checklist”, that showed how a simple checklistcould make an enormous impact on outcomes in both simple andcomplex life-threatening medical procedures. Gawande went on todevelop the article into a book,The Checklist Manifesto: HowTo Get Things Right, that expands his ideas and includes adiscussion of how checklists are used by investors Monish Pabraiand Guy Spier. At the 1998 Berkshire Hathaway annual shareholders meeting,Buffett and Munger discussed another of their basic investmentfilters –opportunity cost– and how they use it. (1) Munger explained that if you have theopportunity to purchase an investment that is better than 98% ofall businesses, then you can use it as a filter to automaticallyeliminate the other 98%. Munger conceded that it’s a simple ideaand wondered aloud why it has not been more widely imitated because1) Berkshire Hathaway was proof that it worked, 2) if practiced ittends to lead to a concentrated portfolio (which Buffett and Mungerbelieve is the rational way to invest), and 3) it saves you a lotof time because you can quickly eliminate investment ideas thataren’t in the top 2%. Buffett went on to explain it this way.Whenever they look at a possible investment, they immediatelycompare it to Coke, which Buffett views as about as perfect aninvestment as you will ever find. Coke not only has superioreconomics and growth prospects far into the future, but also itsfuture prospects arehighly certain. Buffett puts a high premium on certainty.According to Buffett, when you invest you are trying to peer intothe future. With many, if not most businesses, it’s eitherimpossible or fraught with uncertainty. With a few businesses,however, if you do your homework, you can develop real and rationalconviction about their future prospects. If a prospective investment does not passBuffett’s “Coke” or “Gillette” (Gillette was purchased by P&Gin 2005) test, he’s unlikely to buy. Buffett went on to say thatCEO’s should apply the same filter when sizing up an acquisition.If it doesn’t pass the “Coke” test, Buffett asks why not buy stockin Coke or repurchase shares in their own business? According toBuffett this would have prevented a lot of unsounddeals. This is a simple, yet powerful, filter that you can put to useimmediately. (1) Berkshire Hathaway annual meeting, 1997, OutstandingInvestor Digest, August 8, 1997, p. 15. |
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