Sustainable Competitive Advantages
Even if a business is easy to understand, Warren Buffett usually does not attempt to value it if its future cash flows are unpredictable. He wants to own businesses that possess sustainable competitive advantages that keep competitors at bay because he believes that companies with these advantages are much more likely to generate materially higher cash flows with the passage of time. Without these advantages, valuation estimates become very uncertain.
One particular example of an industry Buffett likes to avoid is the Airline industry. Airlines are in a heated battle for the American consumer dollar. Profit margins can be very thin and no company can seem to maintain a competitive advantage for long. Historically speaking, profits are slim in good times and losses are high during recessions…not the kind of business you want to own for the long haul.
Down the “food chain,” however, it is a much different story. Here are the companies that manufacture commercial airplanes and their components. Barriers to entry in this industry are high and cash flows are much more predictable. In many cases, these companies do business for many years with the same customers (“recurring cash flows”) and retain patents on the components and processes they use in their latest products.
Again, we have found that our estimates of a company’s value tend to be much more accurate if we stick to companies with these characteristics.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” -- Warren Buffett
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. It is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Dave Crouch and not necessarily of Raymond James. Raymond James is not affiliated with and does not endorse the opinions or services of Warren Buffett or Charlie Munger. This is not a solicitation to buy or sell Berkshire Hathaway stock or any other security. Investing involves risk, and you may incur a profit or loss regardless of strategy selected. Past performance may not be indicative of future results.