We begin from the premise that ownership of a stock represents ownership of a business. We do not waste any effort on trying to make short term predictions about stock prices, the stock market or the economy because they are unpredictable and largely irrelevant to the long-term investor. Instead, we research and analyze specific companies. A portfolio of only a few select well-managed companies with durable competitive advantages (what Warren Buffett refers to as a company’s “economic franchise” or “moat”) purchased at discounts to their intrinsic values and held for the long-term will likely outperform the market over time. So, when researching a stock, we study the underlying business to determine whether it is one that we would be happy to own indefinitely because it possesses a durable competitive advantage.
There is no sure-fire formula or algorithm to determine whether a company possesses a durable competitive advantage. Buffett’s 1991 letter to Berkshire Hathaway shareholders is instructive:
An economic franchise rises from a product or service that (1) is needed or desired, (2) is thought by its customers to have no close substitute and (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.
We devote substantial effort to assessing whether a company possesses such advantages. This assessment involves subjective reasoning to a considerable degree. However, there are various qualitative and quantitative factors that assist in this process. Only a relatively small number of companies possess such durable competitive advantages. Fewer still are available at reasonable prices relative to their intrinsic values. However, with the proper intellectual framework, research and patience, it is possible to identify those rare, wonderful companies at appropriate prices to build a portfolio capable of producing superior average compounded annual returns over time.
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