Do You Understand the Business?

[karlmarx]

-You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”

http://fortune.com/2014/02/24/buffetts-a...vestments/

This is a very good article and it is one of the few instances where WB is explicit in his explanation.

Unfortunately, most of the easier-to-understand and 'good' companies are sold at not-cheap valuations.

My way around this is to follow lots of companies, identify the good ones that you can understand, and wait for opportunities to buy them cheap.

[specuvestor]

-You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”

http://fortune.com/2014/02/24/buffetts-a...vestments/

This is a very good article and it is one of the few instances where WB is explicit in his explanation.

Unfortunately, most of the easier-to-understand and 'good' companies are sold at not-cheap valuations.

My way around this is to follow lots of companies, identify the good ones that you can understand, and wait for opportunities to buy them cheap.

Actually one of the key traits of Buffett is not quantitative; it’s qualitative: patience

Good companies come at cheap price only during market-stress, not company-stress. Geico and railway companies that are under Berkshire now were discussed by Graham. They have been under Buffett’s radar for a long time. 

Company-stress stocks that are deep value or distressed are not the same as broad market stress. Unless you are able to acquire or rally seizable stakes to force action, one has to recognise the limitation of OPMI

Specuvsestor and VB

Beside reading on industry news, articles, company and competitors AR, and making a judgement call, how else would we know we know a business model?

I enjoy broad discussions and I think VBs have provided a few tips to understand business models: 1) Annual Report 2) stick around AGM 3) IPO or prospectus 4) I like reading brokers’ initiation reports 5) companies’ IR materials etc. A good mental model is actually Porters’ 5 forces while trying to understand the model. This is how they make money.

One common mistake is to think a company is as what is reported at a point of time. It’s actually just a snapshot. To understand it better is to imagine each reporting as a chapter of a book. You can’t understand a story by reading one chapter. You need to read across the chapters to know whether management is reliable, business is working etc. However one good chapter to dwell on more for alpha stocks is how they manage crisis or bad times vs their competitors. This is their edge.

True that most OPMI can only look at consumer stocks. But neither is Buffett a farmer. Nor are we shipping tycoons. So it’s really a lot of reading and common business sense ie what would you do under such sets of circumstances. Difference between Accountants and finance is former look at what happened; latter looked at how and why. That’s why we focus on cash flow. 

Alternatively a lot of VBs here are from IT. So stick to core competence in IT stock where you have an edge. Once you are familiar about how Mr Market figure out a stock, then you might want to venture to other sectors. Different sectors or even country, Mr Market behaves differently, but the emotions are similar.

[dreamybear]

I think the topic on "understanding the business" is one of the most important yet underrated components in investing. Often, investors/financial trainers talked about the valuation metrices but rarely go into a deep dive into the business/industry and at the same time, discuss a tailored "framework" to assess how a specific business will fare in the future. Based on my experience in selecting my multibaggers, I have learnt that "understanding the business" is not as simple as knowing what the business does. 

While I think it could be a long shot to have the privilege of getting someone to sit down with OPMI to teach us, in the book "The Warren Buffett Way", it was mentioned that WB responded to a shareholder saying he reads everything in sight about businesses and industries. (emphasis added). Welcome to the OCD reading club. Well, there are materials on the entire ecosystem the business is operating in and nowadays, we also have social media to cover. As CM said, investing is not supposed to be easy. 

That aside, in the book “Common Stocks And Uncommon Profits” the author suggested to go to several companies in an industry and ask them intelligent questions about the points of strength and weakness of their peers. Just curious whether any buddies have ever tried this or any similar approach ? Realistically, how would a company executives entertain a stranger(OPMI) ? Does this apply more to fund managers ?

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Warren Buffett describes a pivotal moment when he was 20 years old that changed the course of his career
https://www.cnbc.com/2017/09/28/warren-b...-life.html (emphasis added)
"... Buffett’s early passion for reading led him to read through every book the Omaha Public Library had on investing by age 11 and through the ones in his father’s office.......

Davy had no reason to talk to me, but when I told him I was a student of Graham’s, he then spent four or so hours answering unending questions about insurance in general and Geico specifically...."

[weijian]

I am not going to read as much as Buffett in my lifetime. Heck, probably not even 0.1% of his total reading time by the end of our lives.

I am not going to be talking to many people. I do not have much insightful questions for them and more importantly, I do not know where to find them.

But I am fine with that.

I just need to discover what is my natural temperament. I learn from others and become me, not taught by others to be like them. Once I realized I just needed to be "me", investing became fun and enriching at the same time. There was finally some meaning.

We will all have our own pivotal moment, but that moment is unique only to us.

[Ben]

Agree with Weijian.

While we try to emulate WB or any other successful investors as much as possible, we will never be the same as them.

Between CM and WB, I’m sure there are differences too.

What I try to follow is, however, their principles towards investing, thought ultimately my method, approach and style may be different as compared to them. We need to have our own unique ways that suits our own temperament and character, while not deviating too far away from the principles of value investment.

[dreamybear]

I do not mean emulating WB/CM. I do think, though, that their advice is based on their experience being successful investors. In fact, I feel many successful investors come to more or less the same conclusion.

I think there is a difference between how to understand the business and how far you want to go in understanding the business.

At the end of the day, it depends on the investor - how much returns are you expecting - it's like proficiency in one's job, some will climb higher than others.

[karlmarx]

I think the topic on "understanding the business" is one of the most important yet underrated components in investing. Often, investors/financial trainers talked about the valuation metrices but rarely go into a deep dive into the business/industry and at the same time, discuss a tailored "framework" to assess how a specific business will fare in the future. Based on my experience in selecting my multibaggers, I have learnt that "understanding the business" is not as simple as knowing what the business does. 

While I think it could be a long shot to have the privilege of getting someone to sit down with OPMI to teach us, in the book "The Warren Buffett Way", it was mentioned that WB responded to a shareholder saying he reads everything in sight about businesses and industries. (emphasis added). Welcome to the OCD reading club. Well, there are materials on the entire ecosystem the business is operating in and nowadays, we also have social media to cover. As CM said, investing is not supposed to be easy. 

That aside, in the book “Common Stocks And Uncommon Profits” the author suggested to go to several companies in an industry and ask them intelligent questions about the points of strength and weakness of their peers. Just curious whether any buddies have ever tried this or any similar approach ? Realistically, how would a company executives entertain a stranger(OPMI) ? Does this apply more to fund managers ?

I would say "understanding the business model" is one of the first of many requirements to investing success.

Easiest to understand are probably the food retailers, which is arguably one of the more popular choice of business for entrepreneurs. But so few succeed, which should lead most to conclude that quality of management (which determines what they do, and how they do it) is the most important determinant of success. Even when you look at the listed food retailers on SGX, you also see wide variances in their performance. 

There are lots of competitors in every business. But the ones at the forefront of their field are those that work that hardest, are the smartest, or have the most talent, etc.

[dreamybear]

The key performance indicators (KPIs) cited are pretty useful for learning - payback periods of stores ; same store sales growth of the company ; monitoring four-wall earnings before interest, taxes, depreciation and amortisation.

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What’s a VC-backable F&B business model?
https://www.businesstimes.com.sg/wealth/...ness-model

[Big Toe]

There are very few good opportunities left for small businesses in Singapore.
Only the most rare, ulu and elusive opportunities are worth the trouble.
These are financial numbers of a very popular and successful food franchise(not macdonalds, macdonalds usually costs much more).
The outlet generates about $22+K per week.
Located in a relatively popular shopping ctr.
9 full time/part time staff Clocking >350hrs/ week

After deducting expenses, it is profitable but net profit is relatively low.
There is a need to open at least 5-6 to have a decent income for the franchise owner.
Each outlet is several hundred K dollars to start up. With a 15-20% failure rate.

If a person opens a totally new ice cream cafe. In a so so location with lower traffic.
Weekly sales may not even hit 2K, even after 6 months. Failure rate probably is closer to 80-90%
Go figure

I dont own any food business, it is too tough for me, but I do know plenty others who do.
All of them work extremely hard at it. In summuary to open a well known food franchise(or 7-11),
ideally you should have a few M in capital and willing to work very hard to have a higher chance of success.
And there will be outlets when it did not work out as expected(losses are part of the journey.)

Yes I do understand business. At the very minimum, slightly more than the average person on the street.