Keeping it simple and stupid!

If you have ever wondered why Warren Buffet loves to invest in simple to understand businesses, what he is actually trying to do is to keep things simple and stupid. And we can see how this strategy has withstood the test of time through his fantastic returns. Today, he is worth more than 40 billion dollars. As i thought deeper, i began to understand that he was actually trying to reduce the number of variables so that he can estimate the company's cashflow with more certainty. A clear analogy is this if i may: Imagine a mathematical equation that has 10 variables or more compared with a mathematical equation that has 2 variables. Which one would be easier to solve? It is pretty obvious to me at least that the answer would be the latter. So, just to sum up, an oversimplified model of investing in Buffet's head should somewhat be screening companies for simple business models with strong moats. Companies with such qualities would have above average profit margins and sales and will be a cut above competition, an extremely important factor. This leads to an easier estimation of how future cashflows will look like and how capital expenditures might lead to increases owner earnings. In fact, Buffet while he is doing this does not even care about the price of the company as it might distort his valuation. Do refer to Manpreet's previous post on this.

Now, what i may be talking about may be an extremely simple concept. But it is something that is not embraced by many inclusive of the speculators who look a companies with a certain theme or using technical analysis which to me is utter nonsense. Sorry if i have offended anyone but if there is anyone out there that disagrees with me, i would be glad to agree to disagree with you.

Just think about it this way. I am sure all of you knows microsoft. It is a wonderful business , possibly with a moat. The office program is indeed a value to users and there is quite high switching cost. However, what people fail to notice is that Microsoft has not been able to revolutionize their operating system. Before, when the first operating system came out, it wowed the world. Today, their operating systems are not very mush different from the first. There is no revolution whatso ever. And competitors are coming into the field providing possibly better alternatives such as Apple products. How long can microsoft generate free cash flow that is not only growing but also sustainable with competitors coming in. The technology landscape is so complex that you never know when something might hit the market that might take away Micirsofts competitive advantage. For one, lets learn a lesson from history. IBM used to be a giant in the 80s. Now it has been taken over by better companies and has suffered stagnating stock prices.

What about Coca cola. Everyone knows Cocal Cola. People around the world drink the brand and even as i am typing here, there are still many people and countries around the world not exposed to Coca Cola. the growth potential is still tremendous. In fact, Buffet is still holding onto it. Strong moat with an easy to understand business. Competitors like Pepsis come no where close in terms of global popularity. I am so hooked onto Coca Cola that even when i go to Japan or Europe, i asked to be served Coca Cola. But do take beer for instance, in singapore, you might want a tiger but if you do go to Japan, you might want some Sake and if you do go to the US you might wanna try Budweiser. Case in point, coke is so entrenched within the customers mind that there is so much customer loyalty. And customer loyalty leads to recurring income. Simple and Stupid! Hence, in my opinion, it is always easier to value businesses with the buffet approach.