Investing really is like a box of chocolates
By Scott Phillips (TMFGilla) - May 25, 2012
With over 2,000 companies listed on the Australian Securities Exchange, a flick through the share tables in the paper or on your broker’s website can be reminiscent of the proverbial box of assorted chocolates.
From the smallest speculative mineral explorer to the big four banks that collectively dominate our indices, there’s plenty to choose from, and with vastly different characteristics. The combination of size, growth, income, leverage and market sector truly means there’s something for everyone.
Having just returned from the AGM of Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A, BRK.B) in Omaha, Nebraska, there are some different chocolates that are on my mind – real ones.
If you’re familiar with the story of Berkshire’s growth, you will no doubt have heard of See’s Candies, the California-based chocolate maker that Buffett bought for Berkshire in 1972. Buffett himself often cites both this business itself, and his purchase of it when he discusses the characteristics of his favourite businesses.
There is a lot about successful investing we can learn from this small chocolate maker and retailer.
When See’s was bought by Berkshire in the early 1970s, it already had an established business. People enjoyed the chocolates and peanut brittle the company made, and it had a solid foothold in its home markets.
See’s was (and still is) synonymous with great chocolates (or candies, in the vernacular). People wanted See’s, and those of us who attended the Berkshire meeting were inevitably tasked with returning home with some of the company’s wares.
Having built a reputation for quality, See’s has earned itself significant brand power that means people ask for it by name.
Not only is that good for market share, but also for pricing power. Like Berkshire stable-mate Coca-Cola (NYSE: KO) (Berkshire owns almost 9% of Coke), See’s is usually asked for by name, and consumers are prepared to pay more for the company’s product. Sure, some consumers will switch to Pepsi if the latter is available on special at the supermarket, but the switching is far less than for other, more commoditised brands. So it is for See’s.
The company increases prices regularly, and its loyal customer base is prepared to pay up. As long as the product quality continues to be excellent, and people enjoy its products, See’s can keep increasing prices over time. As Buffett once said, “if a 16 year old in California buys a box of that candy and takes it to the girl that he’s fallen for… and she kisses him, we own him… forever”.
It’s one thing to be able to secure customer loyalty and to be able to increase prices every year. Most businesses would kill for that sort of opportunity.
As an investor, if you can find that sort of business, you’re already moving the odds well and truly in your favour.
See’s has an extra advantage which makes it a truly wonderful business. You see, not only can it increase prices and volumes each year, but it gets to keep a very large chunk of the profits that come through the door.
Some businesses need to plow much of their profits back into investments in plant and equipment to keep operations running smoothly. Examples such as airlines, mining and steelworks come particularly to mind, where ‘business as usual’ requires considerable reinvestment in new equipment, repairs and maintenance.
Others, including See’s but also including service businesses such as consultancies, have little need to reinvest in new machinery or other equipment – meaning almost all of the profits are available to management to expand or return the excess funds to shareholders as dividends.
Businesses with high levels of brand power mean less chance of losing market share. Pricing power (often as a result – at least in part – of brand power) means the company is far more likely to be able to beat the ravages of inflation. And favourable business economics – business power – means the licks of profit produced by the first two are much less likely to be eaten up by just keeping the proverbial lights on.
See’s Candies is a famous example of that sort of business, and rightly so. Costing Warren Buffett $25 million four decades ago, the profits from that business in the intervening 40 years have tallied a cool $1.65 billion. Picking wonderful businesses and letting time to the rest is incredibly profitable.
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Scott Phillips is an investment analyst with The Motley Fool. He owns shares in Berkshire Hathaway. You can follow Scott on Twitter @TMFGilla. Take Stock is The Motley Fool Australia’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691).
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With over 2,000 companies listed on the Australian Securities Exchange, a flick through the share tables in the paper or on your broker?s website can be reminiscent of the proverbial box of assorted chocolates.
From the smallest speculative mineral explorer to the big four banks that collectively dominate our indices, there?s plenty to choose from, and with vastly different characteristics. The combination of size, growth, income, leverage and market sector truly means there?s something for everyone.
Having just returned from the AGM of Warren Buffett?s Berkshire Hathaway (NYSE: BRK.A, BRK.B) in Omaha, Nebraska, there are some different chocolates that are on…