RE:CM on Economic Moats

Buffett: "So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn't necessarily mean the profit will be more this year than it was last year because it won't be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that's tenuous in any way - it's just too risky. We don't know how to evaluate that. And, therefore, we leave it alone. We think that all of our businesses - or virtually all of our businesses - have pretty darned good moats. And we think the managers are widening them. Charlie?"

Munger: "How could you say it better?"

Buffet: "Sure. Have some peanut brittle on that one."
From the 2000 Berkshire Hathaway annual meeting

"We suggest the margin of safety concept may be used to advantage as the touchstone to distinguish an investment operation from a speculative one."

Benjamin Graham

Every once in a while a news item comes along that makes one sit up and take notice such as the shock announcement that Kumba Iron Ore has decided to rescind its agreement to sell iron ore to Mittal Steel at cost plus 3%. Another example is that Hulamin announced that BHP Billiton is not only ending the very attractive (from Hulamin's perspective) pricing agreement for aluminium, but that they will completely stop supplying Hulamin with aluminium.

The consequences of this news are important for the future of the SA economy. Two very large and important businesses, namely Kumba Iron Ore and BHP Billiton, have decided to end long-standing contracts. These contracts have effectively subsidised the competitiveness of a portion of South Africa's exports, at the expense of the two businesses' shareholders and taxpayers. The two events highlight the difference in time horizons between the capital investment decisions of business, which is often very long-term, and government's efforts to attract investment to meet their own objectives, which is often quite short-term. This discrepancy in time horizons always carries the potential to permanently destroy significant economic value. Although we have our own views about how government should attract investment (and avoid rent seeking behaviour), these are largely irrelevant from an investment standpoint. No one knows how government will act.

Key Thoughts:
• There are very few businesses with true moats.
• Moats are not absolute and vary in strength.
• "In the long run everything is toasters." The historic return of a business is not necessarily an indication of the future as businesses seldom earn a positive economic return indefinitely. When assessing the strength of the moat, even more important than the level of excess returns is the time period over which it can be sustained.
• Stick to what you know. Investors can reduce risk and improve returns by focusing their efforts on companies for which they can predict the future economics.
• A competitive advantage based on less permanent arrangements requires a higher margin of safety.
• Management plays a central role in investment outcomes.
• Rising electricity costs are a reality and will have a major negative impact on profitability and the feasibility of new and existing capital projects in South Africa (in the case of price taker industries like many resources companies) and inflation (in the case of quality businesses that are able to pass on such effects to customers).
• When government facilitates an advantage for business it should ensure that it is lasting. If it does not, the government's own (legitimate) objectives will suffer.
• In the long run the SA economy will most likely be better off if government focuses on bringing down the cost of doing business while the private sector decides on where to allocate capital.

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Adam Smith on Investor Psychology

“The gold-bugs have been around forever. The market still has gas. Who understands gold, anyway? And how can you worry about something you can’t understand?”

“What is it the good managers have? It’s a kind of locked-in concentration, an intuition, a feel, nothing that can be schooled. The first thing you have to know is yourself. A man who knows himself can step outside himself and watch his own reactions like an observer ...”

“The market is a crowd ... a composite personality. In fact, a crowd of men acts like a single woman. The mind of a crowd is like a woman’s mind. Then, if you have observed her for a long time, you begin to see little tricks like little nervous movements of the hands when she is being false.”

“If the profit numbers on income statements are treated with such reverence, it was obviously only a question of time before some smart fellows would start building companies not around the logical progression of a business but around what would beef up the numbers. ”

“A man is really at his best, his most fulfilled, when he’s on the way to becoming what he’s going to become ... With good men, you can see the learning juices churning around every mistake .”

“Logic, to an outsider, would say that you have a company selling at 10 and you go and do a lot of research on it and figure out the sales and the profits and you figure if they can earn one dollar it will sell for 20. So you buy it and wait, and the story gets that they earn the one dollar … but the market does not follow logic, it follows some mysterious tides of mass psychology . Thus earnings projections get marked up and down as the prices go up and down, just because Wall Streeters hate the insecurity of anarchy. If the stock is going down, the earnings must be falling apart. If it is going up, the earnings must be better than we thought. Somebody must know something we don’t know.”

“Quarterly reports came out saying, the outlook is favourable ... But from 1930 to 1933, a real blight of the spirit took place. The prudent men, believing in the long-term growth of the American economy, saw their holdings in the bluest of American blue chips drop 80%-90%. It was the psychology of panic ... the fall in the market was very largely due to the psychology by which it went down because it went down .”

“We all know what a millionaire is, and when the adding machine says $1m, there is a beaming figure facing it. But when the machine says 00.00 there should be no one at all because that identity has been extinguished, and the trouble is that sometimes when the adding machine tape says 00.00 there is still a man there to read it.”

Adam Smith's "SuperMoney"

What Richemont sees in Net-a-Porter

Swiss luxury goods maker Compagnie Financière Richemont SA on Thursday announced a deal to buy U.K.-based online luxury retailer Net-A-Porter Ltd., a transaction that signals the increasing importance high-end consumer goods companies are assigning to online sales.

Richemont, the owner of brands such as Cartier, Montblanc and Chloe, previously held a 33% stake in closely held Net-a-Porter, but agreed to acquire a majority of the company from a group of private shareholders for up to £225 million ($341 million). Richemont said the transaction values the overall company at £350 million.

What Net founder and chairman Natalie Massenet (mass-in-ay), 44, has done is combine on one website the thrill of shopping at a chic boutique with the pleasure of reading a fashion magazine. Net not only showcases and sells clothes but also publishes a weekly online glossy that decodes the latest trends.

And by mixing these two addictive leisure activities -- shopping and perusing a magazine -- into one designer drug, Net is doing for $2,000 Calvin Klein dresses what Amazon did for "The Da Vinci Code" and iTunes for Coldplay.

As a result the company is growing exponentially at a time when many purveyors of luxury goods are struggling.

The focal points of the office are two giant flat screens that track orders as they come in, a motivational tool that reminds everyone that this is all business. The top screen shows an image of the products and the price of each order as it is placed, along with a running tally of the day's sales figures. The bottom one depicts a map of the world that rotates to show the origination point of the latest order.

"Almaty Kazakhstan $806" moves across one monitor as the locator screen tracks over Europe and past the Caspian Sea before alighting on the business center of the former Soviet Republic. The locator map then shifts to "Hamburg, Germany," while on the adjacent screen a $350 organic cotton tee with that Peter Blake cloud print drifts by.

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Making Sense of Business Philosophy - Eddie Lampert

Lampert on "Making Sense of Business Philosophy":

I just finished Thomas Sowell’s most recent book, Intellectuals and Society. For those not familiar with his writings, Thomas Sowell is one of the clearest and most insightful writers of our era. I look forward to every book and column he publishes. In this book, he discusses the “vision of the anointed” and how their views shape society regardless of their merit. He describes how often these views conflict with reality without altering these views and, paradoxically, sometimes strengthening them. I couldn’t help noticing the parallels between his comments and the “vision of the anointed” in the financial and business world over the past few years.

Business leaders, regulators, public officials, and journalists have become an echo chamber of self-support and self-congratulation, whether on TV, in print or at numerous conferences. Their words and their actions are often self-serving (whether right or wrong), and they are typically regarded and reported on as if they were obvious and selfless. They get repeated as if there were no alternative views or possibility of error in their thinking. Dominant narratives develop and get defended primarily by repetition and secondarily by attacks on those who disagree with those narratives. When these favored people and views become endorsed in laws and regulations, some may benefit, but many get harmed.

There are several examples of issues that have been smothered by dominant narratives. Accepting these narratives without critical evaluation can be a contributing factor to some of the negative unexpected consequences they produce. Did the seizure of Fannie Mae and Freddie Mac (the largest nationalization in our country and likely in history) calm or ignite fear in the financial markets and did those urging or supporting the seizure profit from it? Has raising minimum wage rates helped or harmed the individuals that those advocating such policy intended to help? Is there any link between a higher minimum wage and high unemployment? Has the consolidation in financial services helped or hurt depositors and borrowers? Why were some institutions saved and others seized, merged or left to fail? How does regulatory and policy uncertainty impact investment and risk-taking in society?

I fear that Americans have been provided a false choice between a little more and a lot more regulation and taxes. We keep hearing more ideas to create jobs and generate growth that almost exclusively require more government spending. Jobs can come from government, but those jobs get paid for by taking money from the private sector, reducing the private sector’s ability to provide jobs. On the other hand, there are many who believe that less regulation, less government interference, less arbitrary regulation when it does exist, and lower government spending will generate more growth and more jobs. I agree with those views.

As one of the largest private sector employers in the United States, Sears Holdings recognizes the challenges of finding good talent, developing good talent and keeping good talent. We have created not just new jobs, but new job categories and job descriptions as our industry changes and as new technology provides both new opportunities and new challenges.

Some contend that there is an inherent conflict between labor and capital, yet they fail to appreciate that without investment there will be no growth and no jobs. For there to be investment there needs to be an expectation of profit, and, for there to be an expectation of profit, there needs to be hope and belief in the future and confidence in the rules of the game.

The straw man frequently used to justify more regulation and to criticize free markets is to assert that the proponents of free markets blindly believe that they always work and that they always produce good results. Most free market advocates don’t actually make this claim, and they know that it is not true. Free markets respect individual rights and freedom, preserve choice and accountability, and produce superior results compared with non-free markets. When free markets experience problems and produce poor results, critics are fast to proclaim that things would have been better if only there was more, but better regulation. However, in most industries and societies where there is more regulation, there is typically lower growth, lower employment, and less innovation.

Self-regulation is a better idea and it is a better choice, whether for an individual or a corporation. Any corporation can choose to limit or make investments, increase or decrease compensation, and manage risk at different levels. Companies can compete by promoting their “safety and soundness” or by their “willingness to take risks.” Investors, customers, and workers can choose which companies and their associated behaviors and philosophies appeal to them. Let the media and politicians explain, compare, criticize, and contrast the various policies, so there will be little doubt that success or failure is determined by choice and not by ignorance. Then, make sure that government doesn’t reward failure and punish success by interfering with outcomes based upon political contributions, undue influence, or the personal beliefs of the policymakers.

Extracted from Lampert's 2010 Letter to Sears shareholders.