Thinking of investing in upcoming companies? Pay heed to this advice by Warren Buffett

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2 min read

As the economists and investors eagerly wait for Berkshire Hathaway’s 2019 edition of its annual meeting, one piece of advice from Berkshire CEO Warren Buffet from the 2000 meeting is finding its way in many dialogues and journalist’ articles pertaining to the investment culture in today’s age when the market is seeing brands like Uber and Netflix disrupting and creating new segments. If you are an investor, keep reading on.

Known as the "Oracle of Omaha," Warren Buffett has also been called a “wellspring of investing insights”. One of the most successful investors of all time, Buffett’s purview of investing is a bit old school: moats - a term popularized by Buffett, which refers to a business' ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms.

“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.”

Buffett lays emphasis on the competitive advantage that a business has over others — a USP or some unique aspect to the good it offers that is difficult for other actors to imitate. Also, it underlines the idea that many external factors could go down wrongly in a business. This doesn't mean the moat has disappeared; it means you need to be patient. Businesses see a return on investment usually in the long run. Investors may face small losses in the beginning, but that shouldn’t deter them from pursuing it further. Stick around for a long time to get better returns.

But it's not all sunshine and rainbows articulates Buffett, as he talks about the dangers for businesses. "It gets extra tough when a fanatical small competitor — like a Rose Blumkin, or a Les Schwab, or a Sam Walton set their sights on your particular marketplace," Buffett said, referring to disruptors that built a huge furniture empire, a massive tire retailer, and Walmart. "How do you compete against a true fanatic? You can only try to build the best possible moat and continuously attempt to widen it."

By naming a few disruptors, Buffett is asserting that while you can't predict the kind of disruptions that are coming for the industry, investing in the moat will make this disruption more difficult. This is crucial looking at disruption in today’s economy, where companies are challenging conventional ways of business, even shaking Buffett’s own portfolio.

And while there is no set way to define or identify "moats," though CLSA’s Damian Kestel suggests “measuring profits against the cost of capital and ensuring this is maintained over time.”

Therefore, identifying legitimate moats could pose a great challenge, as well as present itself as an opportunity for investors in the long run.

Himanshu Bhalla