Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage

by Mary Buffett

When do you want to stay away from these super businesses? At the height of bull markets, when these super businesses trade at historically high price-to-earnings ratios. Even a company that benefits from having a durable competitive advantage can’t unmoor itself from producing mediocre results for investors if they pay too steep a price for admission.

In Warren’s world you would never sell one of these wonderful businesses as long as it maintained its durable competitive advantage. The simple reason is that the longer you hold on to them, the better you do.

Still, there are times that it is advantageous to sell one of these wonderful businesses. The first is when you need money to make an investment in an even better company at a better price, which occasionally happens. The second is when the company looks like it is going to lose its durable competitive advantage. This happens periodically, as with newspapers and television stations. Both of them used to be fantastic businesses. But the Internet came along and suddenly the durability of their competitive advantage was called into question. A questionable competitive advantage is not where you want to keep your money long-term.

The third is during bull markets when the stock market, in an insane buying frenzy, sends the prices on these fantastic businesses through the ceiling. In these cases, the current selling price of the company’s stock far exceeds the long-term economic realities of the business. And the long-term economic realities of a business are like gravity when stock prices climb up into the outer limits. Eventually they will pull the stock price back down to earth. If they climb too high, the economics of selling and putting the proceeds into another investment may outweigh the benefits afforded by continued ownership of the business.

Think of it this way: If we can project that the business we own will earn $10 million over the next twenty years, and someone today offers us $5 mill...

If we can only invest the $5 million at a 2% annual compounding rate of return, probably not, since the $5 million invested today at a 2% compounding annual rate of return would be worth only $7.4 million by year twenty. Not a great deal for us. But if we could get an annual compounding rate o...