Buffett’s investing advice: Favorable long-term prospects

Warren Buffett has these 4 key qualities he looks for in a business:

1. I can understand the business
2. Has Favorable long-term prospects
3. Operated by honest and competent people
4. Available at a very attractive price.

And these are topics I write about and dive into on the blog, on social media and teach in my investing course. If you click on each topic above you’ll find more information in articles I wrote and for today I’ll dive into #2: Long-Term Prospects. What does that mean and how can we know if the business will be profitable long-term?

For this article I’m referencing the work of Philip A. Fisher, a 20th century American investor and author, who’s investing technique Warren Buffett is highly influenced by. It’s also learnings that I have applied myself, and I have seen for myself that this works.

According to Fisher some companies aim at gaining the maximum possible profit immediately and with a short-term horizon. Other companies deliberately limit immediate profits in order to build up and gain greater over-all profits over a period of multiple years.

To spot a company that focus on short term result look for  what Fisher describes as “irregular series of uneven spurts in sales”. Instead a long-term company shows a smooth year-by-year line of progress in the revenue.

When looking into businesses to buy stock in, don’t look at how the company performed in the last quarter or last year. Look for how the company performed over several years in the past. I recommend looking 10 years back and sales (also called revenue) is not the only number to look at and to see more numbers download my investing checklist. It’s just a few key numbers we’re focusing on.

If you look at ex. Peloton Interactive, Inc. that by some analysts is praised for having enormous growth, an audacious goal and a stock price that currently is lower than earlier (note that the stock price doesn’t say anything about the real value of the business), Peloton wouldn’t be a company for a value investor. The track record is too short, the company was offered publicly in September 2019, so we can’t identify if it’s a growth spurt or smooth, long-term growth compounding over a decade.

In a business such as Alphabet/ Google, there’s a steady growth year on year and the company became publicly traded in 2004, so we have almost 20 years of track record to look at. Please note that this is not investing advice and I don’t make recommendations, these examples are for educational purposes only and you should do your homework before investing in any of these companies.

Though a company has an excellent track record 10 years back, it might not have “favorable prospects” in the future and that’s why it’s important to understand the business. That’s why number one on Buffett’s checklist is “I can understand the business”. Buffett calls it "circle of competence" and he stays within his circle. Buffett once said:

"I don’t think the Internet is going to change how people chew gum."

What he means by that quote is that in his world tech companies are complicated while consumer products like gum is easier for him to understand. I wrote about Circle of Competence earlier and click on this link to read the article and get started identifying your circle and find companies in it.

To get a sense of if the business will be profitable long-term the company must have a strong competitive advantage – what Buffett calls a moat. To identify if the companies in your circle of competence have a strong moat, read my article about identifying a competitive advantage.

I recommend you read annual reports 10 years back to understand the business. In the beginning it can seem like a daunting task to read a company’s annual report but over time you’ll know which pages to read. In my free investing checklist there’s a table with a competitive analysis and here you’ll find out if the companies you’re looking at are the best in the industry. We want the best in class over time because it’s likely the company with favorable long-term prospects.