Nine Questions to Determine If a Business is Truly an Excellent One

When we think of investing in great businesses we normally try to put on a famous investor’s hat to go with our line of thinking.  Maybe it helps us make better decisions, or maybe, it’s just fun to pretend like we’re Warren Buffett and we’re making investing decisions that will alter the course of history.

I have found that it is easier break this part of the analysis into a series of questions.  Warren Buffett uses a similar approach when he is trying to determine the presence of the consumer monopoly, exceptional business economics, and shareholder-oriented management.

Let’s ask the following questions:

1. Does the business have an identifiable consumer monopoly? 
2. Are the earnings of the company strong and showing an upward trend?
3. Is the company conservatively financed?
4. Does the business consistently earn a high rate of return on shareholder’s equity?
5. Does the business get to retain its earnings?
6. How much does the business have to spend on maintaining current operations?
7. Is the company free to invest retained earnings in new business opportunities, expansion of operations, or share repurchases?  How good a job does the management do at this?
8. Is the company free to adjust prices to inflation?
9. Will the value added by retained earnings increase the market value of the company?

These nine thoughts should spark revelation.  Kind of like trying to figure out if your blind date is a hopeful for the altar.  Ever been married?  Been to college?  Has a good job?  Does he or she snore?

We should do the same thing when we allocate capital to investment. 

As Warren says, “it is better that one act like a Catholic and marry for life.”

Trading and Investing Psychology Continued...

There are a number of behaviors that will almost guarantee losses in the markets.  These behaviors, the antithesis of the way successful traders operate, include:

• Lack of discipline:  It takes and accumulation of knowledge and sharp focus to trade successfully, and more importantly; with consistent results!  Many would rather listen to the advice of others than take the time to learn for themselves.  People are lazy when it comes to the education needed for trading.
• Impatience:  People have an insatiable need for action.  It may be the adrenaline rush they're after, their "gambler's high".  Trading is about patience and objective decision-making, with a long-term perspective on a desired outcome (profit), not action addiction.
• No objectivity:  We tend not to cut our losses fast enough.  It goes "against the grain" to sell.  At the same time, we often get out of winners too soon.  In both cases, we are unable to disengage emotionally from the market.  We marry our positions, and like marriage, we cut our losses when we're too deeply invested.
• Greed:  Traders (and let's face it, EVERYONE) try to pick tops or bottoms in hopes they'll be able to "time" their trades to maximize their profits.  A desire for quick profits can blind traders to the real hard work needed to win.
• Refusal to accept truth:  Traders do not want to believe the only truth is price action.  As a result, they act contrary to their trading plan, and set the stage for the losses that almost always arrive.
• Impulsive Behavior:  Traders often jump into a market based on a story in the morning paper.  And if you're a new brokerage account holder, it's likely that you bought your first stock on the day your funds cleared the account!  Markets discount news by the time it is publicized.  Thinking that if you act quickly, somehow you will beat everybody else in the great day-trading race is a grand recipe for failure. 
• Inability to stay in the present:  To be a successful trader, you can't spend your time thinking about how you're going to spend your profits.  Trading because you have to have money is not a wise state of mind in which to make decisions.  This was a hard lesson for us to learn (and I personally believe, this particular subject is ongoing).  
• Avoid false parallels:  Just because the market behaved one way in 1930, does not mean a similar pattern today will give the same result.

 If you try to bridge the gap between the present and the future with predictions about the market direction, you're guaranteed to be in a continual state of uncertainty whether you admit to it or not.