When evaluating businesses, it’s essential to recognize which ones create lasting value and which ones struggle to stay afloat. Inspired by Warren Buffett’s insights, let’s break them down into three categories:
The Great Business
A great business has a strong competitive edge—what Buffett calls a “moat”—that protects its profits. This could be a globally trusted brand, the lowest cost of production, or an unbeatable distribution network. These businesses require minimal reinvestment and generate increasing earnings over time.
Imagine a company like See’s Candies, which sells a timeless product that customers love. It doesn’t need constant reinvention, and its strong brand lets it maintain high pricing power. The cash it generates can be used to buy more great businesses rather than being poured back into keeping it running.
The Good Business
A good business is profitable but needs continuous reinvestment to sustain growth. Take FlightSafety, a company that trains pilots. It delivers a crucial service and enjoys a solid reputation, but it requires constant investment in new simulators to keep up with evolving aircraft technology.
These businesses can still be rewarding for investors, but they lack the effortless wealth creation of great businesses. Their growth demands more capital, making them less attractive than businesses that generate cash with minimal reinvestment.
The Gruesome Business
The worst businesses combine high capital requirements with low returns. A classic example is the airline industry. Despite massive customer demand, airlines constantly need new planes, face intense competition, and struggle with thin profit margins. Investors get drawn in by the industry’s growth but often end up disappointed.
Buffett once joked that a wise investor at Kitty Hawk should have shot down the Wright brothers to save future investors from financial pain. Airlines have swallowed billions in capital while delivering minimal returns.
Final Thought
Think of these categories as different types of savings accounts. The great business pays high interest that keeps rising. The good business pays a decent return but needs continuous deposits to grow. The gruesome business pays little interest and demands more money just to keep going.
When investing, the goal is to own as many great businesses as possible—those that generate wealth effortlessly and stand the test of time.
Disclaimer:
The ideas, analogies, and examples presented in this blog post are drawn from Warren Buffett’s 2007 Berkshire Hathaway annual letter. Buffett’s framework for categorizing businesses as great, good, or gruesome is entirely his own. This post seeks to highlight and share his insights without modification. All credit for the original text and concepts belongs to Warren Buffett and Berkshire Hathaway.
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