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I'm actually as proud of the things we haven't done as the things I have done. Innovation is saying no to 1000 things. —Steve Jobs The difference between successful people and really successful people is that really successful people say no to almost everything. —Warren Buffett

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Exclusive Warren Buffett – A Few Lessons for Investors and Managers – The Blog of Author Tim Ferriss

by Tim Ferriss , Investing

“This [drawing] looks good — as close as I’ve ever look to George Clooney.” – Warren Buffett. (Illustration credit: Monica Bevelin)

“It’s a funny thing about life; if you refuse to accept anything but the best, you very often get it.”

-W. Somerset Maugham

English dramatist & novelist (1874 – 1965)

I have long been a fan of Warren Buffett, who is widely considered the most successful investor of the 20th century. His net worth is currently estimated at $44 billion.

The fascination with his approach to value investing started with Buffett: The Making of An American Capitalist , which led me to devour all of Buffett’s incredibly readable annual letters to Berkshire Hathaway shareholders. My fervor culminated in early May of 2008, when I made the pilgrimage to Omaha, Nebraska to elevator pitch Buffett and Charlie Munger directly in front of 20,000+ people (See: “Picking Warren Buffett’s Brain: Notes from a Novice” ).

Prompted by all the “Mr. Market” manic-depressive excitement about Facebook, tech, and the world at large, I’m thrilled to offer an exclusive excerpt from a new 81-page book: A Few Lessons for Investors and Managers from Warren E. Buffett .

In it, author Peter Bevelin distills hundreds of pages of annual reports and Berkshire’s An Owner’s Manual into bite-sized principles and key quotes. Of this lightweight handbook, Buffett himself says, “It sums up what Charlie and I have been saying over the years in annual reports and at annual meetings.”

Net proceeds from sales of A Few Lessons are donated to the California Institute of Technology in Pasadena, California. It can be bought at the publisher’s site , which is their preference, or it can be found on Amazon .

For this post, I’ve chosen one of my favorite chapters, which relates to Buffett’s criteria for investments (and acquisitions): Business Characteristics: The Great, the Good, and the Gruesome…

The bolded headlines and text are Peter’s.

Enter Buffett – Business Characteristics: The Great, the Good, and the Gruesome

Our acquisition preferences run toward businesses that generate cash, not those that consume it. (1980)

And those are:

The best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. (2009)

A. THE REALLY GREAT BUSINESS: High returns, a sustainable competitive advantage and obstacles that make it tough for new companies to enter

A truly great business must have an enduring “moat” that protects excellent returns on invested capital. (2007)

“Moats”—a metaphor for the superiorities they possess that make life difficult for their competitors. (2007)

Moats can widen or shrink

Long-term competitive advantage in a stable industry is what we seek in a business. (2007)

Leadership alone provides no certainties: Witness the shocks some years back at General Motors, IBM and Sears, all of which had enjoyed long periods of seeming invincibility. (1996)

The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed. (2007)

One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. (1983)

If a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO. (2007)

A great business has pricing power or the power to raise prices without losing business to a competitor

An economic franchise arises from a product or service that:

(1) Is needed or desired; (2) Is thought by its customers to have no close substitute and; (3) Is not subject to price regulation. The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage. (1991)

The best protection against inflation is a great business

Such favored business must have two characteristics: (1) An ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) An ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital. (1981)

As inflation intensifies, more and more companies find that they must spend all funds they generate internally just to maintain their existing physical volume of business. (1980)

Any unleveraged business that requires some net tangible assets to operate (and almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets simply are hurt the least. (1983)

The dream business—“sweet” returns

Let’s look at the prototype of a dream business, our own See’s Candy. (2007)

In our See’s purchase, Charlie and I had one important insight:

We saw that the business had untapped pricing power. (1991)

At See’s, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972… Last year See’s sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire. (2007)

We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months each year.) Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories. (2007)

Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million.

This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth—and somewhat immodest financial growth—of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that , except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. (2007)

Customer goodwill creates economic goodwill

See’s has a one-of-a-kind product “personality” produced by a combination of its candy’s delicious taste and moderate price, the company’s total control of the distribution process, and the exceptional service provided by store employees. (1986)

It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel. (1983)

Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill. (1983)

A company like See’s is a rarity

There aren’t many See’s in Corporate America. Typically, companies that increase their earnings from $5 million to $82 million require, say, $400 million or so of capital investment to finance their growth. That’s because growing businesses have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments. (2007)

A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment. There is, to follow through on our example, nothing shabby about earning $82 million pre-tax on $400 million of net tangible assets. But that equation for the owner is vastly different from the See’s situation. It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google. (2007)

B. THE GOOD BUSINESS: Earn good returns on tangible

invested capital

One example of good, but far from sensational, business economics is our own Flight Safety. This company delivers benefits to its customers that are the equal of those delivered by any business that I know of. It also possesses a durable competitive advantage: Going to any other flight-training provider than the best is like taking the low bid on a surgical procedure. (2007)

Nevertheless, this business requires a significant reinvestment of earnings if it is to grow. When we purchased FlightSafety in 1996, its pre-tax operating earnings were $111 million, and its net investment in fixed assets was $570 million. Since our purchase, depreciation charges have totaled $923 million. But capital expenditures have totaled $1.635 billion, most of that for simulators to match the new airplane models that are constantly being introduced. (A simulator can cost us more than $12 million, and we have 273 of them.) Our fixed assets, after depreciation, now amount to $1.079 billion. Pre-tax operating earnings in 2007 were $270 million, a gain of $159 million since 1996. That gain gave us a good, but far from See’s-like, return on our incremental investment of $509 million. (2007)

High capital intensity requires high profit margins to achieve a

decent return

At FlightSafety…as much as $3.50 of capital investment is required to produce $1 of annual revenue. With this level of capital intensity, FlightSafety requires very high operating margins in order to obtain reasonable returns on capital, which means that utilization rates are

all-important. (2004)

Consequently, if measured only by economic returns, Flight Safety is an excellent but not extraordinary business. Its put-up-more-to-earn-more experience is that faced by most corporations. (2007)

C. THE GRUESOME: Require-a-lot-of-capital-at-a- low-return-business

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. (2007)

Asset-heavy businesses generally earn low rates of return—rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses. (1983)

A depressing industry equation—undifferentiated products, easy to enter, many competitors and over-capacity

Businesses in industries with both substantial over-capacity and a “commodity”product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. (1982)

What finally determines levels of long-term profitability in such industries is the ratio of supply-tight to supply-ample years. Frequently that ratio is dismal. (1982)

If…costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous. (1982)

In many industries, differentiation can’t be made meaningful

Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking for a “two-ounce candy bar”) but doesn’t work with sugar (how often do you hear, “I’ll have a cup of coffee with cream and C & H sugar, please”). (1982)

Some make money but only if they are the low-cost operator

When a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important. (2000)

A few producers in such industries may consistently do well if they have a cost advantage that is both wide and sustainable. By definition such exceptions are few, and, in many industries, are non-existent. (1982)

With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management. (1991)

Or find a protected niche

Someone operating in a protected, and usually small, niche can sustain high profitability levels. (1987)

Or when supply is tight

When shortages exist…even commodity businesses flourish. (1987)

But it may take time

Over-capacity may eventually self-correct, either as capacity shrinks or demand expands. Unfortunately for the participants, such corrections often are long delayed. (1982)

And it usually doesn’t last long

One of the ironies of capitalism is that most managers in commodity industries abhor shortage conditions—even though those are the only circumstances permitting them good returns. (1987)

When they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates over-capacity and a new profitless environment. In other words, nothing fails like success. (1982)

But in some industries, tightness in supply can last a long time

Sometimes actual growth in demand will outrun forecasted growth for an extended period. In other cases, adding capacity requires very long lead times because complicated manufacturing facilities must be planned and built. (1982)

Berkshire’s unfortunate experience with the textile industry

The domestic textile industry operates in a commodity business, competing in a world market in which substantial excess capacity exists. Much of the trouble we experienced was attributable, both directly and indirectly, to competition from foreign countries whose workers are paid a small fraction of the U.S. minimum wage. (1985)

And whatever improvements Berkshire did, competitors did

Slow capital turnover, coupled with low profit margins on sales, inevitably produces inadequate returns on capital. Obvious approaches to improved profit margins involve differentiation of product, lowered manufacturing costs through more efficient equipment or better utilization of people, redirection toward fabrics enjoying stronger market trends, etc. Our management is diligent in pursuing such objectives.

The problem, of course, is that our competitors are just as diligently doing the same thing. (1978)

Over the years, we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like an immediate winner. Measured by standard return-on-investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly-profitable candy and newspaper businesses. (1985)

I see the immediate but illusory benefits of the cost reductions. I don’t see competitive actions and that all the benefits go to the customer

But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industry wide. Viewed individually, each company’s capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anemic. (1985)

Thus, we faced a miserable choice: Huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital. After the investment, moreover, the foreign competition would still have retained a major, continuing advantage in labor costs. A refusal to invest, however, would make us increasingly non-competitive, even measured against domestic textile manufacturers. (1985)

This devastating outcome for the shareholders indicates what can happen when much brain power and energy are applied to a faulty premise. The situation is suggestive of Samuel Johnson’s horse:

“A horse that can count to ten is a remarkable horse—not a remarkable mathematician.” Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company—but not

a remarkable business. (1985)

An important lesson

We react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) (An Owner’s Manual)

An important truth

In a business selling a commodity-type product, it’s impossible to be a lot smarter than your dumbest competitor. (1990)

But what if I buy a gruesome business at a real bargain?

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit. (1989)

Don’t confuse “cheap” with a good deal

Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces—never is there just one cockroach in the kitchen. (1989)

Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre. (1989)

In some businesses, not even brilliant management helps

I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is

the reputation of the business that remains intact. (1989)

Good jockeys will do well on good horses, but not on broken-down

nags. (1989)

When an industry’s underlying economics are crumbling, talented management may slow the rate of decline. Eventually, though, eroding fundamentals will overwhelm managerial brilliance. (As a wise friend told me long ago, “If you want to get a reputation as a good businessman, be sure to get into a good business.”) (2006)

My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row (though intelligence and effort help considerably, of course, in any business, good or bad). (1985)

Should you find yourself in a chronically-leaking boat, energy devoted

to changing vessels is likely to be more productive than energy devoted to patching leaks. (1985)

Turnarounds seldom turn or take longer than I expect

Both our operating and investment experience cause us to conclude that “turn-arounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price. (1979)

But separate a general and permanent problem from an isolated and correctable problem and temporary setback—assuming it’s a great or good business

Extraordinary business franchises with a localized excisable cancer (needing, to be sure, a skilled surgeon), should be distinguished from the true “turnaround” situation in which the managers expect—and need—to pull off a corporate Pygmalion. (1980)

A great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem as was the case many years back at both American Express and GEICO. Overall, however, we’ve done better by avoiding dragons than by slaying them. (1989)

All earnings are not created equal—Restricted earnings must often

be discounted heavily in capital intensive businesses

In many businesses particularly those that have high asset/profit ratios—inflation causes some or all of the reported earnings to become ersatz. The ersatz portion—let’s call these earnings “restricted”—cannot, if the business is to retain its economic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas: Its ability to maintain its unit volume of sales, its long-term competitive position, its financial strength. No matter how conservative its payout ratio, a company that consistently distributes restricted earnings is destined for oblivion unless equity capital is otherwise infused. (1984)

Let’s turn to the much-more-valued unrestricted variety. These earnings may, with equal feasibility, be retained or distributed. In our opinion, management should choose whichever course makes greater sense for the owners of the business. (1984)

Unrestricted earnings should be retained only when there is a reasonable prospect—backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future— that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors. (1984)

D. OTHER TOUGH BUSINESSES

I-have-to-be-smart-every-day- business

Retailing is a tough business… In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast

is to fail. (1995)

In contrast to this have-to-be-smart-every-day business, there is what I call the have-to-be-smart- once business. For example, if you were smart enough to buy a network TV station very early in the game, you could put in a shiftless and backward nephew to run things, and the business would still do well for decades. (1995)

Fast changing industries can also be troublesome—even if I understand their products, it may be close to impossible to judge future competitive position and what can go wrong over time

Our criterion of “enduring” causes us to rule out companies in

industries prone to rapid and continuous change… A moat that must

be continuously rebuilt will eventually be no moat at all. (2007)

In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. (2009)

A business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns. (1987)

And this includes technology—a few will make money but many will lose and it’s hard to see who does what in advance

A business that must deal with fast-moving technology is not going to lend itself to reliable evaluations of its long-term economics. (1993)

At Berkshire, we make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We’re not smart enough to do that, and we know it. (2000)

Did we foresee thirty years ago what would transpire in the television-manufacturing or computer industries? Of course not. (Nor did most of the investors and corporate managers who enthusiastically entered those industries.) Why, then, should Charlie and I now think we can predict the future of other rapidly-evolving businesses? (1993)

Severe change and exceptional returns usually don’t go together.

Most investors, of course, behave as if just the opposite were true. That is, they usually confer the highest price-earnings ratios on exotic-sounding businesses that hold out the promise of feverish change.

That prospect lets investors fantasize about future profitability rather than face today’s business realities. For such investor-dreamers, any blind date is preferable to one with the girl next door, no matter how desirable she may be. (1987)

Just because Charlie and I can clearly see dramatic growth ahead for

an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy.

At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes. (2009)

Our problem—which we can’t solve by studying up—is that we have

no insights into which participants in the tech field possess a truly durable competitive advantage. (1999)

And growth has its limits—no trees grow to the sky

In a finite world, high growth rates must self-destruct. If the base from which the growth is taking place is tiny, this law may not operate for a time. But when the base balloons, the party ends: A high growth rate eventually forges its own anchor. (1989)

For a major corporation to predict that its per-share earnings will grow over the long term at, say, 15% annually is to court trouble. That’s true because a growth rate of that magnitude can only be maintained by a very small percentage of large businesses. Here’s a test: Examine the record of, say, the 200 highest earning companies from 1970 or 1980 and tabulate how many have increased per-share earnings by 15% annually since those dates. You will find that only a handful have. I would wager you a very significant sum that fewer than 10 of the 200 most profitable companies in 2000 will attain 15% annual growth in earnings-per-share over the next 20 years. (2000)

We readily acknowledge that there has been a huge amount of true value created in the past decade by new or young businesses, and that there is much more to come. But value is destroyed, not created, by any business that loses money over its lifetime, no matter how high its interim valuation may get. (2000)

Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which Charlie and I have no special capital-allocation expertise. For instance, we bring nothing to the table when it comes to evaluating patents, manufacturing processes or geological prospects. So we simply don’t get into judgments in those fields. (1999)

E. THE CORRECT WAY TO LOOK AT ACCOUNTING GOODWILL

We believe managers and investors alike should view intangible assets from two perspectives: (1983)

When you evaluate the attractiveness of a business look at the return on net tangible assets

(1) In analysis of operating results—that is, in evaluating the underlying economics of a business unit-amortization charges should be ignored. What a business can be expected to earn on unleveraged net tangible assets, excluding any charges against earnings for amortization of Goodwill, is the best guide to the economic attractiveness of the operation. It is also the best guide to the current value of the operation’s economic Goodwill. (1983)

Goodwill should not be amortized, but written off when necessary

(2) In evaluating the wisdom of business acquisitions, amortization charges should be ignored also. They should be deducted neither from earnings nor from the cost of the business. This means forever viewing purchased Goodwill at its full cost, before any amortization. Furthermore, cost should be defined as including the full intrinsic business value—not just the recorded accounting value—of all consideration given, irrespective of market prices of the securities involved at the time of merger and irrespective of whether pooling treatment was allowed. (1983)

Operations that appear to be winners based upon perspective (1) may pale when viewed from perspective (2). A good business is not always a good purchase—although it’s a good place to look for one. (1983)

We will try to acquire businesses that have excellent operating economics measured by (1) and that provide reasonable returns measured by (2). Accounting consequences will be totally ignored. (1983)

F. WHAT ARE THE KEY FACTORS FOR SUCCESS OR HARM AND HOW PREDICTABLE ARE THEY?

Let’s translate the analysis into a simple question: Does the business have something people need or want now and in the future (demand), that no one else has (competitive advantage) or can copy, take away or get now and in the future (sustainable) and can these advantages be translated into business value?

Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables. (1994)

The truly big investment idea can usually be explained in a short paragraph. (1994)

Distinguish what matters from what doesn’t—Try to figure out the key factors that make the business succeed or fail. A few examples:

Insurance

Our main business…is insurance. To understand Berkshire, therefore, it is necessary that you understand how to evaluate an insurance company. The key determinants are: (1) The amount of float that the business generates; (2) Its cost; and (3) Most critical of all, the long-term outlook for both of these factors. (1999)

The most important ingredient in GEICO’s success is rock-bottom operating costs, which set the company apart from literally hundreds of competitors that offer auto insurance. (1986)

Because of the company’s low costs, its policyholders were consistently profitable and unusually loyal. (2010)

Newspapers

Within this environment the News has one exceptional strength: its acceptance by the public, a matter measured by the paper’s “penetration ratio”—the percentage of households within the community purchasing the paper each day… We believe a paper’s penetration ratio to be the best measure of the strength of its franchise. (1983)

A large and intelligently-utilized news hole…attracts a wide spectrum of readers and thereby boosts penetration. High penetration, in turn, makes a newspaper particularly valuable to retailers since it allows them to talk to the entire community through a single “megaphone.” A low-penetration paper is a far less compelling purchase for many advertisers and will eventually suffer in both ad rates and profits. (1989)

Retail

We regard the most important measure of retail trends to be units sold per store rather than dollar volume. (1983)

NFM [Nebraska Furniture Mart] and Borsheim’s [Fine Jewelry] follow precisely the same formula for success: (1) unparalleled depth and breadth of merchandise at one location; (2) the lowest operating costs in the business; (3) the shrewdest of buying, made possible in part by the huge volumes purchased; (4) gross margins, and therefore prices, far below competitors’; and (5) friendly personalized service with family members on hand at all times. (1989)

Railroads

Both of us are enthusiastic about BNSF’s future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs. (2010)

To sum up the great, good and gruesome

To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns. (2007)

Business experience, direct and vicarious, produced my present strong preference for businesses that possess large amounts of enduring Goodwill and that utilize a minimum of tangible assets. (1983)

Published with permission from Post Scriptum AB .

### For the comments: Do you have any favorite investment or investor quotes? ###

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“This [drawing] looks good — as close as I’ve ever look to George Clooney.” – Warren Buffett. (Illustration credit: Monica Bevelin) “It’s a funny thing abo…

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Read More: The Simple System I'm Using to Read 30 Books Per Year

Warren Buffett, the man commonly referred to as the greatest investor of the 20th century, was standing in front of 165 wide-eyed students from Columbia University.

One of the students raised his hand and asked Buffett for his thoughts on the best way to prepare for an investing career. After thinking for a moment, Buffett pulled out a stack of papers and trade reports he had brought with him and said, “Read 500 pages like this every day. That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” 1

Buffett estimates that 80 percent of his working hours are spent reading or thinking. It's enough to make you ask, “Am I reading enough books?”

When I asked myself that question recently, I realized that there were some simple reasons I wasn't reading as much as I would like to, and I developed a reasonable system that is helping me read more than 30 books per year.

Let me explain…

How to Read More Books

If you know how to read, then reading books is relatively easy. You simply have to make time to read. Easier said than done, of course.

When I looked at my own reading habits, I realized that my reading habits were mostly reactive, not proactive. If an interesting link flashed across my screen on Facebook or Twitter, then I would read it as a reaction. I wasn't proactively making time to read books each day. I was simply reading interesting ideas that were pushed in front of me.

As a result, most of my reading was done online. Now, there are plenty of excellent articles on the web, but generally speaking, the quality of good books is better. Books typically have better writing (more tightly edited) and higher quality information (better fact-checking and more extensive research). From a learning perspective, it's probably a better use of my time to read books than to read online content.

So, I had to figure out a strategy that would allow me to read more books without letting typical distractions get in the way.

How do you do that?

20 Pages Per Day

Here's the only pattern I've been able to stick with consistently:

Read 20 pages to start the day.

I usually wake up, drink a glass of water, write down 3 things I'm grateful for, and read 20 pages of a book. For the last 10 weeks, I have followed this new habit. As of today, I'm 100 pages into my 7th book. At that pace (7 books per 10 weeks) I'll read about 36 books in the next year. Not bad.

Here's why I think this pattern works: 20 pages is small enough that it's not intimidating. Most people can finish reading 20 pages within 30 minutes. And if you do it first thing in the morning, then the urgencies of the day don't get in the way.

Finally, 20 pages seems small but adds up fast. It's a great average speed .

If time allows, I'll read more at other times as well. After the research I did for my article on how to get better sleep , I have added reading to my “prepare for bed” routine as well. But regardless of what happens during the rest of the day, I still get my 20 pages in each morning.

The First Hour

How do you spend the first hour of your day ?

Most people spend it getting dressed, getting ready, and rushing out the door. What if that time was spent making yourself a better person? What if you woke up an hour before you needed to each day and worked on yourself? How much better would you be at work, in your relationships, and as a person?

That's essentially what this reading strategy is asking you to do. Before you move on to the normal bustle of the day, invest in yourself. Before your life turns into a whirlwind of activity, read a book that will make you better. As with most habits that can greatly impact your life, this will never feel urgent, but it is important . 20 pages per day. That's all you need.

Read Next

Looking for good books to read? I created a public reading list where you can see all of my book recommendations across a wide range of categories. Here are a few of the best books to start with…

If you want practical ideas for creating more good habits (like reading!), check out my book Atomic Habits , which will show you how small changes in habits can lead to remarkable results.

Happy reading!

Read this article to learn the simple system I'm using to read more books. This reading habit has helped me finish 7 books in 10 weeks.

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Warren Buffett's "2 List" Strategy: How to Maximize Your Focus and Master Your Priorities

With well over 50 billion dollars to his name, Warren Buffett is consistently ranked among the wealthiest people in the world. Out of all the investors in the 20th century, Buffett was the most successful.

Given his success, it stands to reason that Buffett has an excellent understanding of how to spend his time each day. From a monetary perspective, you could say that he manages his time better than anyone else.

And that's why the story below, which was shared directly from Buffett's employee to my good friend Scott Dinsmore , caught my attention.

Let's talk about the simple 3-step productivity strategy that Warren Buffett uses to help his employees determine their priorities and actions.

The Story of Mike Flint

Mike Flint was Buffett's personal airplane pilot for 10 years. (Flint has also flown four US Presidents, so I think we can safely say he is good at his job.) According to Flint, he was talking about his career priorities with Buffett when his boss asked the pilot to go through a 3-step exercise.

Here's how it works…

STEP 1: Buffett started by asking Flint to write down his top 25 career goals. So, Flint took some time and wrote them down. (Note: you could also complete this exercise with goals for a shorter timeline. For example, write down the top 25 things you want to accomplish this week.)

STEP 2: Then, Buffett asked Flint to review his list and circle his top 5 goals. Again, Flint took some time, made his way through the list, and eventually decided on his 5 most important goals.

Note: If you're following along at home, pause right now and do these first two steps before moving on to Step 3.

STEP 3: At this point, Flint had two lists. The 5 items he had circled were List A and the 20 items he had not circled were List B.

Flint confirmed that he would start working on his top 5 goals right away. And that's when Buffett asked him about the second list, “And what about the ones you didn't circle?”

Flint replied, “Well, the top 5 are my primary focus, but the other 20 come in a close second. They are still important so I’ll work on those intermittently as I see fit. They are not as urgent, but I still plan to give them a dedicated effort.”

To which Buffett replied, “No. You’ve got it wrong, Mike. Everything you didn’t circle just became your Avoid-At-All-Cost list. No matter what, these things get no attention from you until you’ve succeeded with your top 5.”

The Power of Elimination

I believe in minimalism and simplicity. I like getting rid of waste. I think that eliminating the inessential is one of the best ways to make life easier, make good habits more automatic, and make you grateful for what you do have.

That said, getting rid of wasteful items and decisions is relatively easy. It's eliminating things you care about that is difficult. It is hard to prevent using your time on things that are easy to rationalize, but that have little payoff. The tasks that have the greatest likelihood of derailing your progress are the ones you care about, but that aren't truly important.

Every behavior has a cost. Even neutral behaviors aren’t really neutral. They take up time, energy, and space that could be put toward better behaviors or more important tasks. We are often spinning in motion instead of taking action .

This is why Buffett's strategy is particularly brilliant. Items 6 through 25 on your list are things you care about. They are important to you. It is very easy to justify spending your time on them. But when you compare them to your top 5 goals, these items are distractions. Spending time on secondary priorities is the reason you have 20 half-finished projects instead of 5 completed ones.

Eliminate ruthlessly. Force yourself to focus. Complete a task or kill it .

The most dangerous distractions are the ones you love, but that don't love you back. 1

  1. here .

Read this article to discover the strategy Warren Buffett uses to simplify his priorities and focus on the right things.

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Apply One Investment Principle to Your Everyday Life

writing reading studying hate
In late August of 2005, one of the most dangerous tropical storms in history began brewing.

The waters of the Gulf of Mexico were unusually warm that month, and the high temperatures transformed the ocean basin into a giant cauldron with the optimal conditions for growth.

As the tropical storm cut across the tip of Florida and entered the Gulf, it immediately began to swell.

In less than 24 hours, the storm doubled in size. And as it grew into a full-blown hurricane, the weather experts gave it a name: Hurricane Katrina.

Katrina churned through the tropical waters of the Gulf and quickly escalated to peak intensity. It ripped through the atmosphere with remarkable force, registering gusts of wind that exceeded 175 mph (280 km/h) and lasted for more than a minute. By the time the storm hit the southeastern coast of Louisiana on August 29th, Hurricane Katrina was nearly 120 miles wide.

A storm of Katrina’s size is expected to cause flooding and damage, but coastal cities and neighborhoods use a variety of flood walls and levees to prevent total catastrophe. These walls are built along rivers and waterways and act as a barrier to hold back usually high waters and prevent flooding.

Shortly after Hurricane Katrina made landfall, it became clear that the levees of New Orleans might not be able to hold back the rising waters. A few hours in, the director of the National Hurricane Center said, “I do not think anyone can tell you with confidence right now whether the levees will be topped or not, but that's obviously a very, very great concern.”

Minutes later, the levees began to fail. The waters breached the levees and flood walls of New Orleans in more than 50 different places. Entire districts became submerged in more than 10 feet of water. Evacuation routes were destroyed as bridges and roads collapsed. At Memorial Medical Center in the heart of New Orleans, the surging water killed the backup generators.

Hurricane Katrina levee breach
A breached levee in New Orleans in the wake of Hurricane Katrina.
AP
Without power, temperatures inside the hospital rose to over 100 degrees as doctors and nurses took turns manually pumping each breath into dying patients in a desperate attempt to keep people alive.

Water flooded more than 80 percent of the city. And in the days that followed, the death toll began to rise. Bodies were found floating down the streets. Rescue and recovery efforts failed to track down missing people. At least 1,200 people died, and hundreds more were unaccounted for—the total number of dead is still unknown to this day.

So many residents were displaced by Hurricane Katrina that the population of New Orleans dropped by 50 percent from 484,000 before the storm to 230,000 one year later. In total, the damages from Hurricane Katrina surpassed $100 billion. It was the costliest natural disaster in the history of the United States.

The margin of safety

The great mistake of Hurricane Katrina was that the levees and flood walls were not built with a proper “margin of safety.” The engineers miscalculated the strength of the soil the walls were built upon. As a result, the walls buckled and the surging waters poured over the top, eroding the soft soil and magnifying the problem. Within a few minutes, the entire system collapsed.

This term, margin of safety, is an engineering concept used to describe the ability of a system to withstand loads that are greater than expected.

Imagine you are building a bridge.

Pedestrians Brooklyn Bridge
Pedestrians on the Brooklyn Bridge.
Drew Angerer/Getty Images
The maximum weight for a fully loaded commercial truck is around 80,000 pounds (36,000 kg), but any decent engineer will build a bridge that can safely carry vehicles weighing far more. You don't want to drive an 80,000-pound truck across a bridge that can only hold 80,001 pounds. Just to be safe, the engineer might build the bridge to handle 5x the expected weight, say 400,000 pounds. This additional capacity is known as the margin of safety.

Of course, maintaining a proper margin of safety is crucial not only in construction and engineering, but also in many areas of daily life.

How to use a margin of safety in real life

There are many ways to implement a margin of safety in everyday life. The core idea is to protect yourself from unforeseen problems and challenges by building a buffer between what you expect to happen and what could happen. This idea is widely useful on a day-to-day basis because uncertainty creeps into every area of life. Let's explore a few ways we can use this concept to live better.

Time management

One of the keys to being prompt and reliable is to use a margin of safety when scheduling your day. If it takes 10 minutes to get somewhere, don't wait to leave until 11 minutes beforehand. Instead, leave 30 minutes beforehand. Similarly, if it always seems to take an extra five minutes to wind down a meeting, then don't schedule meetings back-to-back.

If you're always running late it is because you are living your life without a margin of safety. There will always delays in the real world. When everything has to go perfectly for you to be on time, you're not going to be on time very often. Give yourself a healthy margin of safety.

Strength training

When strength training, you can utilize a margin of safety by finishing each set with at least one repetition left in the tank. This strategy ensures you can complete each repetition with proper technique and reduces the odds of injury. Training to failure eliminates your margin of safety.

Similarly, strength coaches often prevent their athletes from attempting to lift as much weight as possible for a single repetition. Instead, they only allow their athletes to select a weight they can do for at least three repetitions. (Elite sports teams often test a three-rep max, not a one-rep max.) This strategy creates a margin of safety and helps prevent injury during training by never placing athletes under a maximal load.

Investing

Warren Buffett, the famous investor, is a proponent of using a margin of safety when considering which stock to buy. He says, “Do not cut it close. That is what Ben Graham meant by having a margin of safety. You don’t try to buy businesses worth $83 million for $80 million. You leave yourself an enormous margin.”

Our predictions and calculations turn out to be wrong all the time. When it comes to assessing investment opportunities, you want a margin of safety that is so wide, it doesn't matter if your prediction is inaccurate.

Warren Buffett
Warren Buffett.
Buffett's business partner, Charlie Munger has said something similar, “The margin of safety ought to be so attractive. The decision should be obvious.”

As Munger says, “If you could take the stock price and multiply it by the number of shares and get something that was one third or less of sellout value… you've got a lot of edge going for you. Even with an elderly alcoholic running a stodgy business, this significant excess of real value per share working for you means that all kinds of good things can happen to you. You had a huge margin of safety by having this big excess value going for you.”

Project management

Many complex projects require coordination between multiple people. Let's say five people need to touch a project before it is completed. On average, it might take each person four days to complete their task. Under these circumstances, it would seem reasonable to set the deadline for 20 days from now, which gives each person four days.

But let's say that the total range of time each stage could take is between two days and six days. It is often better to plan for the worst case scenario and set the deadline 30 days from now, which gives each person six days. Hopefully, the average of four days per person will continue and you'll finish the project early. But in any major project, it helps to have a cushion to safeguard against any unexpected problems.

Personal finance

If you have to spend every dollar you earn each month, then you don't have any margin of safety to protect against unexpected expenses. Conversely, if you can manage to live on 90 percent of your income, then the 10 percent you save provides a nice buffer in case of emergency.

And if you can manage to live on 50 percent of your income, then you can handle a great amount of financial stress. Imagine a medical emergency that requires $25,000 in cash. With a large buffer of cash, you can withstand such an unpleasant surprise. A big bank account can handle a lot of turbulence with inflows and outflows. Meanwhile, one small bank account can be sent into bankruptcy from one big shock. The bigger the buffer, the more chaos you can handle.

Jay Leno, the famous comedian, is a perfect example of this strategy. Leno worked two jobs at the beginning of his career, but lived off the income from one of them.

“When I was younger, I would always save the money I made working at the car dealership and I would spend the money I made as a comedian,” he says. “When I started to get a bit famous, the money I was making as a comedian was way more than the money I was making at the car dealership, so I would bank that and spend the car dealership money.”

Leno continued this habit even after he was making millions of dollars per year hosting The Tonight Show . “When I got ‘The Tonight Show,' I always made sure I did 150 [comedy show] gigs a year so I never had to touch the principal,” Leno says. “I've never touched a dime of my ‘Tonight Show' money. Ever.”

Wildlife protection

There are millions of squirrels in the world today. If a viral outbreak killed 100,000 squirrels, the species would continue just fine. But if a similar virus killed 100,000 lions, the species would be extinct. There is not enough slack in the ecosystem to handle such a catastrophe. Endangered species are in a precarious position because they have no margin of safety.

Mobility and stretching

Each muscle in the body has a “stress-strain curve” which describes how far a muscle can stretch before reaching the point of failure. Injury often occurs near the extreme end of this curve. The closer you get to the limits of your range of motion, the more strain your muscles endure.

workout Flickr/Nathan Rupert
Practicing stretching and mobility exercises can help expand your range of motion and widen your stress-strain curve. This helps to keep your normal movements in the middle of the curve and away from the extremes where injury is more likely to occur. In other words, it is not necessary to be as flexible as a yoga teacher, but it's nice to have a good margin of safety in your mobility to prevent injury.

Summary of margin of safety

Utilizing a margin of safety can serve you well in nearly any area of life.

All information—no matter how bulletproof it may seem—comes with some degree of error. A margin of safety acts as a buffer against the unknown, the random, and the unseen. Perhaps the greatest benefit is that a margin of safety reduces stress and overwhelm. Nobody can predict the future, but there is a sense of quiet confidence that comes over you when you know you are capable of handling the uncertainties of life.

If your life is designed only to handle the expected challenges, then it will fall apart as soon as something unexpected happens to you. Always be stronger than you need to be. Always leave room for the unexpected.

The margin of safety.

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10 months ago

Happy Birthday, Warren! You’ve been a true friend and an invaluable source of advice over the years, and I’m so lucky to know you. It’s an honor to work at the foundation doing my best to turn your generosity into lives saved and improved. Here’s to many more birthdays! https://t.co/ZaCGW5KCWm

10 months ago

I will always have a deep sense of accountability to Warren, paying close attention to the data to track our progress and identify areas where we can do better. But the value of Warren’s gift goes beyond anything that can be measured.