Businesses to invest in

Buffett first looks at the business that the prospective investment candidate operates in. He has gone on record several times stating that he likes businesses that he can understand.

His 2007 Annual Letter tells it all where he states that a truly great business must have an enduring 'moat' that protects excellent returns on invested capital. "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."

In the November 1999 edition of Fortune magazine, Buffett had written that he did not invest in innovation more because of the relatively limited longevity and defensibility of competitive advantage and the difficulty of identifying the few winners in advance and being able to buy them at reasonable prices. Yes, this can characterise the explanation as Buffett not understanding technology. But it would likely be more accurate to say that what Buffett doesn't understand is not, in fact, technology, but the prices other investors are willing to pay for technology.

Buffett speaks
You really want something where, if they don't have it in stock, you want to go across the street to get it. Nobody cares what kind of steel goes into a car. Have you ever gone into a car dealership to buy a Cadillac and said, 'I'd like a Cadillac with steel that came from the South Works of U.S. Steel'? It just doesn't work that way.

First question, how long does the management have to think before they decide to raise prices? You're looking at a marvelous business when you look in the mirror and say 'mirror, mirror on the wall, how much should I charge for Coke this fall?' [And the mirror replies, 'More'.] That's a great business. When you say, like we used to in the textile business, when you get down on your knees, call in all the priests, rabbis, and everyone else, [and say] 'just another half cent a yard'. Then you get up and they say, 'We won't pay it'. It's just night and day. I mean, if you walk into a drugstore, and you say, 'I'd like a Hershey bar' and the man says, 'I don't have any Hershey bars, but I've got this unmarked chocolate bar, and it's a nickel cheaper than a Hershey bar', you just go across the street and buy a Hershey bar. The ability to raise prices- the ability to differentiate yourself in a real way, and a real way means you can charge a different price-makes a great business.
Lecture to MBA students, 1991