We focus our capital in a select number of what we believe to be extraordinary businesses. These companies meet specific standards related to the business itself, the people who manage it, and the discipline they demonstrate when it comes to reinvesting free cash flow1.
- Enduring, predictable high ROEs* and FCF**
- Identifiable, sustainable competitive advantages
- Pricing power in excess of costs, inflation protection
- Easy to understand
- Normally avoid return-regulated industries
- Strong balance sheets
- Management with exceptional skill, integrity, and passion
- Treat shareholders like partners
- Indifferent to Wall Street’s short-term focus
- Lean corporate culture fosters independence, accountability
- Compensation rationally determined
- Pattern of disciplined reinvestment
- Extensive opportunities to reinvest FCF organically or through acquisitions
These three areas of analysis – business, management, and reinvestment – are the key components of what we call our “three-legged stool.” When we find a business that satisfies all three of our requirements, we refer to it as a “compounding machine,” and we seek to purchase shares at a modest valuation.
We know from experience that these businesses are rare.
*Return on equity (ROE) measures the rate of return on the ownership interest (shareholders’ equity) of the common stock owners.
**Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base.