Friday, May 18, 2012

Buffett's version of Aesop's fable

For centuries and centuries, fables by the famous Greek writer Aesop have been the bedtime favourites of many a children. Aesop's fables, you would probably know, are known for their wit and wisdom. For instance, one of the very famous stories is about a hawk and a nightingale wherein the moral of the story goes thus: 'A bird in hand is worth two in the bush.' In simple terms, it means that it is better to have a sure thing instead of gambling for something bigger.

If legendary investor Warren Buffett would have followed Aesop's advice, we would have probably not even known him. For all the enormous wealth that he has created over the last 6 decades as an investor, has been by doing exactly the opposite of what Aesop said. The business of investing is all about letting go of the bird in hand in search of two in the bush. Meaning, one defers consumption in the present and invests money into assets that will give back more money at a later date.

But there are certain caveats that cannot overlooked. If your investment goes for a toss, you not only lose the two in the bush but also the bird that you had in your hand. So what do you do? As Buffett puts it, make sure there are two in the bush, that is, make sure that the pay-off is certain.

That's easier said than done, especially because stocks can be so volatile and unpredictable. So how does one find certainty in pay-offs? Listen carefully to what Buffett has to say about this. The most important thing that an investor must do is find companies with a competitive advantage that have had a history of great earnings and returns. He elaborates his premise with the example of Coca Cola. The company has completed over 125 years. This shows that the company has endured numerous business cycles, two major world wars and all kinds of crises that have conspired during this long period. Will a company that has been successful for so long disappear in the next 10 years? That's highly unlikely. The company operates in about 200 countries and its business has been growing. This means that there is certainty in the business. Moreover, the company has pricing power because of its strong brand value. So, by investing in such solid businesses with a strong past track record you can be almost certain about having two birds from the one that you let go of.

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