{"id":95,"date":"2020-10-12T07:55:20","date_gmt":"2020-10-12T02:25:20","guid":{"rendered":"https:\/\/www.smevalueadvisors.com\/blog\/?p=95"},"modified":"2020-11-05T17:02:25","modified_gmt":"2020-11-05T11:32:25","slug":"think-like-buffett","status":"publish","type":"post","link":"https:\/\/www.smevalueadvisors.com\/blog\/index.php\/think-like-buffett\/","title":{"rendered":"How to See Your Business Through Warren Buffett\u2019s Eyes"},"content":{"rendered":"\n
\"how
source<\/a><\/figcaption><\/figure>\n\n\n\n

A common trait in all value investors \u2013 big and small \u2013 is that they see themselves as part owners of a business.<\/p>\n\n\n\n

They maintain a micro view of the business by analyzing quarterly earning results. But they also maintain a macro view of the business: an educated estimate of the business\u2019 and the performance in the next five to ten years.<\/p>\n\n\n\n

In other words, astute value investors think as promoters should. But most promoters don\u2019t think like this. Little wonder that they struggle to raise capital to enhance their business performance and generate wealth.<\/p>\n\n\n\n

If you think, as a promoter, you\u2019re the biggest investor in your business. Equity investors pump capital into a business. But you infuse your time, effort, blood, sweat, and tears along with your own capital. Don\u2019t you think it\u2019s your responsibility to look at your business the way investors do?<\/p>\n\n\n\n

\n\n\n\n

Look at Your Business Like Warren Buffett Would<\/h4>\n\n\n\n

Warren Buffett<\/a> created tremendous wealth for himself and the stakeholders of Berkshire Hathaway by investing in businesses that generated long-term wealth. Looking at your business through his eyes will help you do the same for yours.<\/p>\n\n\n\n

Equity investors look for the potential of a business to multiply its value in terms of future valuation. Since profits dictate valuations, equity investors assess whether the business is currently generating profits and will continue to do so in the future.<\/p>\n\n\n\n

Businesses that answer \u201cyes\u201d to both aspects match their criteria. It means such businesses will generate long-term-wealth<\/a>.<\/p>\n\n\n\n

As a promoter, here are three questions to ask yourself if you\u2019d like your business to generate long term wealth:<\/p>\n\n\n\n

Q1. \u201cAm I building a sustainable moat for my business?\u201d<\/h5>\n\n\n\n

\u201cThe most important thing [is] trying to find a business with a wide and long-lasting moat around it\u2026 protecting a terrific economic castle with an honest lord in charge of the castle.\u201d \u2013 Warren Buffett.<\/p><\/blockquote>\n\n\n\n

A moat around a castle protects it from enemies. Lesser attacks on a kingdom will mean it has more opportunities to grow and become powerful.<\/p>\n\n\n\n

\"what
(Photo by Angelo Hornak\/Corbis via Getty Images)<\/figcaption><\/figure><\/div>\n\n\n\n

In business terms, a moat is a company\u2019s advantage that protects it from its competitors. This advantage doesn\u2019t come from being the largest or best in the industry. It comes from being different.<\/p>\n\n\n\n

When your business develops a unique ability to address opportunities<\/a>, one that competitors struggle to imitate, it differentiates itself and builds a moat. Nestle built moats with Maggi, as Bata did with children\u2019s school shoes.<\/p>\n\n\n\n

As a promoter, asking yourself the below questions will guide you towards building a moat:<\/p>\n\n\n\n

  1. Are we relevant as a business?<\/li>
  2. What pain points of our customers do we address?<\/li>
  3. Do customers perceive us as a differentiated solutions provider?<\/li><\/ol>\n\n\n\n

    But merely being different is not enough. Just the pursuit of a moat doesn\u2019t guarantee profits. You must also examine whether your differentiation is useful for customers. The next question shows how to find that out.<\/p>\n\n\n\n

    Q2. \u201cAre we building robust financials?\u201d<\/h5>\n\n\n\n

    As stated above, a moat is all about building a differentiated quality business. However, a differentiation turns into a competitive advantage only if customers find it useful or novel, and are willing to pay for it.<\/p>\n\n\n\n

    The below financial ratios will help you track whether customers are willing to pay for your differentiated offering. Working on them will improve the quality and value of your business.<\/p>\n\n\n\n

    Pricing Power Reflected By<\/strong>:<\/p>\n\n\n\n

    1. Operating Profit Margin:<\/em> The percentage of revenue left after incurring the cost of goods sold and operating expenses. The higher the percentage, the better.<\/li>
    2. Net Profit Margin:<\/em> The percentage of revenue that remains after deducting all operating expenses, interest, and taxes from the company\u2019s revenue. The higher the percentage, the better.<\/li><\/ol>\n\n\n\n

      Capital Efficiency Reflected By<\/strong>:<\/p>\n\n\n\n

      1. Return on Capital Employed:<\/em> A financial ratio that measures a company\u2019s profitability in terms of all its capital. The higher the ratio, the better.<\/li>
      2. Return on Equity:<\/em> A ratio that measures how much profits the business generates from the equity invested. The higher the percentage, the better.<\/li><\/ol>\n\n\n\n

        Discipline and Risk Management Reflected By:<\/strong><\/p>\n\n\n\n

        1. Debt-Equity (D\/E) Ratio:<\/em> This ratio indicates a company\u2019s financial leverage by measuring the shareholder\u2019s equity against the debt the company services. The lower the ratio, the better.<\/li>
        2. Interest Coverage Ratio:<\/em> The ease with which a company can pay interest on its outstanding debt. A higher ratio is better.<\/li><\/ol>\n\n\n\n

          Quality of Business Reflected By:<\/strong><\/p>\n\n\n\n

          1. Operating Cash Flow: The amount of cash a company\u2019s core business generates. The closer the operating cash flow is to the operating profits, the better.<\/li>
          2. Current Ratio: The company\u2019s ability to finance its current liabilities with its current assets. A higher ratio is better.<\/li>
          3. Inventory Churn: How well a company generates sales from its inventory. A higher churn is better.<\/li>
          4. Receivables Churn: How quickly cash gets collected from debtors. A higher churn is better.<\/li>
          5. Fixed Assets Churn: How effectively the business generates sales from its fixed assets. A higher ratio is better.<\/li>
          6. Total Assets Churn: How effectively the business generates sales from its total assets. A higher ratio is better.<\/li><\/ol>\n\n\n\n

            \u201cIt is not necessary to do extraordinary things to get extraordinary results,\u201d <\/em>Buffett said. Do what\u2019s simple, and do it well.<\/p>\n\n\n\n

            Fruits change when we work on the roots. Ratios improve when we improve the quality of our business. Focus on the right financial ratios and you\u2019ll build a wonderful, ever-widening moat around your business.<\/p>\n\n\n\n

            (If you cannot access these metrics easily, ask your CFO to make a dashboard that you can track monthly.)<\/p>\n\n\n\n

            Focusing on these ratios is important. But you cannot afford to ignore growth in the process. Which leads us to the final question.<\/p>\n\n\n\n

            \n\n\n\n
            Q3. \u201cAre we growing in the right way?\u201d<\/h5>\n\n\n\n

            Small-sized companies can generate good financial ratios. But maintaining that pace when they grow to medium- or large-sized ones is the true test. When businesses cannot grow in streamlined ways, diseconomies of scale<\/a> occur, where the cost per unit increases as businesses grow.<\/p>\n\n\n\n

            This happens for various reasons. Some include:<\/p>\n\n\n\n

            1. Businesses acquire their competition for hefty prices.<\/li>
            2. They build excess capacities by ignoring the demand-supply situation of the industry.<\/li>
            3. They diversify mindlessly in unrelated areas. (Peter Lynch terms such outrageous diversification as Diworsification<\/a>.)<\/li><\/ol>\n\n\n\n

              The result is chaos where nobody knows what they\u2019re doing and why. All the company focuses on is short-term results. In the process, promoters lose sight of whether they\u2019re heading in the right direction.<\/p>\n\n\n\n

              The right growth trajectory occurs when companies can grow while maintaining their financials. Nestle, Asian Paints, and Page Industries are examples. They went from strength to strength, growing at a wonderful pace while maintaining healthy financial ratios.<\/p>\n\n\n\n

              \n\n\n\n

              Summing Up<\/h4>\n\n\n\n

              Seeing your business through an investor\u2019s eyes doesn\u2019t mean fussing over the balance sheet. It means focusing on the quality of your business.<\/p>\n\n\n\n

              To enhance the long-term quality and valuation of your business, simply ask yourself three questions:<\/p>\n\n\n\n

              1. \u201cAm I building a sustainable moat for my business?\u201d A moat gets built when your offering is differentiated.<\/li>
              2. \u201cAre my financials robust?\u201d Robust financial ratios indicate whether your customers are willing to pay for your differentiation.<\/li>
              3. \u201cAre we growing in the right way?\u201d If your business is growing while the financials stay constant, you\u2019re on the right path.<\/li><\/ol>\n\n\n\n

                When the growth trajectory goes hand-in-hand with financial ratios and differentiation, your business turns into what you dreamed it would be.<\/p>\n","protected":false},"excerpt":{"rendered":"

                A common trait in all value investors \u2013 big and small \u2013 is that they see themselves as part owners of a business. They maintain a micro view of the business by analyzing quarterly earning results. But they also maintain a macro view of the business: an educated estimate of the business\u2019 and the performance […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[2],"tags":[],"yoast_head":"\nHow to See Your Business Through Warren Buffett\u2019s Eyes - SME Value Advisors<\/title>\n<meta name=\"description\" content=\"3 ways in which you can see your business through value investors\u2019 eyes and make it capable to generate long-term wealth.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.smevalueadvisors.com\/blog\/index.php\/think-like-buffett\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"How to See Your Business Through Warren Buffett\u2019s Eyes - SME Value Advisors\" \/>\n<meta property=\"og:description\" content=\"3 ways in which you can see your business through value investors\u2019 eyes and make it capable to generate long-term wealth.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.smevalueadvisors.com\/blog\/index.php\/think-like-buffett\/\" \/>\n<meta property=\"og:site_name\" content=\"SME Value Advisors\" \/>\n<meta property=\"article:published_time\" content=\"2020-10-12T02:25:20+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2020-11-05T11:32:25+00:00\" \/>\n<meta property=\"og:image\" content=\"https:\/\/www.smevalueadvisors.com\/blog\/wp-content\/uploads\/2020\/10\/How-Warren-Buffett-Thinks-1-1024x695.jpeg\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" value=\"Written by\">\n\t<meta name=\"twitter:data1\" value=\"Manish Bansal\">\n\t<meta name=\"twitter:label2\" value=\"Est. reading time\">\n\t<meta name=\"twitter:data2\" value=\"5 minutes\">\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"WebSite\",\"@id\":\"https:\/\/www.smevalueadvisors.com\/blog\/#website\",\"url\":\"https:\/\/www.smevalueadvisors.com\/blog\/\",\"name\":\"SME Value Advisors\",\"description\":\"Business Solutions. 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