The Three Questions Warren Buffett Will Ask About a Business

“Investment is most intelligent when it is most businesslike” is one of the most famous quotes from Benjamin Graham, the teacher of the legendary investor, Warren Buffett.

So much have been talked about the way Buffett invests that if we were to read everything written about the subject, it will likely be a bad case of information overload. Fortunately, if we focus on the basics, there are effectively three business-related questions that Buffett always stresses upon when he’s looking to invest in either publicly-listed or privately-held companies.

1. Is the business simple and understandable?

The most basic question to ask is whether the company is in a business that we as investors can comprehend. A simple-to-understand business is not necessary a tiny company or one with lesser business activities.

CapitaLand (SGX: C31) is the largest property developer in South East Asia and their geographical reach is far and wide. However, the nature of their business is essentially to purchase land and develop them into valuable properties, which can then be sold to the public. The company then repeats the process over and over again. Investing only in companies that we understand can prevent us from being exposed to unnecessary risks that we do not even know exist.

2. Does the business have a consistent operating history?

Investing in companies that have a profitable track record over long stretches of time will give us confidence in their ability to operate successfully in their sector and survive through booms and busts. For instance, the ubiquitous telecommunications operator Singtel (SGX: Z74) has a track record of stable and profitable operations. This will give investors more certainty about its future profitability and the availability of financial resources to reinvest in its business.

3. Does the business have favourable long-term prospects?

A company without growth might one day end up being a value trap for investors. That is the reason why Buffett refused to reinvest into Berkshire Hathaway’s  (NYSE: BRK-A) (NYSE: BRK-B) textile business during its early days as he did not see any favourable long-term prospects for such a business (Buffett took control of Berkshire Hathaway in the 1960s in the USA when it was just a textile manufacturer and has since transformed the company into a conglomerate-giant with a market capitalization north of US$300 billion).

Similarly, when we look at a company, it is crucial to know what the targets are for the company and if its goals and targets for the future are viable.

Foolish Bottom Line

These qualitative questions should be answered by investors even before we look at a company’s financials and work out their valuation. Investing without the afore-mentioned knowledge might be similar to betting blindly on the casino table – you know you will win sometimes, but the odds are definitely not in your favour.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim owns shares in Berkshire Hathaway.