Billionaire investor Warren Buffett has never been shy about sharing his accumulated wisdom and knowledge about investing and that’s a great thing for individual investors like you and me if we consider his track record. Since taking over the U.S.-based Berkshire Hathaway in 1965, Buffett has helped grow the company’s book value (a good proxy for the true economic worth of the business) by an astounding compound annual rate of 19.4% through astute long-term investments made in both private as well as publicly-listed companies. For some perspective, Berkshire’s book value growth has far outpaced the U.S. stock market’s annual return of…
Billionaire investor Warren Buffett has never been shy about sharing his accumulated wisdom and knowledge about investing and that’s a great thing for individual investors like you and me if we consider his track record.
Since taking over the U.S.-based Berkshire Hathaway in 1965, Buffett has helped grow the company’s book value (a good proxy for the true economic worth of the business) by an astounding compound annual rate of 19.4% through astute long-term investments made in both private as well as publicly-listed companies. For some perspective, Berkshire’s book value growth has far outpaced the U.S. stock market’s annual return of 9.9% over the same time period.
Here’s Buffett with two pieces of insights about the types of businesses to avoid while investing (the first is given in his 2007 Berkshire annual shareholder’s letter; the second was mentioned by him in an interview with the Financial Crisis Inquiry Commission in 2011):
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk [the site in which the first controlled powered airplane flight took place], he would have done his successors a huge favour by shooting Orville down.”
“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business [emphasis mine].”
While commodities trader Noble Group Limited (SGX: N21) may be a blue-chip share – it’s a part of the group of 30 shares which makes up Singapore’ market barometer the Straits Times Index (SGX: ^STI) – it may yet be a poor long-term investment if we’re looking at it through Buffett’s lens.
Over the past 10 years from 2004 to 2014, Noble’s revenue has increased by nearly 10-fold from US$8.6 billion to US$85.8 billion. To help create that growth, the commodities trader has spent a total of US$4.82 billion in capital expenditures over that decade. And yet, Noble’s profit has shrank from US$289 million to just US$132 million over the same timeframe. The picture with Noble’s cashflow production ability is even worse as its operating cash flow has sunk from –US$50 million in 2004 to –US$1.1 billion in 2014.
These can be seen as strong signs that Noble’s a business that “grows rapidly, requires significant capital to engender that growth, and then earns little or no money.”
Changes in Noble’s gross margin over the years also point to the strong possibility that it lacks any sort of pricing power in its business.
A company’s gross margin measures the percentage of profit the firm earns for each dollar in sales that it makes after all the costs that are directly related to the sale have been deducted.
Trends in a company’s gross margin, as well as a comparison of it with the firm’s industry-peers, can serve as an indication on how much pricing power it has. A lack of pricing power can manifest itself in erratic or declining gross margins as the company would be unable to pass on any cost increases to its customers.
Source: S&P Capital IQ
As the chart above shows, Noble’s gross margin has fallen by more than half over the decade ending 2014.
A Fool’s take
None of the above is meant to say that Noble will necessarily be a poor investment going forward. After all, we’ve yet to consider the valuation angle (even a lousy business can become a great investment at the right price) and Noble’s management might also be able to improve the business in the years ahead.
But, given what we’ve seen with Noble, investors who are out looking for great businesses to invest for the long-term might want to approach the company with some caution.
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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 writer Chong Ser Jing owns shares in Berkshire Hathaway.