What Makes a Good Business?

securityanalysis1Seth Klarman, clearly one of our favored sources of investing insight, recently took up the task of revising Benjamin Graham and David Dodd’s famous Security Analysis. In the introduction, Klarman observes some of the persistent difficulties in the stock market that enable some investors to generate outsized returns. One such difficulty is the lack of clarity about what makes a good business.

Klarman writes: “Another area where investors struggle is trying to define what constitutes a good business. Someone once defined the best possible business as a post office box to which people send money. That idea has certainly been eclipsed by the creation of subscription Web sites that accept credit cards. Today’s most profitable businesses are those in which you sell a fixed amount of work product–say, a piece of software or a hit recording–millions and millions of times at very low marginal cost. Good businesses are generally considered those with strong barriers to entry, limited capital requirements, reliable customers, low risk of technological obsolescence, abundant growth possibilities, and thus significant and growing free cash flow.” (xxxv)

All told, a very useful set of criteria.  The only thing I would want is some additional criterion about increasing margins.  In highly competitive industries, some businesses find it difficult to raise prices, since their market share quickly drops when they do.  A good business has customers who are relatively unconcerned about marginal price increases.  Businesses that have this privilege include Coca-Cola, Moody’s, Mastercard, and Visa.

Case in point, at the football games this past fall, a Coke was selling for $5 a cup.  And let me tell you, you still had to wait in line to get it.

One response to “What Makes a Good Business?

  1. Thank you for the ‘what makes a ‘good’ business, found if informative and helpful in my studies
    Helen Moule

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s