An excerpt from the 1989 Berkshire letter.
If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.
Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces—never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.
You might think this principle is obvious, but I had to learn it the hard way—in fact, I had to learn it several times over. Shortly after purchasing Berkshire, I acquired a Baltimore department store, Hochschild Kohn, buying through a company called Diversified Retailing that later merged with Berkshire. I bought at a substantial discount from book value, the people were first-class, and the deal included some extras—unrecorded real estate values and a significant LIFO inventory cushion. How could I miss? So-o-o—three years later I was lucky to sell the business for about what I had paid. After ending our corporate marriage to Hochschild Kohn, I had memories like those of the husband in the country song, “My Wife Ran Away With My Best Friend and I Still Miss Him a Lot.”
I could give you other personal examples of “bargain-purchase” folly but I’m sure you get the picture: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.
. . . . .
The key to competitive success lies in an organization’s ability to create unique value. Aim to be unique, not best. Creating value, not beating rivals, is the heart of competitive advantage.
Strategic competition means choosing a path different from that of others. Instead of competing to be the best, companies can, and should, compete to be unique. It is all about value – uniqueness in the value you create.
Strategy is about making choices, trade-offs; it's about deliberately choosing to be different. Strategy is about setting yourself apart from the competition. It's not a matter of being better at what you do - it's a matter of being different at what you do.
Trade-offs allow you focus resources to create something unique. Trade-offs create and sustain competitive advantage.
Competition: The Right Mind-Set
(From Understanding Michael Porter)
According to Porter, the key to competitive success lies in an organization’s ability to create unique value. How a business captures some of that value is determined by its strategy. Making bad choices can unleash a race to the bottom, while good choices promote healthy competition, innovation, and growth.
A good competitive strategy will result in sustainable, superior performance. However, competitive strategy is often misunderstood as a competition to be the best. Businesses competing solely to be the best often end up in competitive convergence, in which rivals begin to look alike. Companies under this winner-take-all influence tend to do damage to themselves by cutting prices to gain volume. They often descend into a price competition that is the business equivalent of mutually assured destruction.
The focus should instead be on creating superior value for chosen customers. Competing to be unique is what sets a company apart and produces the best results.
My investment philosophy has evolved out of my life philosophy.
It is easy in concept, difficult in execution. There are many different definitions of what quality is because as people we are each different, but finding your own definition of quality, and trying to live it, is a good way to go through life.
It is a completely different philosophy than trying to get the most for the least, just as in investing, paying a premium for quality is different than value investing, not that the two can't work together in a kind of harmony.
Above my desk I've printed out a reminder, to try to keep myself on track:
Tell me, what is it you plan to do
with your one wild and precious life?