QUALIPORT
Qualiport Shock: Buffett Can't Be Copied

By Bruce Jackson (TMFGoogly)
May 17, 2001

For the last three and a half years, I've been under the illusion that it's possible to beat the market by following the investing principles of Warren Buffett. In short, I thought his unparalleled investing success was due to him buying good companies when they are trading at attractive prices, and then holding them for the long term.

Simple, hey?

So why then, over the past three and a half years, has the Qualiport so far culpably failed to get anywhere near the returns of the stock market, let alone beat the damn thing? Well, we've made some pretty big mistakes along the way, mostly because we've paid far too much for what have turned out to be mediocre businesses.

Marks & Spencer (LSE: MKS) was a classic example. Whilst the Marks & Spencer brand name did hold them in good stead, and allow them to charge higher prices, eventually the competition caught up, and the suddenly the brand name didn't count for so much. Lesson learned -- don't invest in companies that operate in very competitive sectors, and especially those that don't offer customers good value for money.

Why else has the Qualiport failed to copy Buffett? My summaries of his investing principles, as listed in the first paragraph, are far too superficial. There's much more to Buffett's success than that. The man is a humble and understated genius. He performs complex mathematical equations in his sleep. He understands probabilities. You don't accumulate $30 billion in personal wealth by not being a genius.

By definition, geniuses are rare, and that's why it's impossible to copy Warren Buffett. When it comes to investing, I put myself as about as far removed from genius status as it gets -- just take a look at the Qualiport's record to date!

But that doesn't mean I'm going to give up the ghost. Giving me hope is the fact that I've only just recently heard Buffett himself describe the secrets of his investing success.

The Secrets Of Buffett's Success

As far as evaluating companies, his criteria are simply...

1. Can I understand it?
2. Does it have sustainable long-term competitive advantages?
3. Does the management have ability and honesty?
4. What's the price?

If a company passes each of those filters, Buffett signs his name to the cheque. Simple.

In theory, yes. In practise, no. Numbers 2 and 3 are the hardest to evaluate, especially number 2. Competitive advantages come and go rather quickly. If a company is making high profit margins, competitors are almost always attracted, with the end result that profit margins are driven down. The barriers to entry for competitors for most companies are typically very low.

Examples of long term sustainable competitive advantages include...

• Long term patents, typically common in the pharmaceutical sector. These are also common in companies that license their technology, such as ARM Holdings (LSE: ARM).
• Brand name. A company with a strong and respected brand name can charge higher prices. The brand name also acts as a barrier to entry, and it engenders loyalty. Although I'm not entirely convinced of the long-term economics of the football business, Manchester United (LSE: MNU) springs to mind as an example of a company with an extremely strong brand name.
• Control of the distribution channel. One of the reasons why it was virtually impossible for Virgin Cola to make any sort of dent in the Coke market was because Coca Cola (NYSE: KO) and PepsiCo (NYSE: PEP) control the distribution channel with an iron fist. When little Virgin came along, they did a little muscle flexing, and today you don't hear much at all of Virgin Cola.

So how do the current four Qualiport holdings fare on Buffett's simple criteria? At 645p, when we last topped up on our holding, arguably PizzaExpress (LSE: PIZ) was the only one that got close. And of our 17 buy decisions to date, that's arguably the only one we've got right.

And therein lies the Qualiport's underperformance problem. A 6% success rate will just not cut it.

Conclusion

I'm not managing the Qualiport anymore, so that gives us some hope of a recovery. Maynard is being very discerning in his stock selection, especially being very conscious of the entry price. However, that is only one element of the investing game. By far the most important criteria is a company's long-term sustainable competitive advantage. To our cost, we've found out that just because MMT Computing (LSE: MMT) was apparently cheap on the both occasions we bought it, it may not have that long-term sustainable competitive advantage. We'll be concentrating on that criteria a lot more in the future. If we do that, we still won't be able to copy Buffett, but we hope to close the gap.

Maynard will comment on MMT's interim results, released on Wednesday, in Monday's Qualiport slot.

The author owns shares in MMT Computing, PizzaExpress and Manchester United, and his investment club owns shares in ARM Holdings.