This article is the second in the series which describes how Warren Buffet has described a Great. Good and Gruesome business in his letter to shareholders for 2007.
A good business according to Buffet is one that has a long term competitive advantage in an industry where there is growth though there needs to be significant capital investment in order to finance the growth. The example that Buffet gives is FlightSafety. Buffet says that in this business the profits rose from $159 million in 1996 to $270 million in 2006 however the capital needed to make this happen has been an incremental investment of $509 million. While these are good earnings these are not what will make a business an extra ordinary business. This is the kind of business where if you want to earn more you will need to invest more.
Finally Buffet discusses the gruesome, which he describes as a business which grows rapidly and requires significant capital for that growth but doesn’t earn as much money as would be required to justify growth. Buffet gives the example of the airline industry which has always required massive investment but has never really provided any returns to investors. This is primarily because in the airline business no company has been able to create a lasting competitive advantage for itself.
Buffet summarizes by saying that the great, good and gruesome investments are like three savings account where the great one pays you a extraordinarily high rate of interest which rises as the years rise, the good one pays an attractive rate of return which will be earned also on deposits that are added. The gruesome is one which pays an inadequate rate of interest and also makes requires an investor to keep adding money in order to make that low interest rate.
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