Whether you've got $1,000 to invest or $1 billion, you need to make choices on how to best allocate your money. You can't buy everything, after all, and every dollar you place in one investment is a dollar you can't simultaneously invest elsewhere.
As an investor, your primary goal is to maximize your risk-adjusted returns, given your limited pool of capital. Learning to do that effectively can take years of careful study. Even Warren Buffett had a mentor, Benjamin Graham, who taught him critical investing principles at Columbia University.
While most of us don't have the luxury of studying directly under Buffett, we do have the benefit of knowing the primary principles he and other great investors follow.
Dug-in protection
Key to any company's long-term success is its sustainable competitive advantage -- or in common terms, its economic moat. That moat is what allows the company to survive the onslaught of competition and continue to thrive over time, even as others attempt to emulate it.
Wal-Mart's (NYSE:WMT) moat, for example, is its global distribution system, enabled by its tremendous scale. That allows it to profit, even as it charges its customers significantly less than its competition. Scale like that can't be duplicated without multiple billions of dollars. Taking on Wal-Mart head on at its own game is essentially impossible as a result.
Other retailers can be successful, of course, but they thrive by defining, building, and protecting their own moats. Rather than compete solely on price, for instance, Whole Foods (NASDAQ:WFMI) defines itself by its natural and organic products. While not quite as large a moat as Wal-Mart's scale-driven bargains, Whole Foods has built a tremendous brand and loyal following among those consumers who care about such offerings.
Brilliant capital allocation
In addition, every company will have to make choices of its own on how to invest the money generated by its operations. There is no better allocator than Buffett, and the amazing long-run returns he provided to Berkshire Hathaway (NYSE:BRK-B) shareholders stand as a testament to the importance of strong capital management.
Buffett successfully turned Berkshire from a failing textile business into an insurance and investing powerhouse. Following in Buffett's footsteps, Eddie Lampert is attempting a similar transformation at Sears Holdings (NASDAQ:SHLD). Lampert is turning the company from a collection of struggling retailers into another capital-generating machine. Sears Holdings' amazing run since Lampert resurrected its predecessor K-Mart out of bankruptcy provides yet more evidence of the tremendous benefit from strong capital allocation decisions.
Shareholder-friendly management
Unfortunately, neither the most unassailable moat nor the finest capital allocator will do you any good on their own. As an individual investor, you have little power over a company's management. Unless that management team chooses to treat shareholders well, the rewards from a company's success will never trickle down to the individual investors.
Take, for example, Cisco Systems (NASDAQ:CSCO). The company has a tremendous moat in the networking business and has made several smart acquisitions throughout its history. But it has never paid a dividend to its shareholders, and the $3.9 billion in retained earnings on its balance sheet represents only part of a single year's income. All the wealth it has created over the years? Eaten up by stock options and the resulting buybacks. While outside shareholders may be interested in the stock for its future earnings, historically they have gotten to keep only a sliver of the wealth Cisco has generated.
Contrast that with companies like Eli Lilly (NYSE:LLY) and Target (NYSE:TGT). Both companies have been paying -- and raising -- their dividends for decades. A long-term performance like that, especially one that persists in an economy as challenging as the one we're living through now, showcases a tremendous commitment to shareholders.
Find the best
As an investor with only a limited amount of cash to invest, you'll want to put your money where it will do you the most good. Companies with strong moats, led by great capital allocators, and that treat their shareholders well are ones you want to seek out. At Motley Fool Million Dollar Portfolio, these are the companies we look for, the best of the best, wherever they may be found.
After all, the Fool's own money is on the line, with the Fool's own capital invested in the portfolio according to the selections of its advisors. If you're interested in investing alongside the Fool as we seek out the best companies available for our own cash, click here to learn more.
At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Berkshire Hathaway and Whole Foods Market are Motley Fool Stock Advisor recommendations. Berkshire Hathaway, Sears Holdings, and Wal-Mart Stores are Motley Fool Inside Value recommendations. The Fool owns shares of Berkshire Hathaway and has a disclosure policy.
