"Experience indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago."
- Warren Buffett (1987)
Why is Warren Buffett, the chairman and CEO of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), so successful when it comes to investing while the vast majority of people aren't? A big reason is that he doesn't get caught up in the prevailing investment fad of the day.
"Experience indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago," Buffett wrote in his 1987 letter to shareholders.
His point is well taken. If an investor's objective is to maximize their long-term returns, then the best way to do so is to invest in companies with durable competitive advantages and long track records of success.
If it ain't broke, don't fix it
Take a quick glance at Berkshire's portfolio of common stocks, and one thing immediately sticks out; it holds few if any companies that are on the forefront of an emerging trend or technology.
Wells Fargo, its biggest position, was founded over 160 years ago and is one of the least exciting banks in the country today. Coca-Cola, Berkshire second largest holding, introduced its first product in 1886 and, aside from excluding cocaine since the early 1900s, has done little to change it since. And the same is true of American Express, Wal-Mart, Procter & Gamble, ExxonMobil, and so on.
Indeed, Berkshire's only major holding that appears to be inconsistent with this is International Business Machines (NYSE:IBM), which Berkshire first began accumulating in 2011. Aside from the fact that IBM is now principally a service-based business, however, it wasn't technology that attracted Buffett. It was instead the company's management.
"I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders," Buffett wrote that year.
The reason Buffett loves boring
If you watch or read the financial news, then Buffett's preference for boring companies may seem peculiar. Flip on CNBC, for instance, and you're unlikely to see much talk about how Coca-Cola has yet again not changed its recipe for success.
But, and this is important to appreciate, Buffett doesn't invest for the purposes of entertainment. He does it to make money.
Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But a business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns.
Remember, Buffett is a long-term investor. He's not interested in short-term stock market fluctuations. What he wants are businesses that have an above-average likelihood of compounding returns at market-beating rates for decades to come. And the only place he believes these can be found is among the biggest, oldest, and most boring companies in the market today.
Why Buffett would never buy Apple
To fully appreciate what this means, it's helpful to think about a company like Apple (NASDAQ:AAPL), the Cupertino-based technology firm behind the iPod, iPhone, and iPad.
No one in their right mind would claim that Apple isn't an exceptional company. Not only is it responsible for some of the most popular consumer products to be introduced over the last few decades, it's also exceptionally profitable.
In the latest fiscal year, it earned $37 billion in income from only $171 billion in revenue, equating to a profit margin of 22%. Meanwhile, ExxonMobil, the second largest company by market capitalization on the S&P 500 (after only Apple), earned a comparatively paltry $32.6 billion from $438 billion in total revenue, yielding a profit margin of 7.5%.
But despite these accolades, there's a powerful argument, at least according to Buffett's philosophy, that Apple would make a horrible long-term investment. Here's my colleague Morgan Housel discussing this point in the middle of last year:
The key to [Apple's] success is that it has to keep innovating year after year after year, every single year, if not multiple times a year. The odds that sometime down the road, one of its cycles of creating new products won't live up to past successes it's had with the iPhone and iPad are pretty high and the market needs to discount that.
When you compare that to a company like Coca-Cola, or Clorox, or utilities like Southern California Edison, that's a totally different story because those companies don't need to innovate at all. Coke and Clorox sell the same products today that they did 50 years ago. They'll be selling the same products 50 years from now. There's much more predictability of earnings and the market will pay up for that with a higher multiple.
Boring is better
The point here is that boring is better.
Sure, buying and holding companies like Coca-Cola won't give you exciting conversation fodder for your next work party. And, yes, it eliminates the thrill of checking your brokerage account on a daily (or hourly) basis.
But as Buffett has demonstrated, what companies like this will do for you is to make you rich. If that's what you're interested in, then I'd encourage you to follow his lead.