Intelligent investing is not complex; that does not mean it is easy. What the investor needs is the ability to correctly appraise properly "chosen" investments.

The best companies are those that are able to invest large quantities of capital with high rates of return, above the sector and market average. Those are the companies we are interested in.

Warren Buffett defines competitive advantages as the tools companies use to keep competitors at bay. Competitors will always try to snatch those profits and, most of the time they succeed, bringing the rates of return down. There are however companies that are able to maintain and grow their competitive advantages for decades. These are the superstars, companies that achieve sustainable returns above their cost of capital.

It is important to know how the company was successful in keeping its profits. It is essencial to be in an attractive industry and benefit from a strategy that reinforces competitive advantages.

There are, in general, five ways in which a company can build a sustainable competitive advantage:

  • Product differentiation through functions, technology or patents
  • Perceived differentiation via brand reputation
  • Providing a similar product or service at a lower price
  • Tying” customers with high switching costs
  • Keeping competition at bay by creating entry barriers

How can we evaluate competitive advantages and their sustainability

  • Analysing historical profits and ascertaing if the company has been able to generate solid returns on its assets and equity
  • If the company achieves consistent returns and profits, why can´t its competitors “steal” them?
  • How long will these advantages last?
  • What´s the competition like in this industry? Are there many lucrative companies or is everyone just trying to survive?

The investor should look for a collection of great companies whose businesses have excellent economic fundamentals, are managed by honest and able people and buy them at sensible prices. From time to time, these businesses trade at prices which give us a margin of safety. That´s when we buy.

This way, we are maximizing something we can predict – the financial performance of the company – and minimizing what we cannot guess – the emotions of the market.

Remember, a company is worth the present value of all the money it will generate in the future.