The following article by George Whitehouse featured in The Australian Financial Review, 2 February 2011.
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The key characteristics that Warren Buffett has displayed over decades has been his ability to identify excellent businesses, estimate their value, exercise patience and opportunistically purchase them when they are available at attractive prices.
Excellent businesses have an ability to grow over time through the reinvestment of profits (retained capital) to produce even higher profits. They rarely acquire other businesses and even more rarely seek to raise capital from shareholders.
Further, Buffet is focused on commonsense investing and the following are a few of his key considerations:
- The businesses need to be simple and understandable, driven by strong competitive positions;
- Whilst a monopoly would be great they are rarely available, so a strong branded type businesses that can pass on higher costs to customers via price increases is desirable;
- The business needs to produce high sustainable returns on equity with little or no debt;
- The businesses have to have a proven operating history and possess favorable long term economics & prospects;
- Management need to be rational with capital and resist the institutional imperative to grow at all costs. Management has to honest; and
- Finally after calculating intrinsic value an investor needs to seek a large margin of safety (a price on offer below value) before allocating capital.
The companies we feature below are some of the stand outs in the Australian market. They may not be compelling value at present but investors must be alert to opportunities to acquire them should their market price fall into value.
ARB Corporation
Renowned for designing and manufacturing high quality 4WD accessories. ARB derives its competitive advantage from its expertise in product innovation, marketing, exporting and distribution capabilities. Turning commodity inputs into branded products is ARB’s strength. The quality products as necessities for the 4WD enthusiast, you would not want to be 150km along the Birdsville Track and a bit of your kit breaks leaving you stranded thinking about the few dollars you saved by purchasing a cheaper bull bar. Serious 4WD enthusiasts know this very well and this provides ARB pricing power.
10 Year Total shareholder return: 24.2%
Average owner return on equity last five years: 36.6%
MyClime Valuation: 2010: $5.66; 2011E: $6.52
Blackmores Limited
Blackmores develops, manufactures and distributes branded vitamins and supplements in Australia and Southeast Asia. The competitive advantage stems from quality branded products that people trust. Management depth is strong, Marcus Blackmore has been on the board of directors since 1973, led the business for 33 years and owns close to 30% of the business.
10 Year Total shareholder return: 21.5%
Average owner return on equity last five years: 57.4%
MyClime Valuation: 2010: $26.37; 2011E: $27.33
Cochlear Limited
Cochlear offers the gold standard in implantable hearing devices. The competitive advantage is based on continual and successful research and development expenditure that leads to the quality products and a worldwide market share of around 70%. Countries are realising the benefits of rectifying deafness from an early age. There remains a large untapped market in both the developed and developing markets for implantable devices.
10 Year Total shareholder return: 11.2%
Average owner return over last five years: 59.5%
MyClime Valuation: 2010: $65.88; 2011E: $73.03
Reece Australia Limited
REH sells bathroom and plumbing products to the retail market (~30% of sales) and trade customers (~70% of sales). Pipes, taps and toilets may not be exciting but they don’t go out of fashion and have little risk of substitution. A growing population over time will drive continued and increasing demand for these types of products as the need for housing increases.
Reece derives its competitive advantage from the network effects that come from scale allowing it to negotiate cheaper prices on product and managements disciplined business focus on specialised plumbing and bathroom products.
10 Year Total shareholder return: 22.4%
Average owner return over 5 years: 29.2%
MyClime Valuation: 2010: $18.49; 2011E: $21.21
Woolworths Limited
Woolworths is Australia’s largest retailer with operations across food and grocery, liquor & hotels, petrol, general merchandise, consumer electronics and financial services serving more than 24 million customers weekly across Australia and New Zealand. The competitive advantage stems from an efficient supply chain, a low cost culture developed over the best part of a century of trading and the network effects that come with scale.
10 Year Total shareholder return: 17.2%
Average owner return over 5 years: 39.9%
MyClime Valuation: 2010: $32.75; 2011E: $34.85
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