What Is A Business?

Investment greats say to buy businesses, not stocks — A business is a collection of people and machines — Outstanding business performance requires outstanding collective effort.

VIEW AS PDF

“Shares are not mere pieces of paper. They represent part ownership of a business. So, when contemplating an investment, think like a prospective owner.” - Warren Buffett

WHAT IS A BUSINESS?

Warren Buffett believes in buying businesses, not stocks. Buying a stock implies purchasing with a disregard for the business itself. This type of trading can be done quantitatively where the attributes of a business are irrelevant.

But simply understanding what a business does is not enough to differentiate an investor from quantitative algorithms. For example, creating a portfolio of businesses with strong balance sheets and low valuations is easily replicable by a computer with no knowledge of the business.

So how do we truly invest in businesses?

A Business Is The People In The Boat

A business is a group of people and machines working towards a common goal. Like a multicell organism, a business is the sum of the parts of every individual and tool at the company's disposal. Solving complex problems is difficult, and requires a team working together.

The contributions of every individual in the firm combine to either create or destroy value on a daily, or even minute-to-minute basis.

“We don’t think of ourselves as buying and selling pieces of paper but rather investing in businesses.”- Frank Martin

Culture Is the Coxswain

Culture is the invisible hand that ultimately directs each individual to contribute fully to the business.

Cultures ensures teammates focus on firm wide goals and not counterproductive politics. Culture empowers an employee to raise a concern to management instead of letting a problem fester. Culture drives an individual to give of themselves for the benefit of a customer, teammate, and ultimately, the firm.

Successful cultures create a "one team" attitude, alignment amongst all employees, and a shared desire to succeed. With everyone rowing in the right direction, businesses can solve complex problems and deliver outsized success.

Incentives Are The Current

Misaligned incentives can overwhelm even the strongest cultural crew members. When culture and incentives are opposing, ethics are pitted against greed and envy; the sins usually win out.

Underpinning a successful culture are well thought out incentives that support the group’s goals and avoid scenarios that force employees to chose between their financial well-being and ethical standing.

“When we buy shares of a stock, we are buying a piece of a business. So what is the business worth?”- Mario Gabelli

Invest In the Collective Time & Effort of People

Although Buffett wasn't specific in his definition of a business, he is clear that he values people. He strives to buy businesses run by managers he believes operate with the highest principles, and culture is set at the top. When he has failed, Charlie Munger's incentive analysis quickly identifies the culprit.

At Reference Equity, we love finding groups of people, aligned by culture, and driven by proper incentives, that form incredible businesses. A shared desire for the team’s success, an unfortunately uncommon occurrence in the business world today, sets businesses apart.  In our view, stock prices follow the collective efforts of these individuals, reflecting the value they daily create.