On page 137 of Poor Charlie's Almanack (a book about Berkshire Hathaway (BRK.B) Vice Chairman Charlie Munger), Mr. Munger offers an important insight that is one of the most important things I have ever read about investing. Here is what he had to say:
"Disney (DIS) is an amazing example of autocatalysis… They had all those movies in the can. They owned the copyright. And just as Coke (KO) could prosper when refrigeration came, when the videocassette was invented, Disney didn't have to invent anything or do anything except take the thing out of the can and stick it on the cassette. And every parent and grandparent wanted his descendents to sit around and watch that stuff at home on videocassette. So Disney got this enormous tail wind from life. And it was billions and billions of dollars worth of tail wind.
Obviously, that's a marvelous model if you can find it. You don't have to invent anything. All you have to do is to sit there while the world carries you forward… A lot of what happened to Disney was like what a friend of mine said about an ignorant fraternity brother of his who succeeded in life: 'He was a duck sitting on a pond. And they raised the level of the pond.' To be fair, Disney has been brilliant about creating new stuff-to catch the same tailwind. But by the time it's done, The Lion King alone is going to do plural billions. And, by the way, when I say, 'when it's done,' I mean fifty years from now or something. Plural billions- from one movie?"
There's a lot of things that can sink a company. A firm may take on too much debt. It may lose market share to competitors and generics; imagine if Procter & Gamble (PG) got clobbered by Colgate-Palmolive (CL) and Kimberly-Clark (KMB) every year. It may have terrible management. But when I consider an investment, the first thing that I try to evaluate are the odds that technological changes could ruin the company. I try to keep an eye out for the kind of situation that could turn a sensible blue-chip investment into the next Eastman Kodak.
When I look at Munger's comment above, I think that a company like Disney would be the ideal investment because it tends to benefit from changes in technology. But when I think about portfolio construction, I set my sights a little lower: I look for companies that sell the kind of products that have a very low probability of being displaced by technology.
I understand why both Munger and Buffett have established large positions in Kraft (KFT) throughout their careers. It's very difficult for technology to overthrow the experience of eating macaroni and cheese, hot dogs, Oreos, and Jell-O. Unfortunately, now may not be the best time to establish a position. The news of the stock spinoff has sent shares skyrocketing to the point that they are likely trading at the upper end of fair value, and Kraft has yet to establish a consistent record of raising dividends. Nevertheless, Kraft represents the kind of business that I would enjoy owning for long periods of time.
Most of the businesses that I find particularly resistant to technology sell the kind of products that you can find at Wal-Mart (WMT). How on earth does technology replace the experience of eating a chocolate bar? Hershey (HSY) deserves a spot at the table of firms unlikely to be overtaken by technology. It would be very difficult to replace the experience of eating potato chips brought to us by Pepsi (PEP), and it would be very difficult to replace the experience of brushing our teeth brought to us by Colgate-Palmolive . Likewise, we're probably always going to be cleaning our stuff, and that's probably why Clorox (CLX) is not going to go the way of the buggy any time soon.
Does that mean these companies are perfect worry-free investments? No. Hershey has to deal with escalating input costs. Procter & Gamble, which sells Gillette razors among a whole host of other products, has to face stiff competition from Kimberly-Clark, Colgate-Palmolive and the generic versions of their products. Kellogg (K) tends to have high debt. Colgate-Palmolive pays its management team very, very well. And 3M's (MMM) management is notorious for having difficulties with international expansion. There are all sorts of things that we have to monitor.
Nevertheless, we have to start our investing process somewhere. For me, I look to strong business models that can generate the kinds of natural profits built to withstand the abuses of bad management, excessive compensation, higher input costs, and so on. And the character trait that I often find central to a good business model is this: Resistance to technological change. In many ways, I want the core of my portfolio to be an irreplaceable portfolio. It's not readily apparent to me how you can replace the experience of brushing teeth, using scotch tape, eating potato chips or a chocolate bar, and making macaroni and cheese. While an ideal investment may be a company like Disney that benefits from the changes in technology over time, I am perfectly content to apply a Hippocratic Oath "First, Do No Harm" approach to any investment that I consider. For me, that means identifying the kinds of companies that stand the lowest probability of being hurt by the changes in technology over time.