Buffett's Business Categories: Great, Good, and Gruesome
In his 2007 Annual Report (pages 7–10), Warren Buffett categorizes businesses into three distinct types, using vivid analogies to illustrate his investment philosophy. Here’s an expanded breakdown of each category:
🏆 GREAT Businesses
“The Great one pays an extraordinarily high interest rate that will rise as the years pass.”
🔑 Characteristics:
Wide & Enduring Moat: Sustainable competitive advantage that competitors cannot easily cross
Minimal Capital Requirements: Can grow earnings without significant reinvestment
High Returns on Invested Capital: Consistently high returns on tangible assets
Strong Pricing Power: Ability to raise prices without losing customers
Predictable & Durable: Stable industry with slow change
📈 Example: See’s Candy
Purchase: 1972 for $25 million
Sales then: $30 million; Sales in 2007: $383 million
Pre-tax earnings then: <$5 million; Pre-tax earnings in 2007: $82 million
Capital required then: $8 million; Capital required in 2007: $40 million
Key metric: Earned $1.35 billion pre-tax since purchase while requiring only $32 million in additional capital
Why it’s great:
Strong brand loyalty
Cash business (no receivables)
Short production cycle (low inventory)
Sends almost all earnings back to Berkshire for reinvestment
🏰 Other Great Businesses (by Buffett’s criteria):
Coca-Cola (global brand, pricing power)
GEICO (low-cost producer in auto insurance)
American Express (powerful brand, network effect)
Microsoft & Google (high returns with minimal capital needs)
👍 GOOD Businesses
“The Good one pays an attractive rate of interest that will be earned also on deposits that are added.”
🔑 Characteristics:
Solid Economics: Good returns on capital
Requires Reinvestment: Must reinvest earnings to grow
Durable Competitive Advantage: But less impregnable than "Great" businesses
Steady Earnings Growth: But growth tied to capital investment
Respectable but Not Spectacular Returns
📊 Example: FlightSafety International
Purchase: 1996
Pre-tax earnings then: $111 million; in 2007: $270 million
Fixed assets then: $570 million; in 2007: $1.079 billion
Investment required: $923 million depreciation + $1.635 billion capital expenditures = $2.558 billion total investment
Key metric: Gained $159 million in earnings but required $509 million incremental investment
Why it’s good (not great):
Must constantly buy new simulators to match new aircraft models
Each simulator costs >$12 million (273 simulators total)
"Put-up-more-to-earn-more" model
⚡ Other Good Businesses:
Regulated Utilities (MidAmerican Energy)
Most Industrial Companies
Many Manufacturing Businesses
💀 GRUESOME Businesses
“The Gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.”
🔑 Characteristics:
Rapid Growth Requirements: Needs constant capital infusion
Poor or No Profits: Earns little or no money despite growth
No Durable Competitive Advantage: "Moats" are illusory or quickly crossed
Capital Intensive: Consumes cash
Vulnerable to Competition: Subject to continuous "creative destruction"
✈️ Prime Example: Airlines
Buffett's famous quote: "If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."
History lesson: Buffett bought USAir preferred stock in 1989, eventually sold at a profit during "misguided optimism," then watched the company go bankrupt twice
Why airlines are gruesome:
Insatiable capital demands
Fierce competition
High fixed costs
Vulnerable to fuel prices, economic cycles, and disasters
No durable pricing power
📉 Characteristics of Gruesome Industries:
Capital-intensive manufacturing with rapid technological change
Businesses requiring superstar management to succeed
Industries prone to rapid obsolescence
Companies where success depends on continuous innovation just to survive
💡 Buffett's Investment Implications
For GREAT Businesses:
Buy at reasonable prices and hold forever
Use their cash flows to buy other great businesses
Don't worry about growth rates—focus on return on capital
Example: See's earnings funded many other Berkshire acquisitions
For GOOD Businesses:
Buy at attractive prices
Expect decent but not spectacular returns
Recognize they're "savings accounts" that require deposits to grow
Manage for steady improvement
For GRUESOME Businesses:
AVOID (with rare exceptions for turnaround specialists)
Recognize that "growth" can be a trap if it requires too much capital
Understand industry economics before investing
Buffett's admission: Even he makes mistakes here (Dexter Shoe)
🎯 The Core Philosophy
1. Focus on the Business, Not the Stock:
"It's better to have a part interest in the Hope Diamond than to own all of a rhinestone."
2. Seek Durable Advantages:
"A truly great business must have an enduring 'moat' that protects excellent returns on invested capital."
3. Beware of Change:
"We rule out businesses in industries prone to rapid and continuous change."
"A moat that must be continuously rebuilt will eventually be no moat at all."
4. Management Matters, But the Business Matters More:
"If a business requires a superstar to produce great results, the business itself cannot be deemed great."
Compare: A brilliant brain surgeon's practice vs. Mayo Clinic—the institution outlasts the individual.
📚 Key Takeaways for Investors
Look for businesses that can grow without much capital
Avoid businesses that consume cash for growth
Durable competitive advantages are more important than growth rates
Simple businesses you understand are preferable to complex ones
Price matters—even great businesses can be poor investments at high prices
Buffett's framework explains why Berkshire owns See's Candy but avoids airlines, and why he prefers businesses like GEICO and Coca-Cola over capital-intensive industries. This categorization remains central to Berkshire's acquisition strategy and investment approach today.
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Buffett measures investments by earnings growth and moat widening, not stock price.
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