Chapter 3Filter 1: Competitive Advantage

When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

—Warren Buffett

Jacobian Inverse: If I wanted a high probability of losing my invested capital, I would look for industries where there is poor economics, low barriers to entry, lack of customer loyalty, and readily available alternatives. I want to find businesses where the customer has all the control and the only unique value from the business is that it offers the lowest price with no margin.

This brings us to the correct answer—study industries that are known to have good economics, high barriers to entry, customer loyalty, and limited alternatives.

Unlike man, not every industry is created equal, which in turn means not every company is created equal.

One of the keys to value investing with the 52-Week Low formula is understanding economics. Not simple economics like the kind you learned in high school, but industry economics—the forces that shape and influence a company’s profitability, sustainability, and potential for growth. Good economics is vital. Long before we ever get to a balance sheet, returns on invested capital, long-term debt to free cash flow, or any of the other company-specific filters that dictate those that either make it into the formula or don’t, we look at the industry economic forces that are at work.

This first filter helps to determine those ...

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