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Let’s start with profit. In 1982/3, on a turnover of about $100m pre-tax margin was about 7%. After tax that was roughly $4.5m for shareholders to take away as owner earnings (Buffett’s numbers, set out at the 2014 Berkshire shareholders meeting). So the one-year price to earnings ratio was about 13. Looking at that data in isolation Buffett would not declare it to be bought on the cheap. He said “it was not a bargain purchase”.
Thus we see that the quantitative facts were inadequate to justify the price. With all investments we need to add the qualitative; all investments require analysis of both quantitative and qualitative. The qualitative factors he had observed over decades meant there was a firm foundation for a growing stream of cash: “It was a great business. It was a wonderful opportunity to join as fine a family as I’ve ever met.” (Buffett at the 2014 AGM)
Let’s expand on that. Its 200,000 square-foot store sold by far the largest volume of furniture, carpets and appliances in the country. The key to the strength of the economic franchise was:
- First, they could offer customers a huge selection across all price ranges
- Second, they had a reputation for selling at low mark-ups, resulting in very high volume as people flocked to pick up a bargain. This led to very high sales per square foot ($500).
- Third, they had enormous buying power because of the volume.
- Fourth, they had very low expenses for running the operation. They owned the building and so had no rent; nor did they have any debt. Also, high sales per square foot meant low overhead per unit of revenue.
- Fifth, the above factors form a positive feedback loop resulting in passing on much of the benefit of low costs to customers, which attracts greater volume which, in turn, boosts range, reputation, buying power and lowered costs.
Shortly after buying Buffett wrote: “One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. I’d rather wrestle grizzlies than compete with Mrs. B and her progeny. They buy brilliantly, they operate at expense ratios competitors don’t even dream about, and they then pass on to their customers much of the savings. It’s the ideal business – one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners.”
Charlie Munger, with his great intellectual span, could see the type of business mould NFM fitted into:
“Extreme success is likely to be caused by some combination of the following factors:
- Extreme maximization or minimization of one or t………………To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
