Second, once we are convinced of the presence of certain structural competitive advantages, we seek to get a rough sense of whether the business can grow at a reasonable pace over the next 5–10 years.
Our preferred type of investment is to purchase high-quality businesses with good growth potential and own them for a long time. To do that successfully, we pick our investments very carefully and only purchase at reasonable valuations.
First, we think that the best representation of business quality is a consistently high return on tangible equity — of more than 15% over five years — with a minimal level of debt. We then determine if the business possesses certain structural competitive advantages that can explain the good returns on capital (that would not erode over time due to competitive pressures). Strong competitive advantages include network economics effects, high switching costs, low pricing, favourable location, intangibles (for example, branding and patents), and regulatory barriers, among others.
