What is the ideal company to invest in? Many people, professional investors and laymen alike, would think of a company like Apple or Tesla: revolutionary technology, a charismatic founder and perhaps a cult following among customers. Indeed some companies like this have been great investments. Apple has been one. Tesla Motors certainly has had a good run, but whether it lasts or is a bubble waiting to pop is yet to be seen.
But how would Warren Buffet who is arguably the most successful investor of all time answer this question? He once said his ideal business was an unregulated toll bridge. If people want to drive across the river they have no choice but to use the bridge, and the owner is free to raise the toll whenever he likes. It is perhaps not as interesting as a company like Apple, but as a business you can’t beat it. Buffet has famously said that his favorite investments are those that are like shooting fish in a barrel … when the barrel is drained. The unregulated toll bridge certainly fits this description.
Buffet’s toll bridge comment has a history that is interesting and instructive. In the 1970’s in the early days of his operation of Berkshire Hathaway as a conglomerate Buffet made a major investment in a Buffalo newspaper. The paper was neck in neck with the other daily paper in Buffalo. At one point the competitor sued Buffet’s paper for allegedly using unfair practices and attempting to run the competitor out of business in order to have a monopoly. Buffet himself had to testify in the case. He did a good job of arguing that his paper was increasing competition in newspapers not limiting it as the prosecutor was trying to prove.
But the prosecutor had a trump card which was a comment of Buffet’s that was quoted in the Wall Street Journal. He had been quoted saying that owning a monopoly newspaper is like owning an unregulated toll bridge, “you have relative freedom to increase rates when and as much as you want”. This quotation helped tip the scale and Buffet lost the case, and severe restrictions were imposed on the paper. (The case was overturned years later on an appeal, the competitor folded and Buffet had a monopoly. Berkshire Hathaway still owns the paper.)
What the prosecutor had missed, though, was not only had Buffet expressed a preference for owning monopoly-like “toll bridges”, but he actually owned one, perhaps the only one available to buy in the U.S. at that time. It was the Ambassador Bridge which spans the Detroit River between Detroit and Windsor, Ontario. The bridge, which is one of the most important crossings between the U.S. and its largest trading partner was privately built in the 1920’s. After the Depression the owner was forced to take his company Detroit International Bridge Company public. Buffet bought 25% of the shares in the 1970’s before businessman Matty Mouron bought him out along with the other investors, taking the company private in 1979. Mouron still owns the bridge and has repeatedly raised prices over the years to the consternation of the U.S. government and citizens of Detroit and Windsor.
So what is it about an unregulated toll booth that so appealed to Buffet? The lesson appears to be that the structure of the industry and the competitive position of the business is more important than appealing but transitory factors such as innovation and the charisma of management or a the impact a business has on society. Another memorable Buffet saying is that you should invest in companies that are so good that the even an idiot can run them because sooner or later one will. This is certainly true of a Toll Bridge type business
Some, however, will find this perhaps a little depressing and perhaps lessen their enthusiasm for investing. After all it seems that the unregulated toll bridge is not so much a product of capitalism but a breakdown of capitalism. Do the most successful investors somehow exploit a breakdown of the system?
Yes and no. The line between a great business and one with an unfair advantage that stifles competition can be blurry. Most of Buffet’s successful investments as far as I can tell did not have any unfair, monopolistic advantage. Indeed the fact that Buffet sold his share of the Ambassador Bridge rather than buying the whole thing himself suggests that he was uneasy playing the role of monopolist. In the case of the Buffalo News, his paper won its monopoly position by beating out its competitor at great risk over many years. During the battle it was not at all clear that Buffet would win and he took an enormous risk, betting one fifth of his personal net worth at the time on the troubled newspaper.
But the lesson seems to be that competitive advantage or “moat” and industry structure are what’s most important in an investment. This insight carries over to Buffet’s other investments such as GEICO and Coca-Cola and Wells Fargo and many more.
Investing is not a charitable enterprise where the rewards are meted out fairly to the most deserving candidate, those whose businesses have improved society the most. Many transformative inventions and technologies such as airplanes and automobiles and air conditioning to name just a few ended up being mostly bad or mediocre investments. And as Motley Fool columnist Morgan Housel pointed out earlier this year, the best stock of the twentieth century was a cigarette company.
So is the stock market a flawed and vaguely immoral mechanism for allocating our country’s vast investment capital? Again, yes and no. The market does not always allocate capital efficiently. We could name lots of examples including technology stocks and restaurants that recently have raised vast amounts while better companies are overlooked. But on the whole our system is better than any other and certainly better than a command economy where the government metes out the resources. That model has never worked. The stock market instead is an instance of Adam Smith’s invisible hand. In the short run it behaves in a somewhat erratic and self-serving manner but over time ends up doing a pretty good job of creating wealth and fueling economic growth and ultimately benefiting society more than any other model.