Christopher Begg at East Coast Asset Management explains the primary objective when evaluating an investment opportunity by using an interesting analogy: for the longest time, sailors had no way of finding the longitude of their current position. Scientists, astronomers, and the leading thinkers of the day thought astronomy was the solution (it worked for determining latitude) and largely overlooked a simple solution of comparing the time at which the sun was highest overhead with the time at their original location. Using a simple formula, longitude could be calculated using this method, but wasn’t considered a possible solution because no clock that could remain accurate at sea had been invented yet. Eventually, a determined inventor managed to create such a clock which he named “H4″. Begg uses this story as an analogy for evaluating an investment:
This quarter I want to share a concept with you that has more or less defied words for me throughout my investing career. While I have failed to articulate it effectively, I believe it to be, and it has been a primary objective of our research process. Great investors, defined by a long history of superior rates of compound returns, have been equipped with this ability. For years I have referred to this as “finding the critical data points” of the investment opportunity. It’s the cornerstone of an investment thesis that will determine compounding success and our margin of safety. That description is forgettable, ambiguous, and falls short of describing the objective. In studying great investors equipped with the ability to sort through the complex to see the elementary, I observed they too also found this attribute beyond words. For success in anything: science, the arts, investing – one must arrive at simplicity. Investing success is a journey and investing genius is about determining your location from port to port along your “compounding” exploration. I submit to you an ideal to which we aspire with every investment opportunity we employ. At East Coast, we refer to this as Finding Longitude – which we symbolically endow as H4.
John Harrison gave the world H4 – the first marine chronometer that could correctly determine longitude. The investor’s equivalent of H4 is the ability to infinitely refine a thesis to the critical data points. This mastery of industry and company economics to arrive at investment baseline drivers is a rare skill set. There are two investors that intellectually summon H4 in every investment opportunity they employ.
The first investor is quite obvious, Warren Buffett. When you listen closely to Warren describing important drivers of a business he owns, what he is whispering is longitude coordinates. Warren has up to date datasets in his head that are critical to how businesses will perform. With these baseline assumptions he can determine how the business is operating, its long-term economics and the ability to decipher cyclical challenges versus operational missteps. When Warren Buffett is talking about Burlington Northern, Coca Cola, Wells Fargo, or the economy as a whole, he will generally mention a dataset that is meaningful to the coordinates of that business or the specific economic example. Berkshire Hathaway owns many businesses in different industries yet Warren Buffett can quickly deduce each one with precision as to what are the key drivers or longitude that will allow that business to earn attractive returns on capital.