5 lessons startups need to learn from Value Investing

16th Mar 2016
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Several books have been written on the subject of Value Investing. Warren Buffett himself has been a flag bearer of this philosophy. People who do not understand the stock market consider it the equivalent of a casino. A place full of madness where people are looking to get rich quick without proper research and homework. Similarly, in the startup space, there will be a time when you will see people starting up in a sector because there is a huge mindshare and talk in the media about that particular sector, its people or the funding. The real reason, which is to solve a problem, often gets lost in the hype.

Warren Buffet - The Value Investing champion
Warren Buffet - The Value Investing champion with US President Barack Obama

Startups function in a similar manner to Value Investing. While Value Investing sounds like a heavy term, it can be simplified as the old school method of investing money. Let us explore what makes it so simple and how it can help us in our startups.

  1. Never lose money: According to Warren Buffett, the first rule of Investing is to never lose money. Warren Buffet does not advocate the high-risk-high return principle. And he is quite right. High-risk-high-return glorifies those who make the high return, but forgets to talk about those who risked everything and lost. Even in startups, where everyone says one in 10 survives, the biggest reason for failure is capital running out. Being frugal is what matters, hiring people at sky-rocketing salaries and then running out of cash and firing people to save cash is not the right policy.
  2. Profits instead of debts - One of the most important points to note while investing in a business is its financial statements and especially the Profit and Loss statement of the past several years to see the history of the business. For startups, it might not be possible to be profitable from day one, but that does not mean you burn cash for a long time without any substantial promise or a revenue model that does not promise cash in the near future. Then, you might get caught in a vicious cycle of debt piling and raising money. You can be an e-commerce firm, or an on-demand food startup or any other service provider. Logistics will be a hurdle and will eat into your revenues. Until you sort out the obvious challenges, or build an alternate stream of profit, debt will keep piling up. Remember the lesson your grandpa taught you, “Never owe anyone.”.
  3. Working capital in the bank While evaluating a business to invest in, one of the most important things a value investor looks for in the balance sheet is cash in the bank. We cannot depend on what does not exist. Even if it is funding from outside. Being in talks for funding is not same as money in the bank, and does not give us the right to over-spend based on a few promises. Things can go wrong at any time, and talks can derail at any stage. In the end, the only thing that can help you is the cash with you, not the promise of cash.
  4. Circle of competence - Warren Buffett often talks about circle of competence. Circle of competence refers to the area where you have expertise. Warren Buffett says he does not invest in technology stocks because he does not understand technology. Something similar is at play here. We start e-commerce companies and other logistics-based services without solving the real problem of logistics. We often tend to go with the hottest trend instead of actually working where our expertise lies, it could be IT for most software professionals and they can build a brilliant tech platform to solve the tech part of the problem. Foodtech or e-commerce companies solve only the tech part of the problem. The other part of the business still remains unsolved. For others, we would need someone whose circle of competence covers the said problem. We often tend to forget when we are moving out of our circle of competence and the boundary is extremely blurred.
  5. Build for the long term - Albert Einstein had said, The strongest force in the universe is the power of compounding”. Warren Buffett built the majority of his wealth after he turned 50. A single share of Berkshire Hathaway today costs over $200,000, which is over Rs 1 crore. To build a strong business, one needs to build it for the long term as opposed to going with the current trend. A business built for the long haul will provide bigger benefits compared with several businesses in a short time frame. It took Amazon over a decade to churn out its first quarter. Imagine if Facebook and Google would have sold themselves at the first opportunity that presented itself.

By owning a share in a company, an investor buys a partial ownership in the business. And when a partial owner is so diligent about the business he is investing in, why shouldn't you be when you have invested your time, capital, and other resources in the business, apart from being a complete owner of the enterprise? These are some of the lessons from Value Investing; however, there is more that can be covered to help us build a sustainable business. The playground of doing business is changed. The rules remain the same. In order to solve a problem, we must not forget the basics, which should stand strong today and will stand strong forever.

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