Price and patience: when great businesses become good investments

Identifying an excellent business is only half the problem. The other half is the price. An outstanding company bought at an extreme price can still deliver a poor result for years, while an ordinary asset bought at a sensible price can serve its owner well.

The final chapters of Warren Buffett and the Interpretation of Financial Statements deal with timing: when Buffett has tended to buy businesses with durable advantages, and the rare circumstances in which he has sold. The common thread is patience. This article explains the book’s thinking on buying and selling, works through the arithmetic that sits behind it, looks at why patience is so difficult in practice, and draws out what the same discipline means for business owners making large decisions about equipment, property, acquisitions and growth.

Why great businesses are rarely cheap

Businesses with durable advantages are widely recognised, so they seldom trade at bargain prices by traditional standards. Investors following the strict bargain-hunting approach of Benjamin Graham, Buffett’s teacher, often never own them, because they always look expensive compared with their assets or with the average company.

The book’s argument is that this is a mistake. For a business whose earnings keep rising, a fair price can produce an excellent long-term result, as the article on the equity bond explains. The rising earnings do much of the work over time.

But “fair” still has limits. The lower the price relative to earnings, the higher the long-run return, and the price paid sets the starting yield forever. The question is not whether to care about price, but how to recognise when a good price is available.

When the price tends to be right

The book describes two kinds of moments when good prices appear for excellent businesses.

Broad market downturns

In a bear market, nearly everything falls, including the strongest businesses. Fear spreads across the whole market, and investors sell good and bad companies alike.

The shares of strong businesses may still look expensive compared with weaker companies that have fallen further. It is tempting to buy the weaker companies because they look cheaper. The book’s argument is that over the long run the stronger business is usually the better purchase, because its earnings will recover and keep growing while the weaker company’s may not.

Downturns are also when many investors are least able to act. Those who borrowed heavily or committed all their cash during the boom are forced to sell. Those who kept a reserve can buy.

A one-time, solvable problem

Sometimes an excellent company makes a mistake or suffers a setback: a product launch fails, a division struggles, a lawsuit or scandal hits the headlines. The share price falls sharply as investors react to the news.

If the problem is genuinely solvable and the underlying advantage is intact, the market’s reaction can create an opportunity. A well-known example from Buffett’s career is American Express in the mid-1960s, when a fraud involving one of its subsidiaries hit the share price while the core card and travellers’ cheque business remained intact.

The emphasis is on solvable. A problem that damages the advantage itself, such as a scandal that destroys customer trust in a brand built on trust, or a technological change that makes the product obsolete, is a different matter. The skill lies in telling the two apart.

When to stay away

The book also identifies when to avoid buying: at the height of a boom, when even excellent businesses trade at historically high prices relative to their earnings. Enthusiasm at such times can make any price seem reasonable, and the long-run returns from buying then are usually poor.

Recognising a boom

Booms are easier to recognise in hindsight than at the time, but some signs recur:

• prices of even ordinary businesses rise well above their historical relationship to earnings
• stories about a “new era” explain why old measures of value no longer apply
• borrowing to invest becomes common and easy
• people with little interest in investing start talking about their gains
• new companies with little or no profit attract large sums simply by association with a popular theme

None of these signs predicts exactly when a boom will end. They simply suggest that prices are being driven more by enthusiasm than by earnings, and that caution is wise. The book’s approach does not require forecasting the end of a boom; it requires declining to pay prices that the business’s earnings cannot support.

When selling makes sense

In this approach, a business with a durable advantage is ideally held indefinitely. Every sale ends the compounding and usually triggers tax on the gain, which reduces the amount available to reinvest. Still, the book describes three situations where selling can be right.

1. A clearly better opportunity appears, and money is needed to take it. The bar should be high, because switching has costs.
2. The advantage is weakening. Industries change. The book gives the example of newspapers and broadcasters, whose positions were strong for decades and then eroded as the internet changed how people get news and how advertisers reach them.
3. The price becomes extreme. In a frenzy, shares can trade far above anything the business’s earnings can justify. The book suggests that a price of around 40 times earnings for even an excellent business may be a signal to sell, and that the proceeds should then wait in safe assets for the next downturn rather than chase other expensive shares.

The arithmetic behind selling at a high price

The book frames the sell decision as a comparison. A business is expected to earn a certain amount over the coming years, and someone offers a price today. Selling makes sense only if that price, reinvested at a realistic rate of return, would grow to more than the business would have produced.

An illustration: a business earns $1 per share and is expected to grow its earnings at 10% a year for twenty years. In twenty years it would earn about $6.73 per share, and at a price-to-earnings ratio of 15 the shares would then be worth about $101. Suppose the proceeds of a sale could be invested safely at 5% a year. Ignoring dividends and tax for simplicity:

When the price is reasonable, holding usually wins comfortably. Only at extreme prices does selling come out ahead, and even then the comparison depends heavily on the assumptions. That is why the book treats selling as the exception rather than the rule.

Why patience is so hard

All of this asks for a temperament that is easy to describe and hard to practise: waiting, sometimes for years, for the right price; holding through periods when the share price falls; and resisting the urge to trade in and out.

Several forces work against patience:

• Activity feels productive. Doing nothing, even when it is the right decision, feels like neglect.
• Recent events feel permanent. In a boom, high prices seem normal; in a downturn, falling prices seem endless.
• Others’ gains are visible. Watching others profit from a rising market creates pressure to join in, often near the top.
• Losses hurt more than gains please. A falling share price prompts selling at exactly the wrong time.

A practical way to support patience is to write down, before any purchase, why it is being made and what would justify selling. When emotions run high later, the written reasoning helps separate genuine changes in the business from changes in mood.

Keeping a reserve

Patience also needs resources. Opportunities in downturns are only useful to those who can act on them. That means holding some cash or safe assets during good times, even though they earn little. The book’s suggestion to park sale proceeds in safe assets until the next downturn reflects this. Cash is not just a lack of investment; it is the option to invest well later.

What this means outside investing

For business owners the same pattern applies to big decisions: buying equipment, acquiring a competitor, signing a long lease, entering a market, hiring senior staff.

A good asset at the wrong price is a burden. A machine, building or acquisition bought at the peak of enthusiasm, when everyone is expanding and prices are high, can weigh on a business for years.

Downturns bring opportunities. When conditions are difficult, competitors may sell equipment, close locations or seek buyers for their businesses. Landlords may offer better terms. Experienced staff may be available. Owners who kept a reserve can act.

Solvable problems create bargains. A competitor struggling with a temporary problem, such as a departing owner, a lost contract or a short-term cash squeeze, may be willing to sell a sound business at a reasonable price.

Booms call for caution. When customers, suppliers and competitors are all optimistic, it is worth asking whether commitments being made now would still make sense in an ordinary year.

Write down the reasons. Before any large commitment, record why it makes sense and what would change your mind.

Patience in building a business

Patience matters in building a business as much as in buying one. Many of the qualities the book admires (a trusted brand, loyal customers, efficient processes, a strong balance sheet) can only be built over years. They cannot be bought quickly or rushed into existence with a large marketing budget.

Founders often feel pressure to grow fast: to match a competitor, satisfy an investor or simply prove the idea. Growth that outruns the business’s systems, cash or reputation can damage all three. A steadier pace, in which each stage is consolidated before the next begins, often produces a stronger business sooner than a rush that has to be repaired. Compounding rewards consistency over time, and that applies to reputation and capability as much as to money.

A worked example

A small commercial printing business has steadily built a cash reserve over several good years, despite pressure to spend it on a new press during a period of strong demand. This is an illustration.

When demand in the industry falls, a larger competitor closes one of its sites and sells nearly new equipment at well below its original cost. The printing business, with cash available and no debt, buys a press at a fraction of what it would have paid during the boom.

At the same time, a nearby business with a strong customer base but a retiring owner and no succession plan approaches it. The printing business acquires the customer list and hires two experienced staff, funding the purchase from its reserve.

When conditions recover, the business has greater capacity, more customers and lower costs than before the downturn, all acquired at sensible prices. The decisions were not clever predictions about the economy; they were the result of keeping a reserve and waiting for prices to make sense.

Common mistakes

Assuming a great business is a great purchase at any price. Price sets the return.

Buying weak businesses because they look cheap in a downturn. Strong businesses usually recover better.

Confusing a solvable problem with a damaged advantage. The distinction decides whether a falling price is an opportunity.

Selling excellent businesses too readily. Compounding needs time, and switching has costs.

Spending reserves during booms. They are most valuable in downturns.

Questions to ask

• Is the price reasonable relative to the business’s earnings and growth?
• If the price has fallen, is the problem solvable, or has the advantage been damaged?
• Is the market in a boom or a downturn, and how does that affect the decision?
• What would justify selling, written down in advance?
• For your own business: if a competitor offered its equipment or customers at a sensible price next year, would you have the means to act?

Bringing it together

A great business becomes a great investment only at the right price. The book describes when such prices tend to appear (broad downturns and temporary, solvable problems) and when to be cautious (booms and extreme valuations). Selling is the exception, reserved for weakening advantages, clearly better opportunities and prices far beyond what earnings can justify.

Behind all of it is patience: the willingness to wait, to hold, and to keep resources ready for the moments when good assets are available at sensible prices. That discipline serves investors and business owners alike.

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Source: Mary Buffett and David Clark, Warren Buffett and the Interpretation of Financial Statements (2008). Figures in this article are illustrations, not data. This article is general information, not financial or investment advice. It does not recommend buying or selling any security.