Research Note: Easy Businesses with Extraordinary Economics Beat Turnaround Attempts
Words of Wisdom
"Easy Businesses with Extraordinary Economics Beat Turnaround Attempts. Businesses with favorable industry structures - such as network TV stations that virtually cannot avoid earning extraordinary returns on tangible capital - represent superior investments even at premium prices compared to statistically cheap companies in difficult industries. Buffett's experience with Waumbec Mills, purchased at an extraordinary bargain below working capital value with substantial machinery and real estate essentially free, proved to be a mistake as new problems arose as fast as old ones were solved. Both operating and investment experience demonstrate that 'turnarounds seldom turn,' and the same energies and talent produce far better results when applied to good businesses purchased at fair prices rather than poor businesses bought at bargain prices."
Analysis
The mathematical reality of industry economics trumps individual company factors in determining long-term investment success, as demonstrated by the stark contrast between network television stations and textile manufacturing during the 1970s and 1980s. In his 1979 LTS, Buffett extols network TV stations for "earning extraordinary returns on tangible capital employed in the business," describing businesses where "it is virtually impossible to avoid earning extraordinary returns on tangible capital employed in the business. And assets in such businesses sell at equally extraordinary prices, one thousand cents or more on the dollar, a valuation reflecting the splendid, almost unavoidable, economic results obtainable." Television stations require "virtually no capital investment" while generating substantial cash flows from advertising revenues and retransmission fees, creating business models where poor management can still produce adequate returns while competent management generates extraordinary wealth. This contrasts sharply with Buffett's Waumbec Mills experience, where "by any statistical test, the purchase price was an extraordinary bargain; we bought well below the working capital of the business and, in effect, got very substantial amounts of machinery and real estate for less than nothing. But the purchase was a mistake. While we labored mightily, new problems arose as fast as old problems were tamed." The textile industry's structural challenges—foreign competition, commodity pricing, and capital intensity—created an environment where even exceptional management and bargain purchase prices could not overcome fundamental economic headwinds. Warren Buffett acknowledged that "both our operating and investment experience cause us to conclude that 'turnarounds' seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price." This lesson fundamentally reshaped his investment philosophy from seeking statistical bargains to prioritizing business quality and industry structure.
The opportunity cost of investing time, capital, and managerial talent in difficult industries becomes evident when comparing actual results from "easy" versus "hard" businesses over extended periods. Berkshire's textile operations, including both the original Berkshire Hathaway mills and the Waumbec acquisition, consumed decades of effort and millions in capital while producing mediocre results before eventual closure in 1985. Buffett estimated the Berkshire textile investment cost him approximately $200 billion in opportunity cost because the same capital deployed in insurance and other favorable industries would have compounded at dramatically higher rates. Meanwhile, businesses with superior industry structures delivered exceptional returns with minimal ongoing capital requirements and management intervention. Warren Buffett's Capital Cities/ABC investment demonstrated this principle, as Murphy had compounded Capital Cities' intrinsic value at 23% annually since 1958 through disciplined capital allocation in the media industry's favorable economics. The network television business provided "enormous competitive advantages, including pricing power over advertisers and exclusive content access" that translated directly into sustainable high returns regardless of economic cycles. Capital Cities required minimal incremental capital to generate growing cash flows, allowing management to redeploy excess capital into additional media properties or return cash to shareholders. Berkshire Hathaway acquired Waumbec Mills in 1975 for less than the value of the working capital. Effectively, they took everything over for free, outside of the excess receivables and inventory—understandably, a deal that would be hard to turn down. Yet this statistically attractive purchase proved inferior to paying premium prices for businesses in industries with structural advantages, demonstrating that industry economics matter more than purchase price in determining long-term investment success.
Bottom Line
Investors achieve superior long-term results by paying fair prices for businesses in favorable industry structures rather than seeking bargains in challenged sectors, as industry economics ultimately determine whether management talent and capital deployment can generate sustainable returns. Easy businesses with structural advantages—such as network television stations that virtually cannot avoid extraordinary returns on tangible capital—consistently outperform statistically cheap companies in difficult industries where new problems arise as fast as old ones are solved. The opportunity cost of investing in turnaround situations becomes evident when comparing Warren Buffett's $200 billion loss from textile investments to the exceptional returns available from businesses like Capital Cities/ABC, where favorable industry dynamics enabled 23% annual value creation regardless of management quality, proving that great businesses at fair prices beat poor businesses at bargain prices.