One of the hardest things to evaluate when investing in businesses is how management will allocate capital. The best thing to do is look at management’s historical track record, but there is no perfect way to measure things. Great capital allocation can make an average business a great investment if bought at the right price. Conversely, bad capital allocation can make a wonderful business a terrible investment. A perfect example of terrible capital allocation is Microsoft (MSFT) under the leadership of Steve Ballmer. Ballmer inherited the 1927 Yankees of companies but has dwindled away many of the competitive advantages, and blown tens of billions of dollars on terrible acquisitions. Stock buybacks are another fertile ground for poor capital allocation. Many companies buy at idiotic prices, which destroys shareholder capital. Smart management teams utilize conservative financing so that they are able to buy back stock when the stock trades below the intrinsic value. IBM is an excellent example of superior capital allocation under the prior leadership of Sam Palmisano, who I believe would be the best candidate to take over Microsoft after Ballmer. Low interest rates are rocket fuel for poor acquisitions. Valeant Pharmaceuticals (VRX) is a great example of a company with superior capital allocation through mergers and acquisitions. The company avoids costly and risky R&D and instead focuses on leveraging its international sales force and cutting costs to make the acquisitions funded through low cost debt highly accretive.