For those out there looking for Warren Buffett stocks, if you’re blindly following the “large moat, cheap valuation” mentality, you’re doing it wrong.
But don’t feel bad, most of the media, Warren Buffett fan-blogs, and CNBC commentators don’t truly understand why Warren Buffett was successful. Here’s a hint, it wasn’t simply his knack for finding undervalued stocks.
Uncovering Warren Buffett’s Success
Unbeknownst to much of Wall Street and the investing community, there’s a small hedge fund out of San Francisco that’s spent years studying the early investor letters and 10-K of Buffett. They run a fund dedicated to following a Buffett playbook that’s unsexy and grossly overlooked.
John Buckingham: Busting the Myths & Seven “Valuable” Themes for 2021 [ValueWalk Webinar slides and video]
John Buckingham's presentation titled, 'Busting the Myths & Seven "Valuable" Themes for 2021'. The webinar for ValueWalk Premium members took place on 2/23/2021, and was followed by a Q&A. Stay tuned for our next webinar, Q4 2020 hedge fund letters, conferences and more John Buckingham Principal, Portfolio Manager, Kovitz Editor of The Prudent Speculator newsletter Read More
S&C Messina Capital is that fund, employing a focused strategy to find and invest in companies that can provide a margin of safety while also emulating a young Berkshire Hathaway.
The answer lies not so much in what Warren Buffett bought, but how he bought it. Where did he get the capital? And how did he avoid redemption requests and pressure from limited partners?
The key is that Buffett leveraged Berkshire’s capital by investing in property and casualty insurance companies, which provided even more money to invest in his more famous investments, such as Wells Fargo and Coca-Cola.
Warren Buffett’s Permanent Leverage
By focusing on the property and casualty part of the market, Buffett avoided redemptions and unnecessary pressure from investors. He could truly invest with a long-term horizon, not worrying about performing on a quarterly, monthly, or even weekly basis.
So when someone wants to tout a Buffett-like stock or pitch a stock that Buffett is buying, be sure to know the how and why behind Buffett’s ability to make investments that could take decades to pan out.
But the beauty of using insurance companies, namely property and casualty insurers, isn’t just the idea of a more permanent and sticker capital, rather, it’s about the permanent leverage.
Property and casualty insurance companies with underwriting profitability can take on leverage at negative costs of capital, avoiding all the pitfalls of tradition debt. S&C put in the work, digging through the decades of Berkshire shareholder letters, plus the half century of Berkshire SEC filings, to truly dissect Buffett’s strategy of investing.
The idea of using insurance “float” to increase your buying buyer lies in the mechanics of the insurance business. Insurers collect premiums from policyholders and these premiums are held by insurance carriers as liabilities, or float, that belongs to the policyholders until the insurance contracts expire. This float is owed to policyholders because it is capital being reserved and utilized to fund losses and claims ultimately experienced by policyholders.
Finding The Next Warren Buffett
This includes going to the Berkshire annual reports, which most Buffett aficionados and authors, have never bothered to look at. It’s the Berkshire financials from the late 60s to early 70s that are the most revealing.
That’s where the Buffett obsession with non-traditional forms of leverage shines through, and what S&C calls, “juicing his [Buffett’s] investment returns with unconventional forms of other people’s money or liabilities.”
Then there are the shareholder letters. In all of Buffett’s shareholder letters, he never truly opens up about his strategy of using property and casualty insurers to fund his other investments. But there is one sliver of gold S&C found, which really outlines the crux of Buffett’s insurance strategy.
As S&C notes, it’s a few pages that are perhaps the most important pages ever written by Buffett … “his secret sauce and the holy grail of how to be successful in the property and casualty insurance business.”
Thus, what S&C does is buy companies that look a lot like Berkshire in its most transformational periods of the early 70s, 80s and 90s. The key being that during these periods, the market did not fully understand Berkshire’s compounding power, which was anchored by the property and casualty insurance business.
S&C is targeting companies that have the same fundamental philosophies of an early Berkshire, with history repeating itself as the market continues to under-appreciate the compounding power of special property and casualty insurance companies.
You can get more insights like this and details on the beauty of truly emulating Buffett’s strategy, plus a bit of where S&C is finding value today by joining us in our quest to find underrated small-cap value stocks – click here to check out the Underrated Small-Caps Newsletter.