This post is at the behest of my friend Tom Brakke of The Research Puzzle. It is meant to briefly describe how Warren Buffett’s investing changed over the years.
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The basic idea of Warren Buffett’s investing is simple. Try to compound your capital at the fastest rate consistent with a margin of safety. That margin of safety might be a strong balance sheet, or it might be a product with high gross margins that faces little competition. But compound capital over the long haul. Do it, whether it is public or private investing. Do it, regardless of the form of the asset. Do it, if you have to change in midstream from being an asset manager, to being the manager of an investment-oriented conglomerate.
Those are themes I will explore in this essay, but who can explain Buffett well in less than 1000 words?
Buying Cigar Butts
Ben Graham had a huge influence on Buffett, but Buffett was his own man. He had made money in many ways prior to working for Graham/Newman — he was a very driven, determined man. But buying dud companies where the price was far lower than what the net assets were worth was a simple strategy that few followed. It had great returns from the mid-30s to mid-60s or so.
Why? The Great Depression left the stock market in disarray, and convinced a generation not to touch stocks; they were not able to be analyzed. So a few enterprising men analyzed and made a lot of money.
After Graham-Newman folded in 1956, Buffett started his own investing partnerships, which he eventually consolidated into one partnership in
But there were limits to this exercise. Companies were sold for a profit, and the number of companies selling at bargain basement prices shrank dramatically. Ben Graham folded; Warren Buffett adapted.
End of Buffett Partnership
Buffett ended his investment partnership as opportunities declined, and distributed out the shares to holders around 1969. After a little delay, he consolidated his holdings under Berkshire Hathaway. This was a significant move because now Buffett was running a business as an investor. He had permanent capital, and could use it were he thought best. Berkshire Hathaway itself was a failing textile producer. In hindsight Buffett was too kind, and gave it too many chances, it would have been better to shut down the textile company earlier.
Textile Company to Insurance/Conglomerate Holding Company
Buffett discovered insurance early, through GEICO in 1952, and then through Berkshire Hathaway bought insurance companies which became the bedrock of the company, including buying 50% GEICO in 1974 to rescue it. This would provide the capacity to finance/leverage investment insights.
Influence of Charlie Munger (Growth/Moat)
His friendship with Charlie Munger began in 1959, and he affected the way Buffett thought about investing. Companies that had protected boundaries, or, sustainable competitive advantages deserved a premium valuation. That insight began to free Buffett from the Cigar Butts, i. e., dud companies that have no growth potential, only sellout potential. Such businesses could be bought in whole or in part, but they had to possess a durable advantage. This would play a role as Buffett wold buy Coke, Capital Cities, American Express, Wells Fargo, and many other high quality businesses.
Willing to work Public or Private, and increasingly Private
Though Buffett was known in the 70s and 80s as a public equity manager inside a public company, he increasingly bought private companies like:
- See’s Candies
- Nebraska Furniture Mart
- Scott Fetzer
- World Book (no one is perfect)
- Buffalo News (who could have predicted the Internet?)
This changed his view of what he was up to, and made him willing to run an abnormal conglomerate, one that would operate on a disaggregated basis. Buffett would take the free cash flow from controlled companies, and the dividends from partially owned companies an reinvest them in the areas he thought had the most promise.
Scale rules out Arbitrage / Distressed Debt / Small Cap Equities / not Derivatives
Over time, Buffett invested in many ways, doing deal arbitrage, buying distressed debt, and buying small cap companies. As time went on he had to abandon these for two reasons: he had too much capital to put to work, and competition increased, driving returns down.
Derivatives were different, Buffett was willing to take bets during times of economic stress so long as he did not have to post margin. He took bullish bets on US Credit and Global Equities. Much as he criticized derivatives as gambling, he was willing to take an intelligent bet where his downside was limited.
Buying companies with no auction / Tuck-in acquisitions
Buffett became the home for men who wanted to sell their companies, but preserve the culture. Buffett didn’t pay the highest price, but he did not interfere with the new subsidiaries.
His subsidiary companies would do little tuck-in acquisitions that would further the vitality of BRK, without spending a lot.
Increasing Insurance Scale
And over time, bought all of GEICO, Gen Re, and many other smaller insurers. Supposedly, at one point, Hank Greenberg said to Buffett, “Call me when you have a real insurance company!” The two were frenemies for some time. But today, the show is on the other foot — the largest insurer in the US in BRK.
The increased scale of insurance provided all the more capital to finance Buffett’s asset buys. The underwriting discipline provided additional profits.
Opportunistic Provider of Capital
During the crisis in 2008-9, Buffett provided capital to well-regarded companies like GE and Goldman Sachs. He was ready for odd opportunities like Burlington Northern, Lubrizol, and Heinz.
He was also willing to change his view on buying back shares, setting a line in the sand where he would but back shares, rather than doing a dividend.
Buffett never intended to run a conglomerate, but that is what he did, and did it very well, much like Henry Singleton, who was another compounder.
That’s what he does now. There it is, in less than 1000 words.