Tag Archives: warren buffett investment philosophy

When it comes to stocks, Berkshire Hathaway looks for wonderful companies

“Woody Allen once explained that the advantage of being bi-sexual is that it doubles your chance of finding a date on Saturday night,” Warren Buffett said in his FY2015 letter to Berkshire Hathaway. Why did the Berkshire Hathaway chairman say this?

“In like manner – well, not exactly like manner – our appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire’s endless gusher of cash. Beyond that, having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us,” Mr Buffett continued.

A stockpile of funds from marketable securities?

Yes a stockpile. “Berkshire increased its ownership interest last year in each of its “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 8.4% versus 7.8% at yearend 2014) and Wells Fargo (going to 9.8% from 9.4%). At the other two companies, Coca-Cola and American Express, stock repurchases raised our percentage ownership. Our equity in Coca-Cola grew from 9.2% to 9.3%, and our interest in American Express increased from 14.8% to 15.6%. In case you think these seemingly small changes aren’t important, consider this math: For the four companies in aggregate, each increase of one percentage point in our ownership raises Berkshire’s portion of their annual earnings by about $500 million.”

The legendary investor’s subsequent FY2016 letter to Berkshire Hathaway shows the stakes in these Big Four as at end-2016 were: American Express 16.8%, Coca-Cola 9.3%, IBM 8.5% and Wells Fargo 10%. Apple Inc stocks also came into Berkshire Hathaway’s radar screen, with the group owning a stake of 1.1%, which, according to a CNBC report on Feb 27, 2017, had grown in January 2017 to 2.5%. “At this point, Buffett owns US$17 billion worth of the tech giant’s stock,” said the report.

What does Berkshire Hathaway look for in marketable securities?
On the Big Four in the FY2015 letter, Mr Buffett said that the four investees possess excellent businesses and are run by managers who are both talented and shareholder-oriented. “Their returns on tangible equity range from excellent to staggering. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone,” said Mr Buffett.

The Berkshire Hathaway chairman said that if Berkshire’s yearend holdings were used as the marker, its portion of the “Big Four’s” 2015 earnings amounted to US$4.7 billion. “In the earnings we report to you, however, we include only the dividends they pay us – about $1.8 billion last year. But make no mistake: The nearly $3 billion of these companies’ earnings we don’t report are every bit as valuable to us as the portion Berkshire records.”

The earnings of Berkshire’s investees retain are often used for repurchases of their own stock – a move that increases Berkshire’s share of future earnings without requiring it to lay out a dime. “The retained earnings of these companies also fund business opportunities that usually turn out to be advantageous. All that leads us to expect that the per-share earnings of these four investees, in aggregate, will grow substantially over time. If gains do indeed materialize, dividends to Berkshire will increase and so, too, will our unrealized capital gains.”

This investment philosophy gives Berkshire Hathaway a significant edge, explained by Mr Buffett this way: “Our flexibility in capital allocation – our willingness to invest large sums passively in non-controlled businesses – gives us a significant edge over companies that limit themselves to acquisitions they will operate.”

Fear is the foe of the faddist, but the friend of the fundamentalist

A Bloomberg report (Buffett Broadens Portfolio by Spending $23.9 Billion in Quarter) dated Nov 7, 2011, said that Warren Buffett’s Berkshire Hathaway Inc invested US$23.9 billion in the third-quarter, the most in at least 15 years, as he accelerated stock purchases and broadened the portfolio beyond consumer and financial-company holdings.

“Buffett, 81, drew down Berkshire’s cash as Europe’s debt crisis and Standard & Poor’s downgrade of the US pushed stocks to their worst quarterly performance since 2008. The investments disclosed Nov 4 include $6.9 billion of equities, $5 billion for preferred shares and warrants in Bank of America Corp. and the acquisition of Lubrizol Corp. for about $9 billion,” the report said.

Why was Warren Buffett’s Berkshire Hathaway investing at a time when market sentiment had been hit by eurozone crisis and US economic woes?

Mr Buffett’s letter to Berkshire Hathaway shareholders (March 7, 1995) for Year 1994 gave an insight into his investment approach.

“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of
the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%,” the Year 1994 letter said.

Mr Buffett went on to say in the letter: “But, surprise – none of these blockbuster events made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.”

To underscore this point, Mr Buffett also said in the Year 1994 letter: “A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.”

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013