Warren Buffett, My Hero

I have already mentioned a few of the greatest value investors of our time in this short guide. I want to take a bit of a longer look at the best, though. By examining what Warren Buffet has done, we can perhaps learn from both his mistakes and his successes.

Warren Buffett worked for the father of value investing, Ben Graham. Afterwards, he started multiple investment partnerships with himself as the managing partner, and friends, relatives, and acquaintances as limited partners. In 1967 he bought Berkshire Hathaway, a money-losing textile mill, and in 1969 he closed his investment partnerships.

Buffet made many great investments before buying Berkshire, but it is convenient to start analyzing his record starting with Berkshire. First off, Berkshire Hathaway was probably Buffet’s worst investment: the textile mill never made much money, and Buffet was forced to shut it down in 1985. Until that time, the rest of Berkshire Hathaway, composed of Buffet’s other investments, had to support the textile business.

Why was Berkshire Hathaway (the textile business) a bad investment? Buffet bought it cheap, but he bought a company that had no special competitive advantage; even worse, it was in a dying industry (also a dyeing industry).
Now let’s look at one of Buffett’s successes: Berkshire Hathaway bought shares of The Washington Post Company in 1973. This was a better investment, because it was undervalued, plus its assets were highly desirable. In addition, the management was good. This was quite different from Berkshire Hathaway; Berkshire’s assets, even at the time Buffet acquired the company, were not desirable. Also, the management was not very good, and Buffet had to replace the management of the textile mill.

The rest of the 1970s saw Berkshire Hathaway buy shares of GEICO insurance along with all of National Indemnity Company and Cypress Insurance. All of these are insurance companies.
What’s so special about insurance? There are some details that I cannot address here due to a lack of space, but one of the key reasons why Buffet has bought so many insurance companies is that the stock market tends to undervalue small insurance companies. See the low P/E ratios of, for example, ASI, BER, and UFCS (this does not constitute a recommendation of these companies, however).

Buffet has continued his interest in insurance; since 1990, GEICO was completely bought, General Reinsurance was bought, and many other smaller insurers were bought as well. In fact, much of Berkshire Hathaway’s income is from its insurance businesses.

What can we learn from this? What is important is that we find profitable companies that are undervalued. We won’t find many high-profile companies that are undervalued, and we certainly won’t find many stocks in hot industries that are undervalued. Therefore, many of our investments will be in companies in boring, unglamourous industries, like insurance.
As if to emphasize that point, in recent years Berkshire Hathaway has acquired such exciting companies as Acme Brick, Shaw Industries (a carpet manufacturer), and Clayton Homes (a manufacturer of mobile homes).

One last example of a good move that Buffet made was in buying many Washington Public Power Supply (WPPS) bonds in 1983 and 1984. Two new nuclear units had begun construction but had then defaulted on their bonds. The market reacted and even the price of the bonds secured by the old facilities (that were still generating money to pay off those bonds) fell drastically. There was nothing fundamentally wrong with the old bonds, so they made a nice profit for Buffet. The market will often unduly punish good companies in bad industries, just like with these bonds. That is when adroit value investors will buy.

If you wish to read more about Buffet’s investment style, I highly recommend reading his annual letters to his shareholders, available for free at the Berkshire Hathaway website.

Disclosure: I hold shares of BRK.B and I am also a customer of GEICO. See the disclosure policy.

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