Warren Buffett, the world's most celebrated value investor, is always cautious about moving into new territory. But Berkshire Hathaway, the holding company he controls, recently ventured into Canada to do a little shopping. U.S. regulatory filings show that Berkshire's insurance subsidiary, GEICO Corp., bought 4.6 million B shares in Calgary-based Shaw Communications Inc. in the first quarter of this year. GEICO now owns 10.3% of Shaw, the cable giant that leapfrogged 63 places to No. 101 in this year's R.O.B. Magazine Top 1000.
This purchase fits Berkshire's strategy of investing in market leaders that sell products and services that, quite simply, are used by a lot of people a lot of the time. Alongside long-standing major positions in brand-name giants such as Coca-Cola Co., Gillette Co. and American Express Co., Berkshire controls private companies churning out staples such as shoes, uniforms, insulation, carpet, chocolates and furniture. Famous brands like Dairy Queen ice cream, Acme bricks and Benjamin Moore paints are Berkshire-owned.
The man widely considered the world's most successful investor is assuredly not on the cutting edge of anything. He avoided tech stocks, which meant he entirely missed out on their big run-up. In 1999 and early 2000, his apparently old-fashioned insistence upon value hurt Berkshire's shares and brought out the critics. His approach has been vindicated, however, by the selloff that began to roil the markets last September. How has this 70-year-old been so consistently successful for so long, since, in fact, he took over Berkshire Hathaway almost 40 years ago?
Warren Buffett describes his job simply as "capital allocator." The Berkshire chairman's goal is to make friendly (rather than hostile) investments in outstanding businesses with intelligent management and hold them for a long time. His abilities have made him one of the wealthiest people in the world--alongside Bill Gates of Microsoft, Robson Walton of Wal-Mart and King Fahd of Saudi Arabia--with a net worth of $33 billion (all currency in U.S. dollars).
Investors have been taken on an amazingly profitable ride since 1965, when Buffett took control of Berkshire, a struggling textile manufacturer. Berkshire shares traded then at $13; recently, they changed hands at $68,600 (the shares, which have never been split, are the world's most expensive publicly traded shares). A $1,000 investment then was worth $6 million at the end of last year. In Berkshire's 36 years as a public holding company, there has not been a single year in which Berkshire lost money or its book value declined. No money manager with a public record and no major stock market index can match Buffett's 27% average annual return. Many of the original shareholders have never sold. Only 3% of the shares change hands each year, compared with an 80% turnover on the New York Stock Exchange, and 200% on Nasdaq.
"Because of his great intellectual capacity, Buffett is able to take the best of worldly wisdom and mould it into a unique investment style that is not as simple as it looks on the surface," says John Zemanovich, CEO of Mississauga, Ont.-based Raven Investment Management Ltd. "His record is unsurpassed-he is the Babe Ruth of investing."
The last two years have seen the pace of growth slow, however. The year 1999 witnessed the worst performance in Berkshire's history, as major holdings such as Coke and Gillette stumbled, and the newly acquired General Re proved troublesome. Performance had not picked up significantly by the time of the annual meeting in 2000.
"I've been deploying capital since I was 11 and am still doing it," Buffett told the 12,000 shareholders who flocked to Omaha, Neb., this April to attend Berkshire's legendary annual meeting. "There's no master plan, we just try to survey the whole financial field. We look for things we understand, with a durable business advantage and where the price is right."
Berkshire Hathaway's annual meeting is an event unlike any other in the investment world. Thousands of people from all walks of life make the annual pilgrimage to the unlikely destination of Omaha, population 670,000-the quiet Midwestern town Buffett has chosen for his home and headquarters-for a weekend-long celebration of capitalism. Shareholders exchange Buffett anecdotes at cocktail parties, baseball games and at Borsheim's, a local jewellery store owned by Buffett. The meeting goes on for more than six hours as Buffett and his sidekick, vice-chairman Charlie Munger, respond to hundreds of questions-from precocious 11-year-old wannabe investors, stars of the business world, politicians and celebrities. During the marathon question period, Buffett tosses off witticisms while he consumes See's chocolates and Cherry Cokes (both products of the Berkshire empire).
Included on the list of 300,000 shareholders and often spotted at the meeting are columnist Ann Landers, Bill Gates-one of Buffett's friends and bridge partners-homemaking queen Martha Stewart, retired Washington Post chairwoman Katherine Graham, and Benjamin and Buzz Graham, sons of the late, legendary value investor and Buffett mentor Benjamin Graham.
Actress Debbie Reynolds told me she came this year to learn from Buffett, whom she considers a generous and articulate teacher. The 69-year-old said that trust is important to her, after being taken advantage of by her third husband and several business managers. She was forced to sell her Las Vegas hotel and casino at a 1998 bankruptcy auction, but maintains that it is never too late to turn things around.
"I'm not a businesswoman, and I like to feel I'm investing with a company that's conservative and wise," she said. "I also like the way Warren cultivates long-term relationships with the managers of the companies he invests in-it's a dignified approach."
Buffett savoured sweet vindication at this year's meeting after being chastised a year earlier for missing out on the high-tech boom. His portfolio of old reliables was certainly looking tarnished. In March, 2000, when Nasdaq peaked, Berkshire's Class A shares were trading at a mere $40,800, less than half of their record value, reached in 1998. (B shares, which trade at 1/30th of A shares, were created to appeal to ordinary investors.) James Cramer, a high-profile U.S. television commentator, was touting Berkshire as a candidate for short-selling, a bet that the stock would fall further. The Financial Times concluded that "Buffett deserves a D grade." While Buffett doesn't measure success by short-term movements in the share price, he admitted that even he was unhappy with his performance.
Fortunately, by the time of the annual meeting, Nasdaq had plunged while Berkshire's shares had recovered to about $68,000. Buffett explained simply that he stayed away from technology stocks because it was impossible to see which businesses had a long-term edge. In his homespun turn of phrase, he couldn't discern which castles were protected by moats. "The moat is what it's all about," he told his followers. "If you can enlarge the moat and protect the business, everything else follows." To Buffett, a castle moat is a metaphor for the most important characteristic he seeks in a business. The moat signifies a powerful business franchise or formidable barrier to entry that protects a company from competition, and often goes hand in hand with the ability to increase prices. It can be a dominant brand name, a proprietary product, a geographic advantage, patent, discovery, or some other edge that makes it difficult for competitors to storm the castle.
"I don't think I have a better understanding of what companies have an enduring competitive advantage in that business [technology]than I did last year," Buffett admitted at a press conference. "I haven't got anything against it, it's an important field with a lot of growth possibilities. I just don't know who's going to make money. I do know who's going to make money selling bricks in Texas or candy in California. Incidentally, I know many people in the technology business, and they don't know who's going to be making money 10 years from now either."
Berkshire's most important business by far is insurance, led by subsidiary GEICO Corp., the sixth-largest automobile insurer in the U.S., and General Re Corporation, one of the four largest reinsurers in the world. It is the insurance business that provides much of the cash to fund Berkshire's acquisitions. Billions of dollars in "float" are generated for Berkshire by the premiums that insurers accumulate. There's no due date on payouts, and the float gives Buffett "other people's money" to use without the dangers and expense of bank debt. Berkshire currently has a float of about $29 billion, with an annualized cost of about 3%. Add another $10 billion of deferred taxes on unrealized capital gains, and Berkshire has a war chest of $39 billion.
Buffett says he has no game plan for future acquisitions. "Insurance could be our biggest business in 10 years, but something else might come along. I'm no more certain than when we bought the original textile mill in 1965."
The Berkshire chairman is a patient buyer, and will wait as long as it takes for opportunities that fit his stringent investment criteria, led by intrinsic value (the present-day value of the cash that a business will generate during its lifetime). The main problem now is that a Goliath like Berkshire must eat large portions to feed its growth, and Buffett is looking for "rare elephants" in the $5-billion to $20-billion price range. Suitable acquisitions are becoming more difficult to find as the company gets bigger, limiting its ability to grow.
"When you have smaller sums of money, there's a larger world of mispriced opportunities available," he says, referring to companies that are undervalued thanks to "irrational emotions" in the stock market. But Buffett also says he needs only a few big ideas. In fact, more than half of Berkshire's value is limited to a dozen of its hundred or so holdings. These days he's casting his net in the realm of privately held companies that he can buy in their entirety, rather than pieces of public companies with prices that "belong in Gulliver's Travels." He also prefers the business behaviour of private enterprises because they are not trying to please the stock market. Lately, he's been looking beyond the United States.
He minimizes risk by rigorous scrutiny of a company before an investment is ever made, and then buys at a price that allows for a significant margin of safety. "It bothers us not at all if a stock drops 50%-in fact we like it-it means we can buy more at a lower price," he said. "We look to what's happening within the business to gauge our success, not the market."
Buffett's ability to steer clear of trouble probably has as much to do with his temperament as with his investment criteria. From his perch in Omaha, Buffett is able to make calm decisions on what to buy and how much to pay. In fact, he has a rule against trading when he's in the hectic environment of New York City, where, in 1991, he acted as interim chairman of Salomon Brothers Inc. for nine months in order to deal with a bond trading scandal, which he successfully resolved. He believes that "nothing sedates rationality like large doses of effortless money."
"A pin lies in wait for every bubble," he wrote in his 2000 annual report, which is eagerly awaited every year by investors. "And when the two eventually meet, a new wave of investors learns some very old lessons. First, many in Wall Street-a community in which quality control is not prized-will sell investors anything they will buy. Secondly, speculation is most dangerous when it looks easiest. At Berkshire we make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We're not smart enough to do that and we know it."
Years of experience are an advantage. Buffett is 70 years old, and Berkshire vice-chairman Charlie Munger, his partner, sounding board and lifelong friend, is 77. They rely upon a head office staff of only 13 in Omaha. They both possess the psychological wiring that makes being a contrarian appealing.
"We automatically suspect anything the crowd goes along with," Munger said after the annual meeting. "Early on, when I saw how successful you could be having that temperament, I intensified it. Temperament is vastly more important in financial success than IQ. It doesn't take a genius, but it does require the proper temperament."
Buffett is not all work and no play, and in fact is a bit of a ham. Sometimes called Chairman Buff, and known as "T-bone" by his on-line bridge friends, he has musical talent and strums the ukulele. He has golfed with Tiger Woods, discussed the intricacies of the economy with U.S. presidents, played bit parts on the soap opera All My Children, and regularly plays bridge with world champion Sharon Osberg.
Whenever he needs personal advice, he can call his good friend Ann Landers. Politically, he's a Democrat. He prefers a simple existence, and still lives in the house he bought for $32,000 in 1958. Plans are in place to leave his fortune to charity through the Buffett Foundation. While the exact beneficiaries are unknown, he has supported local sports teams, theatres and youth organizations, as well as organizations like Planned Parenthood.
Buffett considers Berkshire to be his vehicle of artistic expression, and money is his paint. In creating his work, he has used Berkshire as a public platform to teach a set of investment ideas and a value system. The joy for him is in the creation. And he's not finished yet.
Investing Principles of Warren Buffett
Buffett's conservative criteria help him stay out of trouble Be a long-term investor and invest with the best. As a shareholder in Berkshire, your future is tied to Buffett's. He owns close to 40% of the company, and has 99% of his wealth in Berkshire. He has never sold any of his shares.
No stock splits, ever. A high stock price means you can make a meaningful investment with fewer shares and lower brokerage commissions.
No dividends. Instead of paying taxable dividends to shareholders, all earnings are reinvested to provide future growth.
Don't overcompensate managers. Buffett's salary is only $100,000 a year. There are no stock options, which he considers an expense that favours management and dilutes the value of the shares.
Sell holdings rarely. Buy carefully and, when possible, hold forever. This defers taxes on capital gains.
Develop long-term relationships. Buffett and Charlie Munger have been business partners since 1978. In 36 years, Berkshire has never had a manager of a significant subsidiary voluntarily leave to join another business.