My Biggest Beef with Warren Buffett

by JT McGee

My dad used to joke that he was worth more dead than alive, a passive reference to some kind of life insurance policy – and maybe our monthly mortgage payment.

For Berkshire Hathaway, I think the same is also true. Berkshire is worth more if Berkshire dies than if it lives.

Warren’s Capitalist Greediness

Warren’s a greedy capitalist, and it really ticks me off. When you think about all the companies that Berkshire owns outright – or those that it would eventually own outright if Berkshire keeps reinvesting – you know that some of the best brands are going to be off the market for public owners.

This list excludes those which Berkshire does not own outright (Coca-Cola, Johnson & Johnson, Wells Fargo, etc.) but it does show the extent to which Berkshire owns some seriously killer brands:

You can see all of the control businesses here.

Why I Care

Berkshire Hathaway has impressive returns on capital because it has a lot of capital – capital which it doesn’t actually own. This is why insurance is a spectacular business – people pay insurance companies to hold onto their money, with a guarantee that the insurance company will, over time, pay you back less than you pay the insurance company.

This float is very valuable. Basically, Berkshire’s GEICO clients essentially fund Burlington Northern Railways, or any one of the many companies Berkshire owns. It’s kind of like how Apple uses absolutely ZERO capital to run its business. By the time Apple pays its suppliers, it has already collected money from customers. Apple has negative working capital. That doesn’t happen very often, but when it does, you know you’re looking at a good business.

I’ll repeat that again: Apple operates on other people’s money, despite the fact it has $100 billion in cash in the bank.

The setup that Buffett has gives him a huge advantage.

Buffett basically takes money borrowed at 0% and invests it in businesses earning 10%+ per year. That’s pretty awesome. I respect him for working the business model better than anyone. But what I don’t respect him for is….

Holding onto All These Great Businesses

The businesses that Buffett owns were great before he owned them. He’s not a venture capitalist. He’s not an entrepreneur. He’s an investor. That’s what he does well…probably better than anyone that will ever take a breath of air on this third rock from the sun.

Owning the businesses he owns in the way that he owns them (in a way that one can lean on another during hard times or periods of extensive capital expenditures) is great for Berkshire. But it sucks for investors. Buffett’s holding onto so many quality businesses that other investors cannot own because…well, Buffett owns them.

So what if you want to own The Pampered Chef? Well, the only way to get exposure to it is to own all the other companies that Buffett owns, because you’ll have to buy Berkshire. That’s annoying.

And it also means that Berkshire is worth more as pieces than it is combined. For the most part, the businesses he owns don’t need the structure that he has in Berkshire. There’s a reason Buffett traditionally avoids businesses with large capital expenditures. He wants businesses that require minimal cash infusion. So control ownership isn’t really a big deal for him.

What Buffett Should Do

If Buffett were a cool cat he’d ditch the idea of continuing Berkshire. He’d wait for a market top, and then he’d piece out every business that he owns as an IPO. I think he owes it to the market to do it. Consider it philanthropy for Wall Street – it’s tough out there for investors!

People who want to be bullish on suburban Volvo-driving soccer moms can buy The Pampered Chef. People who want to long efficient transportation can buy BNSF. People who want exposure to the reality that airlines suck can buy NetJets.

See? So much better. Investors never have to deal with the “baggage” of all the other businesses if Berkshire is broken up.

So who’s with me? We only need $175 billion for control ownership. Anyone know an activist?

{ 4 comments… read them below or add one }

PK July 30, 2012 at 10:56

DM; BI right?

Pretty funny perspective – but I haven’t seen you that high on insurance stocks lately. I’ve got my AFL still (consider that my disclosure).

Reply

JT McGee July 30, 2012 at 11:39

I’m never high on insurance as a whole. I love property and casualty insurance, as well as risk-based health care services (e.g. MDF), but don’t really like life/long-term disability insurance. Too much inflation/yield risk at the moment, and horribly unpredictable going forward. Basically, combined ratios will be all over the board in long-term insurance stuff. In P&C? MONEY! And float! Dollar, dollar bills ya’ll.

I look at insurance companies like I look at fixed-income securities – not enough money-making potential. Talk to me when I’m 55. They’re great “value” plays, but they’re just not my cup of tea.

Reply

Matt @ Dividend Monk August 2, 2012 at 19:18

Insurance companies (specifically property and casualty insurance) are certainly some of my preferred investments. The business model can be so attractive.

Buffett was smart to engineer his company the way he did. By going so heavy into insurance, he gave himself access to 0% capital (or even negative% capital), as you pointed out, which allowed him to grow his corporate engine more quickly than he otherwise could. Unlike most insurers that invest their float into low-return bonds, Buffett bought a diversified basket of higher-returning businesses, stocks, and some bonds.

A few points:

-Buffett said, in the last shareholder letter I believe, that he expects the float of his company to stay flat or perhaps decrease a bit. Not good news. (Not horrible news, but not good news.)

-You can own Buffett’s businesses by buying Berkshire stock. One reason he holds onto them for so long is that passionate owners that sell their business want to keep running it their way, and/or want to make sure it doesn’t get dismantled piece by piece by private equity. Based on his reputation, business owners are generally happy to sell their businesses to him when they want an exit. He has even described, previously, that he sometimes won’t sell a company that he knows isn’t giving him very good returns, due to the qualitative damage it could do to his reputation when it comes to buying other businesses.

-Buffett’s long streak of avoiding capital-intensive businesses ended when he started getting into railroads and utilities. After growing so large, he switched course, and now needs big capital sinks that he can dump money into to get fairly reliable returns.

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JT McGee August 3, 2012 at 00:36

Going on your points:

1) I think reducing the float is great. Then again, you like dividends, and this blog might as well be known as the BuybackMonk. 😉

2) This is a very good point about Buffett’s sweetheart deals and the perception of his firm as an acquirer. Makes perfect sense.

3) I would be surprised if Berkshire continues the hunt for high capex businesses. Personally, I think KO and WFC are likely to be future places to store BRK’s money. As you note, his foray into capital-intensive companies is a necessity.

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