Warren Buffett’s Secret from the Heinz Deal

by JT McGee

Warren Buffett, you are officially predictable.

This morning it was announced that Warren Buffett and a private equity firm would acquire all of Heinz in a $23 billion deal. It was also this morning that Buffett confirmed, once again, his rather predictable investment patterns.

Here’s how Buffett invests:

  1. He buys companies with floats – Floats are the most valuable thing in the world because running a business on someone else’s money is the bee’s knees. Apple, for example, pays its suppliers AFTER it gets paid for each iProduct sale. Apple has a float. But Buffett wants less risky stuff – companies that will have a float and operate in perpetuity – so he sticks to insurance companies, which take in premiums long before paying out claims. When a business runs on negative working capital it means that the owner DOES NOT HAVE TO INVEST A DIME of his or her retained earnings to keep the profits rolling in. All profits – rather, all money received for a product not yet delivered – can then be invested in another business, not the business you just acquired.
  2. He invests the float in consumer staples – Companies in the consumer staples space are Buffett’s favorite for several reasons. First, they’re large, so they can “move the needle” for Berkshire. Secondly, they sell inexpensive products, so people do not shop around. Third, he buys the premium brand in the space, because the combination of a consumer that does not shop around and a premium price means disgustingly high returns on capital. Nobody better understands consumer shopping patterns and psychology than Charlie Munger and Warren Buffet. Buffett didn’t buy Coke because it was Coke. He bought it because Coke has no taste memory, meaning you can drink 10 cans and the 10th tastes just as good as the first, leading to growing consumption. Munger didn’t like Wrigley because he likes gum, he liked it because you’re not going to pick a competing brand to save $.20 on something you put in your mouth, of all places. Berkshire Hathaway has piles of research on simple actions like these, and Munger manages to turn any 10 minute discussion on investing into Psychology Hour with Munger. They eat that stuff up.
  3. He looks for control ownership, if possible – Control ownership gives you 100% freedom with the cash flows, but it also gives you the ability to mark your asset on your books however you want. If you own 100% of a company, you don’t give a flying you-know-what about what the market thinks about the value of your company. Rather, you pick the value, stick it on the insurance company’s books, and cease to worry about volatility or capital requirements for insurance businesses.
  4. He waits – The beauty of consumer staples companies is that they stick around and grow slowly. Heinz is a company that will never, ever die. Its cash flows could be best described as an inflation-adjusted perpetuity because Heinz will live on forever and it will increase prices at or above the rate of inflation each year. Hence, if Buffett buys at an immediate earnings yield of…say, 8% with a growth rate equal to inflation, he will completely rock the market on that kind of investment…and he can hold it forever, so that he’ll never, ever pay capital gains taxes on the sale (effectively floating money from the government.)

That’s really it folks. If you don’t believe me, look at the combination of Berkshire’s stock portfolio and the companies he owns outright. The Wikipedia nerds have made this really easy! The pattern is too easy not to see.

{ 8 comments… read them below or add one }

krantcents February 14, 2013 at 17:18

Very interesting! I never thought of it that way. I love how you point out that he is using other people’s money. That is the key to success. It helps though that you have his cash or access to cash.

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JT McGee February 16, 2013 at 13:02

Other people’s money is definitely the key to Buffett’s success. He successfully bought companies that made money and which would allow him to invest more and more of other people’s money. He works the system, no doubt about it.

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Brick By Brick Investing | Marvin February 14, 2013 at 20:25

I love Warren Buffet’s style of investing. He proves time and time again that investing is simple. Buy dominant companies and low valuations and wait. It’s that simple.

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JT McGee February 16, 2013 at 13:02

The easiest answer is usually the best!

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PK February 15, 2013 at 10:51

“Warren Buffett, you are officially predictable.” – We’ve figured him out, and it only took until age 82!

So, $23 Billion, 57 varieties – my math says that’s $403,000,000 a flavor. Not bad!

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JT McGee February 16, 2013 at 13:03

Heh, he was predictable long before that, but yeah. I like the math. Looks like a bargain, though I’d pay far more for one of those 57 varieties than the other 56. ;)

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Sarah Park February 17, 2013 at 14:17

No wonder Heinz is the best ketchup ever made.

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William @ Drop Dead Money February 19, 2013 at 11:50

Love your opening statement!

There’s another wrinkle becoming a staple: adding in preferred stock paying 9% or more. I haven’t heard if these shares are convertible to common stock, but I seem to recall the GE and Goldman Sachs preferreds had sweetheart conversions included in the deal.

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