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:
- 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.
- 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.
- 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.
- 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.