Peter Ball, 23 August 2018

Warren Buffett is widely considered one of the greatest investors of all time. Buffett has turned Berkshire Hathaway - a small, failing textile mill - into a US$490bn conglomerate with businesses that span insurance, rail, energy and chocolate. Today, it is the eighth largest company in the world.

Since Buffett took control of Berkshire in 1965, the company’s share price has generated an annualised return of 19.6%, double that of the S&P 500 over the same period. To put this in perspective, if you had invested US$10,000 into US shares it would have been worth a tidy US$1.6m at the end of 2017. If you had instead put your capital behind Buffett, your US$10,000 would be worth US$108.9m.

Buffett studied at Columbia University under famed investor Benjamin Graham. Graham had a significant influence over Buffett’s approach to investing and the need to conduct thorough analysis on a company before investing in it. Buffett had huge success with this methodology when running his investment partnerships. He identified the flagging Berkshire as a company that was trading at a significant discount to its underlying assets. Having initially viewed it as a short-term opportunity, his frustration with management compelled him to keep buying shares until his investment partnership had majority control, at which point he could effect change.

As Buffett slowly sold off the textile operations, he started putting the cash to better use. His first acquisition was National Indemnity, a small Omaha-based insurance company, for US$8.7m. Insurance was a sector Buffett understood very well and one that became integral to Berkshire’s success.

An insurance company receives premiums upfront and pays claims later. This “collect now, pay later” model leaves it holding large sums of money, called float, that may eventually be needed to pay out insurance claims to customers. However, until that day comes, the insurance company can invest this float for its own benefit. The opportunity Buffett saw from this business model was the ability to access more money to invest beyond what Berkshire’s equity capital alone would permit.

To say that Berkshire’s move into the insurance business was a success would be an understatement. When Berkshire purchased National Indemnity in 1967, it had an insurance float of US$17m. At the end of 2017, Berkshire’s float had grown to US$114.5bn.

berkshire graph

Vice Chairman, Charles Munger, has also played an integral role in Berkshire’s success. Buffett credits Munger with convincing him to move away from his original approach and towards Berkshire’s modern investment strategy - buying wonderful businesses at fair prices. This change became vital as Berkshire’s insurance float started rising at a rapid rate. Finding companies with durable business models, high quality management and attractive growth prospects has been crucial to the company’s success. Examples over the years have included businesses like Coca-Cola, American Express and Gillette. Today, Berkshire is a conglomerate that owns over 80 businesses spanning a diverse range of industries throughout the US, with insurance now just a small part.

Every year around 40,000 shareholders descend on Omaha for the company’s annual meeting, commonly referred to as ‘Woodstock for Capitalists’. Held at Omaha’s largest stadium, it includes stalls selling products from many of Berkshire’s businesses.

Berkshire is synonymous with its founder, and a perennial question is what the future will hold when Buffett is no longer at the helm. Succession is an issue Buffett has put considerable time and planning into. He has said there is a detailed, yet top secret, succession plan in place that could be implemented within 24 hours.

The day Buffet elects to step aside, Berkshire loyalists will lament the retirement of one of the world’s greatest investors. However, he and Munger have built a company with a unique philosophy, which will remain an enduring legacy for decades to come.