Warren Buffett (Trades, Portfolio) likes to say that he will only buy good businesses. In many ways, this is true. He only buys firms and parts of companies when he knows they will produce profits for Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and other investors.
When it comes to publicly traded securities, the Oracle of Omaha has been quick to sell stocks when it is clear they are no longer as attractive as they were when he initially acquired the position.
However, when it comes to wholly-owned businesses, Buffett rarely sells, even when performance has deteriorated or stagnated. There are a couple of examples that stand out.
First off, there's Berkshire's McLane distribution business. Acquired in 2003, the business reported pre-tax earnings of just $246 million, a profit margin of 0.18% in 2018. You can make a good argument that the capital employed in this business could be better used elsewhere based on this razor-thin profit margin.
The other example is Precision Castparts. Acquired in 2015, the company has been a pretty poor investment for Berkshire.
At the time, it was the biggest deal in Berkshire's history. It paid $32.3 billion for earnings of $1.5 billion. Since then, the company's growth has stagnated, and this year, it looks as if the business will make a loss.
Despite this performance, it's unlikely Buffett will sell. To find out why, we need to go back to Berkshire's 2005 annual meeting of shareholders. Buffett said at the time:
"But we say that Charlie and I have this quirk, which business schools would teach is a mistake, in that if we have a business that's underperforming and we could sell it and put — and achieve greater returns someplace else, we don't do it. We say that if a business is going to permanently lose money, we'll get rid of it. If it has major labor problems over a period of time, we might get rid of it. But we are not going to engage in what we call gin-rummy type management where we pick up one card and discard another."
When he elaborated further, Buffett explained that he did not want to follow this course of action because "we don't want to live our lives that way." He went on to add:
"We like being associated with the managers that we are, even the ones that are in — facing headwinds. I mean, but in a sense, you almost identify more with the ones that are facing headwinds because they're doing a hell of a job under very tough conditions. And every business decision or investment decision isn't going to work out perfectly. And some businesses are going to run into unexpected surprises. But the people that have gone in with us have stuck with us in times like that. And our attitude is we'll stick with them."
This approach seems to have worked relatively well over the past few decades. Buffett has cultivated an image of himself as a long term investor, and this has helped Berkshire draw in deals.
Maybe it wasn't the best approach. Buffett might have made more money by adopting a private equity kind of business model, where Berkshire bought and sold businesses to make a quick profit.
Based on Buffett's personality, I think this is unlikely. He doesn't have the personality suited to be a private-equity baron, and it certainly wouldn't have fit into Berkshire's insurance-focused business model.
This is what really matters. Buffett has built a strategy around what suits him, rather than what other people may say will make the most money. By doing so, he has been able to use the power of time and compound interest to build wealth instead.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Berkshire Hathaway's Snowflake Deal Shows Us Where Warren Buffett Is Heading
- Warren Buffett on When Diversification Makes Sense
- Why Warren Buffett Didn't Get Into Ballet
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