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Jose Vasquez
Jose Vasquez
Articles (13)  | Author's Website |

Some Thoughts About Warren Buffett, Heinz and Big-Cat Insurance

February 22, 2013 | About:

I have been discussing with a fellow investor about the merits of Warren Buffett's latest investment. About whether his best days are over and why he does not sometimes stick to the quotes that made him famous instead of apparently sounding more and more like a politician or a media celebrity. This was not a deep discussion and I hardly know anything about Heinz, besides the great taste of its ketchup. The comments below come from the accumulated knowledge gathered through the years.

Warren Buffett is a complex person and many of the things he preached are often taken from a time when his investment style was different than today. His investment philosophy cannot be categorized easily; he is way too complex for that and has opportunistically taken the best out of many investment styles. For all the value fanatics out there remember that he even said himself in his shareholder letters that he considers pointless the whole dividing discussion about value versus growth investment. It is understandable when you think that Philip Fisher, one of the investors who influenced him and Charlie Munger the most, was famous for being the father of growth and technological investments. It is also worth noting that "cigar-butt" investment, the one made famous by Benjamin Graham, was practiced by Buffett mainly in his early days.

Buffett notes that it was an error to buy control of Berkshire, which was then involved in the difficult textile manufacturing business. He admits that he bought the company mainly because it looked cheap, which was a mistake. Buffett said that "unless you are a liquidator, that kind of approach to buying businesses is foolish." He indeed had to act as a liquidator with Berkshire's textile operations, and he apparently did not enjoy it that much. He learned many times over, the hard way, to understand that "time is the friend of a good business and the enemy of a mediocre business." He provides an example on this lesson with Hochschild, a department store company. Buffett bought the company at a big discount to book value. It included hidden real estate value and a large inventory cushion. Initially he felt confident in the purchase, but three years later he felt lucky to be able to exit at a break-even.

The point is that through the years Buffett has continuously evolved — he has kept on learning and polished his investment philosophy. His example fits perfectly with what Charlie Munger said: "In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time - none, zero."

Buffett and Graham are much more complex than what is widely perceived. If you read, for example, Graham's "Memoirs" or Buffett's "Snowball," you will see that they have both been involved in all sort of things, such as:

- shorting stocks

- using leverage/margin

- using banks' cash as well as insurers’ float

- elaborated schemes to minimize taxes

- traded currencies

- bought what seemed to be extremely cheap companies

- bought what appeared to be expensive companies

- boring companies

- had at specific occasions an ultra concentrated portfolio

- were involved in activist investments

- were legally accused of manipulation to buy cheap companies

- practiced short-long paired trades

- bought distressed bonds

- traded cocoa beans

- worked as hedge funds, started without putting their own money

- bought airplane and private banking stocks

- bought technological stocks

- involved in restructurings

- created complex organizational structures

- bought penny stocks

- involved in big legal proceedings

- traded silver

- sold option puts on indexes and specific companies
And so on... If you just read that list, would you a priori think that Buffett or Graham were involved in such activities?

What counts to me is more what I learned from Buffett through the years. I don't really care as much anymore about what he does. I "coat tail" him only if it makes personal sense. I think that his Conoco Philips investments, both the buying and selling, were done at the very wrong time. There are several things about which I don't agree with him. Specially in politics, political interference on the economy and taxes for the rich. If I could have it my way I would eliminate all taxes, specially to the rich. I'd cut the government size to 5% of what it is now. I would just leave a government in charge of making sure that private property is respected and personal security enforced. I would not allow to keep the status quo of a government whose main task is to legalize the expropriation of goods. I would privatize the issue of money and back it up by gold or a commodity basket, as proposed by Benjamin Graham. I would outlaw central banking and fractional banking while simultaneously really privatize (now they are controlled by the government) and deregulate all banks. I'm pretty sure that Buffett would be completely opposed to those ideas.

On a lighter subject now, regarding Buffett's latest actions: The good thing about Heinz (HNZ) is that it still is a good business. Its brand has a powerful mind share, and such an image is almost impossible to take away from the social collective brain unless they really make many errors, for several years. Heinz will now be controlled by Jorge Paul Lemann, 3G's boss. And I trust that Lemann, by observing what he has already done, can continue to create value — like what he did with Burger King or how he built his global beer empire.

Heinz is probably now very different than what it will become in five years, after Lemann's touch. Note that Buffett bought half of Heinz and will have no control in it. It's a not a huge investment for him. He bought that half using debt he recently issued at record low interest rates. He is using historically ultra cheap debt to buy something sustainable with a much higher return than the debt interests. If interest rates go back up, as they should, he can always call back his bonds at a much lower face value.

Note also that Buffett today and since the last 10 years must be more diversified. The main reason is that he is a huge insurer, the biggest maybe in big catastrophe insurance. He indeed specializes, thanks to Ajit Jain, in big cat insurance and reinsurance. That is big one-time catastrophes (hurricanes, earthquakes). As such he cannot afford to be concentrated. Why? Because he is basically using float from insurance premiums to invest in what some may consider "risky" stocks.

That explains a big part of his great returns. He basically has free money, and most times better than free, to invest. That is equivalent to lots of leverage. The flip side to that is that regulators would not allow him to be too concentrated, and for a good reason. The insurance regulatory body considers investing in stocks risky by definition. Buffett knows that he must be ready to put a huge amount of money if a mega earthquake or a huge hurricane comes. And one big cat will come sometime, that's certain. That mere possibility alone forces him to have several readily available billions of cash in his balance sheet to cover the insurance of such a disaster. This situation was not the same 10 or more years ago.

With that said please note that even today, without accounting for his private investments, his portfolio of public stocks is very concentrated. It is hard to find other investors who have a public portfolio more focused than his. Just a handful of stocks compromise 80% of his publicly invested money.

In such a situation no other big insurer would invest as aggressively as Buffett. I guess he cannot afford the luxury of concentrating further. If he did concentrate more and his investments fell, some times all together, during a market crash, and at the same time there was a big catastrophe (I stress that eventually one big cat will come, don't forget) he could find himself in a tight position. And we all know that he does not like to depend on "the kindness of strangers" when he needs money. So he will probably not put himself in such a situation by over concentrating.

Of course he does not talk about this publicly. I do not think he would like to shed too much light on that subject. But if you think about it, this might explain why he currently must be more conservative than in his first days, when insurance was a minor or non-existant part of his investments.

All that I said above was not mean to sound critical. On the contrary, I utterly admire Buffett as an investor. I meant more to highlight how flexible he is and what are the underlying motives that influence his actions. He is the best investor I know; he is the one I have learned more from and to which I owe the vast majority of what I've gained investing.

Disclosure: long Berkshire Hathaway (NYSE:BRK.B)

About the author:

Jose Vasquez
I was born in Spain and lived in France, Chile, USA and Belgium. I used to work in IT and Banking. I am a family man, I have a lovely wife, 3 sons and one step daughter. I have humble tastes, I like to stay home and read about companies. I started investing before the internet bubble. I knew little and liked technical analysis so my results were bad. Fortunately I did not have much to lose. Some years later in 2006, bored of doing real state investments, I opened an interactive brokers account and restarted. This time, not wanting to make mistakes, I decided to follow a model: Warren Buffett, he was at good making money via stocks. So I started reading about him, his shareholders letters, the books that he recommended, etc... I started applying his principles, reading 10K's digesting all sources of information. I started buying good and cheap companies to hold forever unless something changed fundamentally. When the housing crisis started I was 75% cash. By then I had identified good companies at very cheap prices so I invested most of my savings in stocks. It doubled fast. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. I changed lifestyle and moved from Belgium to the beach, Brazil, north east coast (www.kuchita.com). The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return, to move away from the inhuman life of civilization and to have some peace and sunny weather. Now I can think and study about companies 60 hours/week. I can finally do what I want full time and can say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! My portfolio is disclosed here: http://www.kuchita.com/view/sumo.php For more:

Visit Jose Vasquez's Website

Rating: 3.9/5 (22 votes)


Koheleth - 3 years ago    Report SPAM
Well done, and I agree with you. I think you have just proven a more thorough understanding of Buffett than some of his book authors.

I heard Guy Speir say about what he heard from people within Berkshire at the annual meetings: "Watch what Warren does, not just what he says." And of course, the stock picks are increasingly done by Weschler and Combs.

And he has said to business school students and elsewhere repeatedly that if he had to start over with just $1 million he would be doing things completely different to the way he is now. I take that to mean more concentrated positions in good businesses.

I think if he did have to do it all over again he might still do some cigar-butt style investing as a basket approach -- low PE, low P/B -- just because he enjoys doing it more than he expects to make a fortune from it. He's done it with Korean stocks and in a recent tv interview I saw he had a thick handbook on his desk listing every Japanese publicly traded company. (I wish the reporter asked him about it, but rarely are the real smart questions ever asked).

I look forward to reading more from you!

Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
Thanks Koheleth, I did not know that comment from Guy Spier, I completely agree with it. Interesting person too.

Indeed with 1 million dollars Buffett said he could make a lot every year. He would have much more opportunities to chose from and basically anything he would invest in would make a difference to that small base. Now, with several billions, his universe of possibilities to chose from is much smaller. There is just a small percentage of companies he can chose from the total. Small and medium caps are almost out of his reach and would not make any difference to the market cap of Berkshire if he invested in them. To make a difference he would have to buy hundreds of them, but since he prefers concentrating its unlikely that he will ever do that with a lot of money. But with 1 million the possibilities would really multiply.

That's a reason why it is nice to have a small amount of money :).

Best wishes!

Crafool premium member - 3 years ago
In my understanding of Berkshire Hathaway, Buffett uses a "barbell" approach to the insurance. Yes, Berkshire and Buffett runs a concentrated equity portfolio, however he keeps about $20 billion at all times liquid in cash and short term bonds. Please note that this is also a barbell approach, but not the one I am talking about. It is just a part of the "barbell". The overall "barbell" is the that Berkshire Hathaway's insurance only writes a VERY SMALL amount of insurance exposure to its required capital base. What do I mean? It seems that I read (Please verify on your own!) that Buffett's Berkshire only does about 10% of what it is legally allowed and what the average company in this sector levers up to. So what I see is his concentration in capital is mitigated by his under leverage on insured catastrophe risk.

In my opinion, Buffett's love of insurance of insurance is out of default or a by product of not being allowed to fully embrace his first love of "banking" . Both industries allow access to cheap to even " paid to hold" cash that he can invest else where at a higher rate of return and earn the difference or "spread". Buffett loves this structure. He doesn't love all "spread" structures like margin (high rates and no control) or hedge funds doing it (same thing), but the low cost of funds that the FDIC franchise gives you and insurance float second is his kind of borrowing. As he likes to say "I like hurdles that I can step over and not have to jump over." I remember him say this exact thing around the time of TARP and he saying he would do TARP if he could get the then borrowing rate that the government was able to get of around 3% or less looking at the 10-year Treasury bond.

A lot of people forget that at one time Berkshire owned a bank, but was forced to spin it off to shareholders when the law separating banking and commerce was signed into law. I believe Berkshire to this day maintains a completely up to date ready to go shelf registration to start a bank should that law be repealed (Note: I think Wal-Mart does it as well.). Buffett's love for banks is pretty clear in my opinion. Consider what he has done within the confines of the law. He keeps raising his position in Wells Fargo and only seems content to hit the 10% max that he is allowed knowing that WFC will be instituting major share buy backs once cleared to do so allowing the shrinkage in outstanding shares to carry him over the 10% threshold and allowed. His large stake in Bank of America through the warrants will do the same thing as will his stake in Goldman Sachs (Considered a bank), American Express (Now a bank, he owns around 15%), his US Bank position along with M&T Bank. If you tallied up his percentage of ownership in all these banks as if they were stand alone banks, you might just see that BRK owns the equivalent of a Top 5 bank in the US.

Bank leverage is his favorite for it is quantifiable rather than insurance that comes with surprises like hurricanes, tornados and other big disasters. Buffett likes Wells and BofA because of their deposit base! Millions and millions of small deposits that don't run off in the time of crisis thanks to depositor assurance given to them from FDIC. what is it Bill Gross says shake hands with the government. Well the FDIC is the biggest handshake to a businessman desiring cheap access to funds can find.

As far as Buffett's political interests and public statements, I agree with your "watch his actions and not just listen to his words". Buffett has never denied using tax structures or the tax code for his and Berkshire's benefit. I like Buffett and greatly admire his contribution to my knowledge of investing as well as the returns I have made from investing in BRK. I just think that a man that extracts punitive deals on others at times of distress (12% interest on Preferred Stocks, etc.), the deals he carves for himself and me! Is not necessarily a full fledge advocate for the little guy or gal and the Democratic Party. I think our history is full of individuals like Rockefeller, Carnegie, and others that felt the public ire for their vast wealth. Buffett has huge goals and ideals. What is that old expression "Keep your friends close and your enemies closer!" What the republicans would dismantle his empire and goals? Not likely,

Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
Thanks for your interesting point of view Crafool.

It is indeed interesting to think about how much he loves banks

and was nice to note how much his bank holdings add up to.

I had never done that exercise.
Mohdzam44 - 3 years ago    Report SPAM
1) One of the advantages of Buffett's insurance businesses is any big catastrophes occur today, it takes many years for the claims to be settled.

2) The bonds Berkshire issued weren't for the acquisition but for its utilities business. He has about 48 billion sitting in the bank earning close to nothing. One part of the Heinz's deal that is attractive to Buffett is the 9% preferred shares.

3) It is a flaw to say that diversification can avoid market risk. Buffett and Munger never believe in diversification. If there is another Wells Fargo, or a IBM or a Coca-cola come along tomorrow, they will have no problem to load it up.

4) Buffett's political stance, ie taxes was made in his personal endeavor. Berkshire Hathaway is a corporation that has thousands of shareholders whom he has to account for. People always mixed up between Buffett and BH.
Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
Thanks Mohdzam44 for your points of view. It is interesting to say that big catastrophes are settled in many years. I'll keep it in mind when I study how long in average claims in previous mega disasters have lasted. With United States Gypsum, another of Buffett's investments, it took years to settle the Asbestos claims, that did not avoid the company to go bankrupt many years after asbestos caused its effects.

It is interesting that Buffett decided to leave his fortune to the Bill Gates foundation. He believed that they could do a much better work at allocating money than the US government or anyone else. I tend to agree with him.

As I see it money is fungible and can be used indistinguishably to any corporate purpose. It is an advantage to have access to low interest loans and investments with high yields, such as Heinz's preferred shares.

I also agree with Munger & Buffett that diversification tends to generate mediocre results. It can even be dangerous if it does not let you focus on the things you know better. It currently seems to me that the best strategy is to focus on the best ideas. Now that Berkshire has billions, 60 private business and at least 10 public investments, in many different sectors, it is hard to imagine how they will be able to ever replicate the performance of the early years. In that context it makes sense when Buffett said he would make 50% a year if he had only a million dollars.

Diversification has the danger of buying too much companies that you do not know about.

Best wishes,

V Investor
V Investor - 3 years ago    Report SPAM
Good point. The people who try to educate others on how Buffett invests usually do not mention hat his style adapts to his circumstances. Today he invests in quality companies at fair prices, 50 years ago he invested in not-so-quality companies at rock-bottom prices. The professional investor mimicking his approach today as he manages tens of billions is perhaps not the best idea for someone with just a few million to invest, since Buffett would be investing in much different companies if he had less money.
Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
"since Buffett would be investing in much different companies if he had less money."

nice and direct way of saying it, i tend to agree that his style is extremely flexible, that makes him such a special person, a perpetual learning and constantly evolving human being

and he has made very few errors in that dynamic process, which makes it even more remarkable
AlbertaSunwapta - 3 years ago    Report SPAM
^I agree on the millions vs. billions advantage but not on what Buffett did 50 years go. I'd say that 50 years ago, I believe, Buffett also favoured investing in quality companies (Sanborn Map, Dempster, etc.). Share prices paid were sometimes over $50-100/sh back in the 1960s. Maket capitalization, liquidity and shares outstanding though, were often small.

As I recently pointed out on another thread, Buffett talked about "generals" as being his largest performers. "Workouts" were second to generals. Workouts aren't necessarily low quality, they are just mispriced. i.e. Spin-offs aren't necessarily low quality, though I would say liquidations are in terms of business models by not necessarily in terms of assets. And then were "control" positions.

One more thing, again I believe Buffett sometimes held large numbers of those workouts for diversification purposes (20, 30, maybe 40 or more at a time.) If that's true, I don't know if he is more diversified today than years ago.
Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
Interesting points AlbertaSunwapta,

Sanborn Map and Dempster were indeed not bad companies even though they were very cheap. I should read his partnership letters that I have somewhere around.

He also used to be very diversified when buying penny stocks. He called it fishtanking. That shows how flexible he was in his investment style, even as a young investor. He did not seem to exclusively follow Graham even while he worked with him. He took the other side of Graham's trade on the cocoa beans transaction. That made him earn lots of money, using cocoa futures, that was when he was just starting to make serious money, being very young.

The one who seems to have adopted Graham's, style even better than Graham himself, was Walter Schloss. I wrote a bit about him here on Gurufocus: Walter Schloss: The Essence of Value Investing

Buffett had periods of extreme concentration too. Like when he bet a huge percentage on Geico's recovery, when he invested there for the 2nd time, or when he started accumulating Berkshire heavily after closing his partnerships. Even with Coca-cola or when he concentrated on American Express, during the salad oil scandal. He seems to have know well at what times to focus and bet heavily when chances were heavily on his side.

Not too long ago I remember him saying that he could have made a killing during the 2008/2009 crash and that American Express at 10 was a steal.

The flexibility and variety of his approach to investing seems to me outstanding.
Wahoo8212 - 3 years ago    Report SPAM
Buffett almost always never acts like he preaches . I have a big problem with his view of social issues.

First of all he pays no taxes ,he collects them . We the consumer or the end user pay all the taxes ,period . Any taxes he and his companies pay are passed down to the end user .I own my business and I can tell you that my consumers pay all my expense . If my cost goes up from taxes I just passed them to my consumers . Buffett idea of a perfect world is 1000 or so companies collect all the taxes or revenue to operate the goverment . Then is up to people like himself to run our country like he runs his company . He is the only voice there . The BOD are for show , no dividend is ever paid . He has got his now he is using the stock holders money to build this empire to help fund his social issues .

He pays no taxes on the investments he makes with the insurance float . He pays no dividends to shareholders ,so no taxes are collected and so on you get the picture .

Want the rest of you be glad when all his shares are sold by Gates and then the company can be broken up in to pieces so the stockholders will at least get some profit.
AlbertaSunwapta - 3 years ago    Report SPAM
^ Actually he does act very much like he preaches. Wahoo8212, you just haven't been exposed to enough, or any of his preachings. Read what he has said about taxes over the years, going back to the early 60s. In his more recent annual reports he has also discussed the relative degree of taxes he has paid to the gov't. It's huge.

You are perceptive in saying that Buffett's companies pass on the taxes to consumers. Hopefully the same with inflation. Here again Buffett has talked about the power of inflation to tax the investor and so Buffett seeks out companies with the power to survive inflation. Not all companies can pass on their cost increases, you're very lucky to have one of those.

On breaking up the company, that may happen, but Wahoo, you should really slow down and think before you type. An understanding of how share holdings, insurance company taxation, the power of compounding, investment value as it is reflected in share pricing, etc. would prove invaluable to you and your debating ability.
Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
Buffett idea of a perfect world is 1000 or so companies collect all the taxes or revenue to operate the goverment . Then is up to people like himself to run our country like he runs his company. He pays no taxes on the investments he makes with the insurance float . He pays no dividends to shareholders ,so no taxes are collected and so on you get the picture .

Wahoo8212 Great points of view, and original thinking. It seems to me by looking at it that way that he played the system like a real genius.
Jose Vasquez
Jose Vasquez - 3 years ago    Report SPAM
Looks like Warren Buffett does not value anymore his old habit of buying fair businesses at cheap prices:

More than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price. Despite the compelling logic of his position, I have sometimes reverted to my old habit of bargain-hunting, with results ranging from tolerable to terrible. Fortunately, my mistakes have usually occurred when I made smaller purchases. Our large acquisitions have generally worked out well and, in a few cases, more than well.

Regarding his Berkshire Hathaway textile business "cheap" acquisition he just mentioned again:

Your chairman has not been free of this sin. In Berkshire’s 1986 annual report, I described how twenty years of management effort and capital improvements in our original textile business were an exercise in futility. I wanted the business to succeed and wished my way into a series of bad decisions. (I even bought another New England textile company.) But wishing makes dreams come true only in Disney movies; it’s poison in business.

Source from the recent 2012 Shareholder letter

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