I have just finished reading a new book on Warren Buffett (Trades, Portfolio)’s investment history, published by Columbia Business School Publishing. Written by Yefei Lu, a portfolio manager at Shareholder Value Management AG, the book takes a look twenty of Warren Buffett (Trades, Portfolio)’s most lucrative investments and tries to figure out why Buffett was initially attracted to these stocks in the first place.
"Inside the Investments of Warren Buffett: Twenty Cases"is not a book that tells you how to invest like Warren Buffett (Trades, Portfolio), it is almost the exact opposite. Yefei Lu tries to take an objective approach to each investment based on the financials Buffett would have had access to at the time. The central theme of the book is trying to identify what Buffett will have seen in the businesses that he invested in over the years. By understanding what these companies looked like before Buffett got involved, readers can search for businesses with similar traits themselves, or that is the idea anyway...
The Buffett Illusion
"Inside the Investments of Warren Buffett (Trades, Portfolio): Twenty Cases"Â has convinced me that it is impossible for most investors to achieve Buffett-like returns. You see, in most of the cases profiled in the book, Buffett had an edge over ordinary investors. Whether it be via a personal relationship with the CEO, a deal structured to yield a profit no matter what the outcome or personal activist involvement, most of Buffett’s greatest investments have produced outsized returns because he has been involved.
Let’s take a few examples. Buffett’s most lucrative and well-known investment and subsequent purchase has to be that of GEICO. Although Buffett was interested in GEICO as early as 1951, his biggest investment in the company came in 1976 when GEICO was on the verge of bankruptcy. Most investors would shy away from investing in an insurance business on the brink of bankruptcy, as it is almost impossible to tell how deep the problems run with an insurance business and how long the company may be making up for past mistakes. Buffett invested because he was able to schedule a meeting with the company’s new CEO and then, to give the company more time to restructure, Buffett negotiated the deadlines and stringency of the regulatory capital requirements set for GEICO with the D.C. insurance regulator. On top of this, Buffett was able to convince Salomon Inc and the infamous John Gutfreund to underwrite a $76 million convertible stock offering for the company.
GEICO is just one of the investments were Buffett was able to use his influence and cash to ensure the best returns for himself and his investors. Another example is Buffett’s investment in the Washington Post company.
After buying a stake of 10% in the business, Buffett became close with the company’s CEO, Kathrine Graham, and instilled a shareholder friendly mindset in the management, which ultimately led to better returns for Buffett and other shareholders.
In Buffett’s lucrative Capital Cities/ABC deal, the billionaire was called on to provide financing ($517 million) for the merger of these companies, a merger which would give the enlarged group significant operating leverage and improve returns over time. Without Buffett’s involvement here, it is likely the businesses would have been unable to achieve the results they did in later years.
Buffett also structures deals to work in his favor, as in the case of US Air Group (LCC, Financial) and Salomon Inc., Buffett and Berkshire Hathaway (BKR.B) were able to negotiate favorable preference share deals. In the case of US Air, Buffett’s preferred stock converted into common equity after ten years and yielded 9.25% per annum. Any dividends missed were to be repaid in full when the company’s profitability returned to a certain level. The Salomon deal was structured in a similar way, but the interest rate on the preferred securities was 9%.
Some Companies Just have Attractive Traits
Most of Warren Buffett's (Trades, Portfolio) significant investments outperformed because of his influence. However, Buffett's involvement had no bearing on some investments such as Berkshire Hathaway’s stake in Coca-Cola (Ko) and Wells Fargo.
It is these investments that give a fascinating insight into Buffett’s strategy. What was so unique about these businesses? It all comes down to return on tangible capital. Both Coca-Cola and Wells Fargo had shown (in the years before Buffett’s involvement) that they could produce a return on tangible capital of more than 20% per annum and could reinvest this capital in the business at a similar rate of return. If it was not possible to reinvest the capital, managements had shown a desire to return capital to investors.
The Bottom Line
So what are the key takeaways from "Inside the Investments of Warren Buffett (Trades, Portfolio): Twenty Cases"? Well, for a start, it is evident from the book that most investors do not have the tools available to them to achieve the returns the Buffett has over the years. Warren Buffett (Trades, Portfolio)’s power and influence have played a significant part in his ability to achieve outside returns for Berkshire Hathaway’s investors.
Secondly, when it comes to choosing the best long-term investments, it is not always about buying the cheapest stocks, it is about looking for those businesses that have been able to and can continue to compound shareholder equity at a double-digit rate, without the use of financial engineering or continual capital investment.
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