Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) has been a major investor in some of the biggest and best known companies in the world. At different times, Berkshire has been a shareholder of Gillette, Duracell, Wells Fargo (WFC, Financial), Coca-Cola (KO, Financial) and Apple (AAPL, Financial), just to name a few.
These are all large and complicated corporations, and it can sometimes be difficult to sort through their many different parts to arrive at an accurate valuation.
However, you don’t have to be an accounting genius to get a general sense for what Buffett and his partner Charlie Munger (Trades, Portfolio) look for in a business. At the 2017 Berkshire annual general shareholder meeting, the duo used See’s Candy - a very simple company - to clearly illustrate their principles.
Laying down money today for more money tomorrow
Berkshire acquired See’s Candy in 1972 for $25 million. In today’s money, this would be worth just under $155 million.
At the time, See’s was earning around $4 million annually before tax (just under $25 million in today's dollars), so Buffett and Munger paid roughly 6.25 times earnings for the business. They were essentially betting that See’s Candy would continue to be as profitable - if not more - ten years down the line. Fortunately, that bet paid off: by 2017, the business had earned Berkshire around $2 billion, or 80 times what it had been acquired for.
Selling candy is a pretty straightforward business, which makes See’s the perfect example of Buffett’s and Munger’s core beliefs: that investing is about putting some amount of money down today in order to secure a larger amount of money in the future.
How far into the future? The ideal Buffett/Munger investment is one which generates cash forever, repaying the investor many times over. Incidentally, this is not how Buffett started out. In the 1950s and 1960s, his modus operandi was to buy cheap shares of companies that were on their last legs to extract the last bit of value out of them, a strategy which has lost its effectiveness as times have changed.
It is therefore interesting that Berkshire almost missed out on See’s Candy. Buffett said at the 2017 conference that he wouldn’t have paid much more than $25 million for it in 1972 (although Munger would have), remarking: “If it had been $5 million more, I wouldn’t have bought it." Of course, with the benefit of hindsight, paying $5 million more back in 1972 for a cumulative total of $2 billion in earnings by 2017 would have been a no-brainer decision.
Munger also added that Berkshire’s early experience with distressed companies gave him and Buffett a lot of experience in what not to look for, saying that trying to “fix the unfixable” was so hard and horrible that it made them reassess their entire philosophy. So far, it seems to have paid off.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Mohnish Pabrai: Don't Think Too Much
- Cognitive Biases That Can Wreck Your Investment Process
- The Value Investor's Handbook: How Management Can Game Depreciation Figures
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