In my experience, the role Blue Chip Stamps played in helping Warren Buffett (Trades, Portfolio) to build Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) into the conglomerate it is today is often overlooked.
Market commentators tend to focus on Buffett's investment prowess and the success of individual businesses such as Sees Candies rather than Blue Chip.
In some respects, this is understandable. Just like National Indemnity, which was Buffett's first insurance company and a significant source of capital in the years after he acquired it, Blue Chip is a relatively boring piece of the puzzle.
It was also a disaster. Between 1969, when Buffett and his partner, Charlie Munger (Trades, Portfolio), originally got involved with the business, and the mid-1990s, sales plunged 99%. Blue Chip was eventually wound up.
But here's the thing, without Blue Chip, Buffett would not have been able to buy See's Candies.
Blue Chip buys See's
The cash to fund this acquisition was derived from Blue Chip's float, the money stamp buyers had paid to the business, which had not been redeemed or paid out. After See's, the new owners of the business bought 80% of Wesco Financial and then the Buffalo Evening News. Blue Chip supported many of the key acquisitions and deals in the early part of Buffett's career. Without the business, Berkshire would not be the enterprise it is today.
Buffett's actions, which turned the company from a struggling business on a downward trend into a booming conglomerate, are a good case study for investors.
His decisions to invest the company's float in three key businesses provides two lessons.
First, all these were just three meaningful decisions, which have ended up generating billions of dollars in profit for the investor. The first lesson is to make meaningful decisions and act with conviction when an attractive investment presents itself.
The second lesson is the flexibility of capital. Blue Chip was already struggling in the 1960s.
Many managers might have taken on the business and spent significant sums trying to reinvent the enterprise to drive sales growth. The chances are, this would have been a waste of shareholder capital.
Instead of going down this route, Buffett and his team decided to look past the core business altogether and focus on other companies with brighter long-term outlooks.
Investors can implement the same strategy by reinvesting dividends and profits from mature businesses into growth enterprises. Just because a company has given you some profits (dividends) does not mean these profits have to be reinvested back into the same business.
Investors can take this cash and deploy it into growth opportunities.
Capital flexibility
We've seen Buffett follow this approach again and again over the past few decades. See's Candies is another example.
In the past, he's said the business has struggled to expand into different markets. Therefore, rather than reinvesting See's profits back into an unprofitable expansion, Berkshire has taken the capital out of the business to use in other subsidiaries.
The same is true with National Indemnity and other insurance companies under the Berkshire umbrella.
In the insurance business, it does not pay to chase growth. Doing so may expose a company to unprofitable risks and large losses.
So, instead of pursuing growth, Buffett has deployed capital from insurance companies' balance sheets into other businesses. Over the past few decades, insurance has been a cash cow for the Berkshire group, providing capital for many of Buffett's large deals and his equity portfolio.
Put simply, Blue Chip is just one example of Buffett's successful capital allocation policies, but it is often overlooked. The case study of how the Oracle of Omaha was able to use this struggling business as a springboard for Berkshire's growth provides some good lessons for investors.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- 5 Things to Watch in Berkshire Hathaway's 3rd-Quarter Results​
- Warren Buffett: I Knew Enough to Lend Money, but Not to Buy the Stock
- Warren Buffett on the Predictable Nature of the Beer Market
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