Over the past six decades, Warren Buffett (Trades, Portfolio) has built Berkshire Hathaway (BRK.A, Financial) (BRK.) into one of the world's largest conglomerates. He has taken the company from strength to strength by acquiring individual businesses and investing in the equity market.
Due to the diverse nature of the conglomerate, we cannot pin down only one investment or strategy that is responsible for most of the group's performance since Buffett took the firm over in the late 1960s.
Instead, the Oracle has used a collection of investment principles and ideas to turn Berkshire into what it is today by seeking out companies he believes can earn high returns for their shareholders.
At the core of this network of mental models is the principle that every equity should be viewed as an individual business, not just a gambling chip on a casino table.
Look-through earnings
In his annual letters to investors, Buffett frequently tries to make it clear that when Berkshire buys an investment in a business on the stock market, it is viewed in just the same way as an acquisition would be.
As part of this thought process, the Oracle frequently uses so-called look-through earnings. This includes both money paid out to investors and money reinvested back into the enterprise on a per-share basis.
For example, if Berkshire owns 5% of the company, its look-through earnings would be 5% of cash returned and invested, even though it is not receiving all of this cash in the same way it would with a subsidiary.
Buffett believes this principle is a much better reflection of the company's value to investors, and it is also an approach individual investors can make use of as well.
Buffett explained this idea in a letter to Berkshire shareholders:
"We also believe that investors can benefit by focusing on their own look-through earnings. To calculate these, they should determine the underlying earnings attributable to the shares they hold in their portfolio and total these. The goal of each investor should be to create a portfolio (in effect, a "company") that will deliver him or her the highest possible look-through earnings a decade or so from now. "
As the letter went on to explain, this approach can help investors think about stocks as businesses, rather than just blips on a screen. It can build that association between the company and the shareholder, as it illustrates the underlying earnings for shareholders rather than emphasizing accounting gimmicks and financial ratios:
"An approach of this kind will force the investor to think about long-term business prospects rather than short-term stock market prospects, a perspective likely to improve results. It's true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball. To put runs on the scoreboard one must watch the playing field, not the scoreboard."
This approach may also force investors to avoid companies they do not understand. If I try to build a synthetic company using shares, I will focus on the businesses I understand most. These will be the easiest to analyze. The more I know about each business, the more comfortable I will be owning the stock as part of a synthetic company portfolio.
The overriding aim of this approach is to focus on investment rather than speculation. Some investors may not be comfortable with this level of analysis, which suggests individual stock investing may not be suitable. However, if one is comfortable owning individual stocks, visualizing them as part of a more comprehensive synthetic corporation could be an excellent psychological trick for encouraging a long-term mindset.
