Over the past seven decades, Warren Buffett (Trades, Portfolio) has developed Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) to become a fortress.
The Oracle of Omaha has come under attack in recent years for his conservative investing approach, but we are now starting to see how this approach is really designed to work.
As geopolitical and economic uncertainty increases, Berkshire has outperformed the market as well as many of the companies that were previously claimed to be better investments than this slow and steady conglomerate.
For example, over the past 12 months, Berkshire has outperformed the S&P 500, returning 34% compared to the index's 16%, excluding dividends. It has also outperformed the ARK Innovation ETF (ARKK, Financial) by a staggering 80% over the past year.
At this point, I should state that I have not written this article just to brag about how great Berkshire is as an investment. That's not what I'm trying to say at all. The point of this article is to understand how Buffett has developed his company into a fortress and what we, as investors, can take away from this method to help improve our own strategies.
I believe there are a couple of reasons why the conglomerate has become a safe haven in stormy waters. The first is diversification. Berkshire is a collection of very good businesses. On top of this, it also has a rock-strong balance sheet with over $140 billion of cash available to deploy at a moment's notice.
There are three core business divisions at Berkshire: insurance, railroad and utilities. On top of these, there are many smaller companies as well as the companies in the equity portfolio. The equity portfolio holdings include seveal financial services companies as well as Apple (APPL) and Coca-Cola (KO, Financial), just to name a few. The diversification means the company is well placed to succeed in any market environment.
Further, the company's entire business and equity portfolio is concentrated on companies that have a relatively stable and predictable customer demand. There will always be a demand for insurance products, and there will always be a demand for utilities and railroad services. Apple has a sticky customer base, and there will always be a need for financial services and consumer goods like Coca-Cola beverages.
Another quality that links all of these companies is cash generation. They all generate significant amounts of free cash flow, which they can either deploy back into the business or return to investors. This means they don't have to borrow a lot of money and have a level of protection themselves against economic and geopolitical uncertainty.
I think these are the three qualities that have helped Berkshire over the past seven decades and will continue to help the conglomerate navigate any future crisess if and when they arrive.
For individual investors, the three lessons can be broken down as:
- Diversification is not a dirty word. There will always be unknown unknowns in investing. Black Swan events can and regularly do happen both with individual companies and the economy. The best way to protect against these shocks is to have some diversification.
- Having a strong balance sheet is vital for long-term investment success. It may be sensible for investors to avoid using margin (leverage) to buy stocks. It may also be sensible to avoid borrowing too much on credit cards or personal loans. Individual investors have to think about their entire personal financial situation rather than just their investment balance sheet. Having cash available to take advantage of situations when they arise and ride out any uncertainty is an important quality.
- Finally, investors may be able to replicate Berkshire's stability by seeking out equities that provide a good or service that fulfills an essential need for the consumer. These companies are far more predictable with stable cash flows than other assets.
