Warren Buffett (Trades, Portfolio) is not just a great investor. He is a master of the financial world.
Over the past five or six decades, he has created tens of billions of dollars of wealth at Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), not just by investing sensibly in securities, but by using the most favorable financial structure for every transaction. I think this is important to understand when analyzing the career of the successful investor.
He has become successful not just because he is a great investor. It is because he is able to squeeze every single dollar and cent from every single transaction to unlock as much value as possible. Investors cannot overlook these simple transactions when working to increase their own net wealth and improve their investment performance.
In other words, the Oracle of Omaha is not just looking for attractive investments to buy. He is always looking for the most financially savvy avenue to improve returns and generate value. This could be anything from a different corporate structure to maximize tax benefits to an obscure financial asset, which other investors are overlooking because they do not understand the structure or didn’t have the financial resources to make the most of the opportunity.
A great example of this strategy in action can be seen in the transcript of the 1994 Berkshire Hathaway annual meeting of shareholders. That year, the company proposed a motion to allow it to issue preferred stock.
Buffett has always tried to avoid issuing new shares in his conglomerate because he has said this strategy only destroys value. There are a couple of exceptions to this rule, but on the whole, he has avoided issuing new shares to acquire businesses, relying instead on retained earnings and occasionally debt.
However, that year, he did propose issuing new shares, specifically preferred shares. As he went on to explain at the annual meeting, he wanted to bring in this role because it might open up a new avenue for the company to fund acquisitions in a financially savvy way:
“The preferred stock may offer sellers of a business the chance to do a tax-free exchange with us. And they may not want common stock, because they may have an ownership situation where they don’t want to run the risk of common stock ownership. And that’s why our preferred is flexible as to terms. Because we could give those people a straight preferred with a coupon that made it worth par at the time we issued it. And then they would know what their income would be for the next umpteen years. And that may be of paramount interest to them.”
As Buffett explained, the preferred stock issue would allow Berkshire to offer sellers the option of a tax-free exchange and a guaranteed income stream for their business.
The billionaire has used this approach himself many times in the past. He has inked deals with other corporations to lend money via preferred stock with a guaranteed interest rate.
As Buffett went on to add, the main objective of using the preferred stock would be to provide options to sellers, which could improve the attractiveness of selling to Berkshire:
“So that we simply have more forms of currency available to make acquisitions if we have the ability to issue various forms of preferred. Because a preferred stock, if it’s properly structured, allows for the possibility of a tax-free transaction with a seller. And that’s important to many sellers.”
This simple example illustrates just one of the ways Buffett’s overwhelming knowledge of the financial system has helped him create value for investors time and time again. Many other managers would have ignored the options provided by this strategy and relied on common stock and debt issuance alone.
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