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David Merkel
David Merkel
Articles (5983) 

Moat, Float, Growth

March 02, 2010 | About:

If you have to invest a lot of money, you have to think differently than the average investor. The average investor thinks he can easily get in and out of positions. Really large investors, if they are doing more than indexing, act like private equity investors, realizing that they are buying large chunks of nontradable businesses. So, when I wrote the piece, The Forever Fund, I wrote it in view of the fact that Buffett’s job is a hard one — most of us have enough trouble generating returns off our small portfolios, but Buffett has to do it in size.

My summary of what he is trying to do can be summarized in one sentence: “A business with a big moat, financed by cheap insurance float, will lead to book value growth.” Moat — the business possesses sustainable competitive advantages that are significant. It would be very difficult to reverse-engineer the competitive position of such a business. Float — ordinarily, property-casualty insurers lose money on operations, but make it up on investing the funds that exist because of the delay in time between premium payments and claims. Buffett calls that cost “float,” and indeed over the last seven years, Berky has made money on the insurance operations, far from it being a cost. All the better as he invests the funds generated from insurance operations in businesses that will generate a growing stream of earnings in businesses that have sustainable competitive advantages, such as Burlington Northern and his utility investments.

We hear too much about Buffett the investor, and too little about Buffett the businessman and insurance CEO. In the old days he was the former — today he is the latter. He is trying to create a stable of superior operating businesses that can benefit from the cheap financing that the insurance companies generate.

That is a tough job — he is thinking about how he can preserve value forever. I am reminded of King Solomon who wrote Ecclesiastes, because my family is reading it in family worship presently. He agonized about how he could preserve what he had built in his life after his death and concluded in sorrow that there was no way to do that. Again from Ecclesiastes 9:11 [NKJV]– I returned and saw under the sun that—

The race is not to the swift,

Nor the battle to the strong,

Nor bread to the wise,

Nor riches to men of understanding,

Nor favor to men of skill;

But time and chance happen to them all.

Buffett is one among several billion, trying to fight the vicissitudes of this life after he dies. Like Solomon, he wants what he has built to live a long and prosperous life. Alas, we can assure nothing even while we live, how much less after we die? Buffett is likely doing better than most who confront the problem, but the problem remains.

Thus, my view of Berkshire Hathaway is that it is more critical as to who is the CEO/COO rather than who is the Chief Investment Officer. The greater need is to manage the businesses, rather than manage slack cash for high returns.


Among all the commentary regarding Berky’s annual report, there has been a dearth of comment about them entering life reinsurance. Personally, I think their best move would be buying RGA at book value. (Yes, I own some RGA.) Why shouldn’t the best life reinsurer be a part of Berky? There is a talented management team, and the best firm dealing with facultative life reinsurance. Berky is already reinsuring some major life insurance risks, but who are they reinsuring?

One thing I appreciate about Berky is that they don’t purchase reinsurance. They size their appetite for a risk relative to their own balance sheet.


On page 7 of the Berky Shareholders Letter, there is a joke about buying higher. It is really tough to buy more of some stock that you have bought at a lower level.


In the long run the risk for Berky is that it gets a manger that does not get my summary, “A business with a big moat, financed by cheap insurance float, will lead to book value growth.” But in detail, there is the possibility of a loss of focus. Can Berky motivate managers to perform?

That is the tough question. While Buffett lives, there is the “You don’t want to disappoint him” effect, but that will disappear after his death.


It is impossible to assure value permanently, but men will try to do it anyway, and fail mostly….

Full disclosure: long RGA

David Merkel


About the author:

David Merkel
David J. Merkel, FSA, CFA, is the Chief Economist and Director of Research of Finacorp Securities. His specialty is looking at the interlinkages in the markets in order to understand individual markets better. He holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth.

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