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Rupert Hargreaves
Rupert Hargreaves
Articles (948)  | Author's Website |

Warren Buffett: The Best Acquisitions Fall Into 2 Buckets

Some thoughts from Buffett on acquisitions

October 10, 2019 | About:

In his letter to shareholders of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) in 1981, Warren Buffett (Trades, Portfolio) talked at length about acquisitions.

Specifically, he outlined the qualities of good acquisitions and added the traits of companies that had an excellent acquisition record.

He also highlighted the common traits of businesses with lousy acquisition records. For example, Buffett wrote that many managers "often relish increased activity and challenge," which leads them into takeover battles and fights for no other reason than the activity.

Buffett also explained that many companies and managers measure their success in terms of size. I.e., how big they've made their business or their bank balance. There's no consideration given as to how much value they've created or destroyed in the process.


And finally, Buffett said that many management teams "apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad's body by a kiss from a beautiful princess."

He went on to explain that bad managers often waste their shareholders' money on bad acquisitions or "toads." These businesses have bleak prospects, but managers often mistakenly believe they can turn these businesses around with their skill and capital. Such recoveries are few and far between.

After highlighting these problems with the acquisition process, Buffett defined two categories of impressive acquisition strategies:

"The first involves companies that, through design or accident, have purchased only businesses that are particularly well adapted to an inflationary environment. Such favored business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital."

Buffett explained that even managers with "ordinary ability," who have focused on finding these types of businesses, have done well purely because of the strengths of the businesses.

However, very few companies possess these qualities. As a result, in most cases, it's difficult for managers to keep still for long enough to wait for the opportunities to come to them.

"The second category involves the managerial superstars - men who can recognize that rare prince who is disguised as a toad, and who have managerial abilities that enable them to peel away the disguise. We salute such managers as Ben Heineman at Northwest Industries, Henry Singleton at Teledyne, Erwin Zaban at National Service Industries, and especially Tom Murphy at Capital Cities Communications (a real managerial "twofer", whose acquisition efforts have been properly focused in Category 1 and whose operating talents also make him a leader of Category 2). From both direct and vicarious experience, we recognize the difficulty and rarity of these executives' achievements."

Managers who fall into the second category were happy to wait for the right opportunity to strike. They would only pay what they thought the acquisition was worth and wouldn't get caught up in any deals just for the sake of doing deals.

Buying the right companies

Buffett's advice from 1981 may be a few decades old, but it is just as relevant today as it was at the time it was first published.

Good companies fall into two main brackets: those with pricing power anyone can run, and those with good managers.

Finding these companies is half the battle with investing. They may not come around all that often, but if you can find these businesses at attractive prices, it is worth acting quickly and with conviction to take advantage of the opportunity.

Disclosure: The author owns shares of Berkshire Hathaway.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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