To Warren Buffett, investing is neither an art nor a science. Rather, it is a study of human nature and a willingness to follow a mundane path. As the Oracle of Omaha has proved, boring does not equal unprofitable. His investments often reflect the most basic products and services, ranging from consumer goods like razor blades and laundry detergent to soft drinks and automobile insurance.
A basic tenet of Buffett's strategy is to invest in companies he believes will provide a long-term value investment, rather than investing in fads or technologies that may be profitable in the short run but are likely to become obsolete in the foreseeable future. His investments are guided by his famous words: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Choosing Investments With Long-Term Value
In 1987, Buffett famously stated, "I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty." While he later stated that the tobacco industry was burdened with issues that made him change his opinion of it, this statement sums up Buffett's description of the perfect investment.
Buffett's holding company, Berkshire Hathaway (BRK.A), has a portfolio that contains both wholly-owned subsidiaries, such as GEICO Auto Insurance and Benjamin Moore & Co., and sizable blocks of shares in publicly traded corporations. For example, Berkshire Hathaway is the largest shareholder of both Coca-Cola (KO) and Kraft Heinz (KHC), brands that are ubiquitous throughout America's supermarkets. The company's SEC Form 13F displays its most recent holdings.
While these investments are profitable, Buffett's most ingenious picks were his purchases of See's Candy and Gillette. Both were so seemingly ordinary that they belied their capacity to generate profits that most companies only dream about.
Buffett is perhaps the world's most famous 'value investor.'
Buffett's secret to investing is to find solid companies with strong brand name recognition, excellent management and positive financials, and then actively invest in them (buy it outright, or buy a significant amount of shares, usually a controlling interest).
Buffett's strategy also relies heavily on the power of compounding, e.g. make an investment and then stick with it for years.
Once Buffett identifies a company that meets his criteria, he'll wait until it reaches a price he considers fair, or if it is fairly valued, he'll invest immediately.
Buffett considers it important to be invested and not just sitting on the sidelines waiting for all the stars to align.
See's Candies: The Perfect Business Model
In 1972, Buffett purchased See's Candies from the See family for $25 million. See's has been around since 1921, and its stores, designed to look like they belong on Main Street in a traditional American village, can be found throughout the western United States as well as in many airports.
Their selection is neither trendy nor flashy; the company offers the type of fare that while not in style, also never goes out of fashion. Over the ensuing decades, Buffett invested another $32 million into the business. Since its acquisition, the seemingly simple confection and the retail manufacturer have returned $1.35 billion to its owners.
What attracted Buffett to this investment? Primarily, it was a highly profitable business with extraordinarily attractive fundamentals. Its pretax earnings were 60% of its invested capital. As a cash business, accounts receivable was not an issue.
As for cash flow, the rapid turnover of products combined with a short distribution cycle minimized inventories. Operating strategies, such as increasing prices before Valentine's Day, provided extra revenue that went straight to the bottom line.
Thus, this enterprise was a perfect business model. In addition to financing its growth over the years, See's has proved itself to be a valuable cash cow whose profits offer Berkshire Hathaway another internal source of revenues with which to make other acquisitions.
Gillette: Another Great Success Story
Gillette provides another example of Buffett's investment strategy. In 1989, Gillette was a company with core products that were so firmly entrenched in the marketplace that seemingly every household in America used them. Gillette's razors, and more significantly the razor blades that fit them, once provided the bulk of the company's profits and held a huge market share as one of the top brands in the U.S.
The company's Paper Mate pens, pencils, erasers, and Liquid Paper, equally lacking in glamour, were sold in every venue imaginable, from stationery stores to supermarkets to newsstands. White Rain shampoo, Right Guard and Dry Idea antiperspirants, and Gillette Foamy shaving cream were also powerful name brands.
During the 1980s, the razor industry was shaken up as disposable razors initially took away a significant share of sales from Gillette. In 1988, Coniston Partners attempted a hostile takeover of the Gillette company. Gillette won that battle, and in 1989, the company redefined the industry with the introduction of the Sensor Razor, a product that appealed to men's desire for a high-quality, hi-tech product and reinvigorated the company's sales and profits.
That same year, Buffett stepped in with a $600 million purchase of preferred stock, making Berkshire Hathaway the owner of 11% of the consumer goods company, a seat on the board, and a healthy $52.5 million annual dividend. Through the 1990s, Gillette's stock price gave Berkshire Hathaway a significant paper profit. In less than 24 months, the $600 million investment was worth $850 million.
Buffett's modus operandi is to be patient, so he did not liquidate his holding and take an immediate profit. Rather, he continued to demonstrate his confidence in Gillette's management, even as the company invested millions of dollars in research and development and acquired Duracell, another classic American brand.
In 2005, the acquisition of Gillette by Procter & Gamble (PG) valued Berkshire Hathaway's shares at more than $5 billion and made Berkshire Hathaway the largest shareholder of the world's leading consumer product manufacturer.
Since P&G fits Buffett's parameters as a company that possesses many of America's favorite brand names, he assured Wall Street that he would not only hold the shares but would increase his position in the company.
While See's and Gillette are, on the surface, very different companies, Buffett recognized that both possessed the most valuable formula a company can achieve: profitable and timeless name-brand products.
Boxed candy has been a staple of American society for generations, and See's is such a well-loved product that the company saw growth even during the years of the Great Depression. Gillette's shaving products serve a need that will never disappear, and its products have been found in homes throughout America and the world.
Financially, both businesses reflect strategies that have proved to be successful. The cost of producing boxed candy has often been, like perfume, less costly than the packaging and marketing of the product.
This translates into extraordinary profit. And the razor blade business that Gillette pioneered and still dominates is the original example of the business model of giving away a larger, infrequently purchased product (the razor) to sell a smaller, repeatedly purchased product (the disposable blades) to customers for the rest of their lives. This is known as the Razor-Razorblade model.
What is Buffett's preferred type of investment?
Buffett looks for companies with strong brand name recognition and a product line that is virtually indispensable, such as railroads and personal care products.
What is Buffett's preferred holding time for an investment?
The short answer is forever. Buffett looks for companies that have strong staying power and positive cash flow and a solid, long-term outlook. This enables him to benefit from both price appreciation of the investment as well as dividends over the years.
Does Buffett get involved in the day-to-day management of the companies he owns or controls?trols?
Generally speaking, no. One of the reasons Buffett will buy a company is the strength of its management team, and he prefers to allow them to maintain the day-to-day operations of the company. When it comes to a potential acquisition, or other major strategic move, Buffett will definitely have his say.
The Bottom Line
The first step in replicating Buffett's investment strategy is to locate wonderful companies, as Buffett puts it, with long-term value and a fairly priced stock. The next step is to get away from the sidelines and invest.
See's was profitable before Buffett purchased it, just as Gillette was already known on Wall Street as a desirable investment. It is Buffett's willingness to put his cash down and hold these stocks for the long run that separates him from those who only watch and wait.
Buffett has described his strategy as the "Rip Van Winkle approach" after the main character of the famous short story by American author Washington Irving who falls asleep and wakes up 20 years later. Perfect timing is difficult if not impossible to achieve, but Buffett explains that "we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."