Investing like Warren Buffett 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. (For more on Warren Buffett and his current holdings, check out Coattail Investor.)
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 ValueIn 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 (NYSE: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 (NYSE:KO) and Kraft Foods (NYSE:KFT), brands that are ubiquitous throughout America's supermarkets. To find the most recent holdings look for the SEC form 13F.(Learn to assess the systems by which businesses make their revenue in Getting To Know Business Models.)
While these investments are profitable, Buffett's most ingenuous picks were his purchases of See's Candy and Gillette. Both were so seemingly ordinary that they belied their market shares and their capacity to generate profits that most companies only dream about. Let's take a look at them in depth.
Example 1: See\'s Candy: The Perfect Business ModelIn 1972, Buffett purchased See\'s Candy from the See family for $25 million. See\'s has been around since 1921, and its stores, designed to look like they belong onMain Street in a traditional American village, can be found throughout the western United States as well 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 nominal confection and retail manufacturer has 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 seemingly nominal enterprise was a perfect business model. In addition to financing its own 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. (For related reading, see Spotting Cash Cows.)
Example 2: Gillette: Another Great Success StoryGillette 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 71% of the company\'s profits and held a huge market share as the top brand in the United States. The company\'s Papermate 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, Rite Guard and Dry Idea antiperspirants, and Gillette Foamy shaving cream were all powerful name brands, which together represented $1 billion in sales in 1989. 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/high 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. (Learn about the strategies corporations use to protect themselves from unwanted acquisitions in Corporate Takeover Defense: A Shareholder\'s Perspective.)
Patience PaysBuffett'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 Proctor & Gamble (NYSE: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.
If Buffett had invested the original $600 million in the Standard & Poor's 500 Index rather than in P&G, its value before dividends would have grown to only $2.2 billion. (To learn more about dividends, read Dividend Facts You May Not Know.)
While See's and Gillette are seemingly 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) in order to sell a smaller, repeatedly purchased product (the disposable blades) to customers for the rest of their lives. (For more, read Think Like Warren Buffett and Warren Buffett: How He Does It.)
ConclusionThe first step in replicating Buffett's investment strategy is to locate wonderful companies with long-term value and 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 a 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."