Buffett is a great businessman as well as a great investor.
Warren Buffett, chairman of Berkshire Hathaway, gets plenty of attention in the financial media and the merest rumour that Buffett has bought a company's shares can be enough to put a few percentage points on its share price.
Buffett's investments receive such a level of interest because thanks to Berkshire Hathaway's tremendous record there are lots of people out there who like to buy whatever he's buying. Unfortunately this focus upon Berkshire's investments means that Buffett's business expertise tends to be overlooked.
Despite what some people think Berkshire Hathaway is not an investment trust. It is a conglomerate, with a strong focus upon insurance, and much of its growth has come from Buffett's business expertise. As Buffett puts it, "I'm a better investor because I'm a businessman, and I'm a better businessman because I'm an investor."
So rather than pore over the latest gossip about what shares Buffett has bought or may be buying, investors can pick up some useful pointers by looking at his business activities.
An Early Start
Buffett started his business career, whilst in primary school, by selling lemonade and Coca-Cola. He soon ventured into the stock market, buying his first shares at the age of eleven, and over the next few years he added several paper rounds and regularly worked as a caddy at the local golf course (where he also sold golf balls which he found on the course).
Buffett's first share purchase demonstrates one of the most important rules of investing; in order to invest you must first obtain capital with which you can invest. The vast majority of us are not natural entrepreneurs like the young Buffett so the best way for us to obtain capital to invest is to spend less than we earn and save the difference.
In his mid-teens Buffett set up the Wilson Coin Operated Machine Company with his friend Don Danly to lease pinball machines to local businesses. To assuage any concerns that their customers might have had about their age the pair of them pretended that they worked as hired hands for "Mr. Wilson" who made all the decisions.
The Activist Investor
In his late twenties Buffett was running a hedge fund out of his house in Omaha. Buffett was a very active investor and on several occasions his fund bought controlling stakes in a company in order to make some major changes to the company; which usually involved replacing some or all of the senior management.
One of the most notable cases was when he purchased the loss-making Dempster Mill Manufacturing, a firm which made windmills and farm implements. Buffett replaced the senior manager with his own man who then proceeded to implement a big cost-cutting programme which involved losing more than a hundred jobs. When he was asked how he could sleep at night after the mass sackings Buffett remarked "If we'd kept them the company would have gone bankrupt."
Dempster's profitability improved dramatically after these changes and soon it started sending large amounts of cash to Buffett for him to deploy elsewhere. A few years later he sold Dempster for three times what he had paid for it!
From Buying Shares To Whole Businesses
Buffett prefers businesses with what he calls a "moat"; a feature of the business which provides strong protection against competition. The most common types of moat are a strong brand name or having some form of a monopoly.
What happened after Berkshire bought the Buffalo Evening News in 1977 is very instructive. Before the takeover there had been a truce with the other local paper, the Buffalo Courier-Express, which meant that amongst other things the Evening News didn't produce a Sunday edition. Several years later, after putting out a Sunday paper and engaging in a ferocious price war, the Courier-Express folded which left the Evening News with its local monopoly.
However, after many years of earning substantial profits, the Evening News has seen its moat torpedoed by the internet, other media and the likes of Craigslist and eBay who have eaten into the classified advertising market.
Today's Berkshire has become so large that small share purchases can't have anything like the same effect upon the company's overall performance as they did in the past. So Buffett is looking more and more to acquire entire companies, as seen with the recent $34 billion deal to buy the 77% of the Burlington Northern Santa Fe railroad that Berkshire didn't already own.
A Look At The Future
Buffett was recently asked on CNBC whether he'd be interested in buying General Motors if it ever returned to the stock market. His reply was that he whilst he was certain that Americans would be driving lots of cars in ten years time he'd prefer to be insuring cars rather than betting upon who is going to be making them.
Taking a ten-year view forms a major part of Buffett's attitude towards business; he likes to visualise the state of a company's markets in ten to fifteen years time. If he can't get a good picture, he won't buy. This is the reason why he avoids high-technology companies, particularly those in the computer business, because their markets are prone to disruption from new products and technologies, many of which will be totally unforeseen.
Buffett prefers companies which are easier to predict such as Wal-Mart and Tesco (LSE: TSCO), both of which will still be selling food in ten years time, and consumer goods companies of the likes of Coca-Cola and Proctor & Gamble which also have predictable markets.
So if you want an insight into the future, look at what businesses Berkshire is buying and consider what this means for the next decade. For example, Berkshire's purchase of Burlington Northern tells us that Buffett sees the future prospects for moving goods over long distances around North America as being far better for trains than for trucks.
That's good news for the railways but bad news for Rubber Duck and his fellow truckers.
More from Tony Luckett:
> Tony owns shares in Berkshire Hathaway
