When I have a lump sum to invest in stocks, I often think about how to invest like Warren Buffett. And when I do this, I usually come to the conclusion that the best way to do this is to invest with Warren Buffett.
As a result, I have more money in Berkshire Hathaway (NYSE:BRK.B) than any other business. Having a lot of money in one business brings risk, but it’s a situation that I’m very happy with.
It’s not just Buffett that I think makes Berkshire a great investment. It’s the way the company is run and the competitive advantage it has.
Investing like Warren Buffett
A lot of the time, investing like Warren Buffett is about working out which stocks to buy. It’s well known that the Berkshire Hathaway CEO has distinctive criteria for identifying stock opportunities.
Copying the Oracle of Omaha is difficult, though. There are two main reasons for this.
First, Buffett has (in my view) some unique attributes. Chief among these is his patience and temperament.
The secret behind Buffett’s investment success, as I see it, is his ability to wait for the best opportunities. That’s difficult for investors like me who haven’t been investing for 60 years.
Second is the fact that Buffett has access to a unique source of investment capital. The key to Berkshire’s success is the way that its insurance business generates cash.
Insurance
Berkshire Hathaway owns a number of insurance businesses. These work by collecting premiums in exchange for providing cover against risks.
One way for insurers to make money is by paying out less in claims than they make in premiums. But this isn’t their main source of income.
Insurance companies also invest the premiums they take in. This way they can generate returns before paying claims.
This means that its insurance operations give Berkshire access to capital to invest. When the insurance business collects premiums, Buffett can invest these to generate returns.
Berkshire’s big advantage
This structure is true of insurance companies in general. So why is Berkshire Hathaway so special?
Unlike other insurers, Berkshire invests its insurance premiums in common stocks and businesses. Other insurers typically invest most of their premiums in bonds.
Since stocks and businesses typically produce higher returns than bonds, this means that Berkshire outperforms its insurance competitors.
The next question is why Berkshire’ competitors don’t invest their premiums in stocks and businesses, rather than bonds? The answer is that they can’t.
Berkshire is able to maintain a big stock portfolio because of the huge cash reserves that protect its underwriting. Other insurance companies just don’t have this and it’s hard for them to generate it.
In order to build a big cash base, an insurer needs to take in a lot of premiums and invest them well. But in order to do that, they need a big cash base to protect themselves from losses.
This is why Berkshire Hathaway has such a big advantage over its competitors. There is risk associated with owning stocks over bonds and there’s risk of overpaying to acquire a business, but I think that Berkshire’s competitive position is unrivaled and it’s why I’m happy to invest a significant sum in the business.
