0 to Warren in Three Buffettisms
Warren Buffett is one of the most successful investors of all time, and there have been countless articles, books, and studies written about his approach to building wealth.
But if you asked me to break down his philosophy into three simple ideas, this is how I would do it…
Seek out cash cows.
It’s no secret that Buffett loves insurance companies.
But why does he love them so much? Because they spin off huge amounts of cash!
Here’s how he explained it in his most recent letter to shareholders:
“Before I discuss our 2017 insurance results, let me remind you of how and why we entered the field. We began by purchasing National Indemnity and a smaller sister company for $8.6 million in early 1967. With our purchase we received $6.7 million of tangible net worth that, by the nature of the insurance business, we were able to deploy in marketable securities. It was easy to rearrange the portfolio into securities we would otherwise have owned at Berkshire itself. In effect, we were “trading dollars” for the net worth portion of the cost.
“The $1.9 million premium over net worth that Berkshire paid brought us an insurance business that usually delivered an underwriting profit. Even more important, the insurance operation carried with it $19.4 million of ‘float’ – money that belonged to others but was held by our two insurers.
“Ever since, float has been of great importance to Berkshire. When we invest these funds, all dividends, interest and gains from their deployment belong to Berkshire.”
Of course, insurance businesses are just one part of the cash generation game over at Berkshire.
The company’s other holdings also tend to kick off large earnings streams, which Buffett and company use to continue compounding their returns.
That brings me to…
Reinvest your cash whenever possible.
I’ve outlined all the reasons to reinvest your dividends (as well as other investment proceeds) before.
But Buffett illustrates the power of the approach on a grand scale. Here’s how he explained it back in his 2014 letter:
“Berkshire increased its ownership interest last year in each of its ‘Big Four’ investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of Wells Fargo (increasing our ownership to 9.2% versus 8.7% at year end 2012) and IBM (6.3% versus 6.0%). Meanwhile, stock repurchases at Coca-Cola and American Express raised our percentage ownership.
“The earnings that these four companies retain are often used for repurchases of their own stock – a move that enhances our share of future earnings – as well as for funding business opportunities that usually turn out to be advantageous.
“All that leads us to expect that the per-share earnings of these four investees will grow substantially over time. If they do, dividends to Berkshire will increase and, even more important, our unrealized capital gains will, too. (For the four, unrealized gains already totaled $39 billion at year end.)
I’d like you to pay particular attention to that last paragraph. Because the point is that reinvesting your dividends doesn’t just compound your future income potential, it also compounds your future capital appreciation potential.
And where does Buffett find most of his investments?
The “mother lode of opportunity resides in America”
Buffett has always been bullish on the United States, and he remains so right now.
I’ll let him explain:
“Late in 2009, amidst the gloom of the Great Recession, we agreed to buy BNSF, the largest purchase in Berkshire’s history. At the time, I called the transaction an ‘all-in wager on the economic future of the United States.’
“That kind of commitment was nothing new for us: We’ve been making similar wagers ever since Buffett Partnership Ltd. acquired control of Berkshire in 1965. For good reason, too. Charlie and I have always considered a ‘bet’ on ever-rising U.S. prosperity to be very close to a sure thing.
“Indeed, who has ever benefited during the past 237 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. And the dynamism embedded in our market economy will continue to work its magic. America’s best days lie ahead.”
Make no mistake: Buffett still believes there are big opportunities overseas, too. In fact, Berkshire has been making many important moves in foreign markets.
But to anyone who thinks the U.S. is no longer a fertile place to invest, Buffett says think again. And I agree!
So at the end of the day, building a quality portfolio can be as simple as buying solid, cash-rich American companies … reinvesting all the proceeds … and hanging on for the long haul.
To a richer life,
Editor, The Rich Life Roadmap