Thursday, April 1, 2010
Buffett: Better Investor or Better Businessman?
Berkshire
Hathaway (BRK-B) Chairman and CEO
Warren Buffett has often written and said, “I am a better investor
because I am a
businessman and I am a better
businessman because I am an investor.” This is not unlike Buffett’s
mentor Ben Graham’s remark in The Intelligent Investor (and I am paraphrasing
here) that all investing will be successful to the extent that it is business-like. And
while I couldn’t
agree more with either of these
statements, it is true that Buffett is probably better known now more as
a businessman than
he is as an investor. This obviously begs the questions, if you had to pick one of these traits, would
you conclude that Buffett is a better businessman or is he a better investor?
Let’s first examine Buffett as an investor. For some time
now Buffett and the phrase value investing have become synonymous. He
studied under the father of value
investing Ben Graham at Columbia
University, worked for Graham at the Graham-Newman firm, and then after
leaving Graham’s
partnership, formed his own firm,
which ultimately became the foundation for Berkshire Hathaway.
Buffett’s partnership was not unlike most
modern day hedge funds. He pooled money from various individuals, and invested their money in what he deemed
to be undervalued securities and special situations. In his partnership letters Buffett referred to the
latter as “work-outs.” Similar
to many hedge fund managers of today, Buffett also didn’t
take any of the profits for himself
until he had earned a certain return on his investors’ capital each
year.
This is now known as a hurdle rate. Buffett’s compensation structure, though, was slightly
different from most of today’s hedge fund managers. Most
of today’s managers charge a management
fee (1 to 2 percent of assets) and
then a performance fee (typically 20 percent of the profits) over the
specified hurdle
rate. Buffett, on the other hand, charged 0 percent management fee, but took 25 percent of the profits
over his specified hurdle rate.
And
Buffett’s partnership results were
fantastic, handily trouncing most widely accepted benchmarks (Dow,
S&P, etc),
and tending to do much better in
down markets than in up markets. This success meant that
when most other
money managers were busy trying to
recoup losses, Buffett was able to further pull away from the pack. He
put fresh
capital to work during down markets,
thereby giving an even bigger boost to his long-term returns. Not
surprisingly, these results made Buffett fabulously wealthy by most standards.
Yet,
by the late 1960’s amid a massive bull market, Buffett began to have
trouble putting capital to work with
new ideas—and was also likely tired of the money management business in
practice—so
he eventually closed down his
partnership, and returned capital to his investors.
This action set the stage for the building blocks of what today is known as the
investment conglomerate, Berkshire Hathaway. While
running Berkshire, an old New England textile manufacturer,
was certainly more of an entree into
running a business, Berkshire’s early results were fueled by its
acquisition of
insurance company National
Indemnity. And insurance became Berkshire’s compounding
machine, as Buffett
became able to source capital and
low to negative costs, and invest it in undervalued securities—and
eventually wholly
owned business—with the benefit of
insurance leverage (investable assets as a multiple of equity).
Thus,
one would rightly argue, that in the first decade
of Buffett’s control of Berkshire,
the company’s growth was driven more by his prowess as an investor than
his
abilities as a businessman. In
fact, it wasn’t probably until the mid-1980’s, as more and more
of Berkshire’s earnings were
attributable to its wholly owned businesses that Buffett became known
more as a businessman.
Over
the ensuing years, this
earnings stream has become a bigger
and bigger component of Berkshire’s net worth, as the conglomerate now
owns everything
from utilities to insurance to
retailers to railroads. With this expansion, not only has
Buffett’s
reputation as a businessman grown,
but he has become a go to source for commentary on the state of
American—and in some
cases global—businesses.
And
while
I generally agree with his
reputation as a source of economic insights—and certainly follow his
commentary myself—given
his more than 60 years of studying
businesses, economies, and human behavior, as well as the fact that he
is seeing data almost
daily on all of Berkshire’s
businesses, I for one, still think his success is derived more from his
abilities as an
investor than as a businessman.
At
Berkshire, Buffett doesn’t run any of the businesses on a day-to-day basis. Nor does he individually
manage the thousands of employees that work in all of the Berkshire subsidiaries. In
addition, I do not
suspect that he regularly meets with
individual clients face to face, nor does he likely regularly meet with
regulators or
suppliers or any number of other
constituencies that most people running businesses (either large or
small) have to deal with
on a daily basis.
What Buffett does do--and he has repeatedly said this himself--is to make major
capital allocation decisions either in business acquisitions or in securities purchases. In
addition, his
schedule is relatively open, which
allows him to read a lot and to study other potential businesses that
might fit under the
Berkshire umbrella. Throughout his career, he has worked through other managers by encouraging them and
by giving them resources, and then sharing in their successes and failures.
And
most likely, that is Buffett’s strong suit, staying back and making
decisions,
rather than having to get his hands
deep in the mud like so many other businessman and leaders must do. To
that end, if you were to write a job
description for him, it would probably sound more like a securities
analyst than a typical
CEO.
Given
his track record and his
job description, I tend to think of
Buffett as a better investor than a businessman, though his investing is
very much as
Graham said, “business-like.” And
in a way, he selects investments for Berkshire in the same
way as he ran the Buffett
partnership. The main difference, however, is that Berkshire exists in
the public domain,
which in my mind has made people
more aware of him as a businessman, even though he seems to still be an
investor at heart.
I’d
love to hear your
thoughts on Buffett as a businessman
or Buffett as an investor, so please do send me any comments or
suggestions you may have.
Justin
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