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The Berkshire Model - Why has it not been done more often since Buffett?


BargainValueHunter
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You'd think that such a successful strategy would inspire more imitators than Biglari:

 

He purchased Berkshire Hathaway, a dying textile mill. What began as a classic Graham value play became a longer-term investment when the business showed some signs of life. Cash flows from the textile business were used to fund other investments. Eventually, the original business was eclipsed by the other holdings. In 1985, Buffett shut down the textile business, but continued to use the name.

 

How come, for over 45 years, Warren Buffett has been one of the few to do this?  ???

 

On its surface, it seems too simple NOT to imitate!

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I feel as though plenty of people have done this. They just tend to focus on their circle of competence so it looks different. Buffett is most interesting because he has the widest circle.

 

I also think your thinking suffers from survivorship bias.

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I wrote a short book on this, but here is my theory as to why (and Biglari is not 100% on the same page in terms of trying to imitate Buffett) there are very few copiers.

 

1) You almost need control of a corporation to pull this off, as many boards will not allow the kind of capital allocation that Buffett has done.  This probably knocks off 75% - 90%+ of all publicly traded companies.

 

2) You need to have confidence and a knowledge of other businesses

 

3) The time frame is different (1960's vs. now), so maybe harder to get deals done.  Also, more competition from hedgies, PE, etc.

 

4) Information is more readily available to the masses, disadvantage to a Buffett wanna be who exploits value.

 

That being said, I can't think of 1 GD reason that he isn't imitated.  The same level of success may not be there (99% chance it won't), but the model is fantastic!  Simple.  Very simple.  Note the following:

 

1) Centralized management with less than 40 employees (flat org. structure)

2) CEO of investments also CEO of risk management (this is critical, think AIG)

3) Small CEO pay - keep profits in company and growing

4) Maintain capital - no wasteful dividends and buybacks (why...b/c capital can be reinvested at higher rates of return)

5) Model allows for capital to flow to BEST source at all times (and best source may equal cash and patience)

6) Float - hmmm....this may have something to do with BRK success

7) Integrity

8) Ability to negotiate from position of strength!  

9) Preferance for boring businesses

 

Biglari is very interesting...he may follow 1,2,4,5,6,9 - maybe 8.

 

NO WAY JOSE on 3 and 7!

 

 

 

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I feel as though plenty of people have done this. They just tend to focus on their circle of competence so it looks different. Buffett is most interesting because he has the widest circle.

 

I also think your thinking suffers from survivorship bias.

 

Allow me to qualify what I originally meant:

 

I'm not asking why there isn't another Buffett.

 

I just find it hard to believe of the thousands of dying public or private businesses around the country and the thousands of insurance or asset allocation professionals in the U.S. only a few have even had a little success with this method.

 

I'm thinking about the business development companies, SPACs and even family offices.

 

Looks like its just another reason to celebrate Mr. Buffett and his unique talents!

 

 

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The biggest impediment, IMO is the fact that to get enough control of a company that can be used as the shell of the holding co / provide the float, you are basically forcing your investors to accept a pretty concentrated position. So I think that having the right investor base is really important and it's hard to get.

 

Look at how difficult it is for Biglari to acquire FMMH. There aren't a whole lot of great insurance businesses that can be acquired by a small fund and in insurance, you usually need to find a great company.

 

The people who come closest are also ones that made their money outside of the funds they run. Carl Icahn and Loews come pretty closest (Loews more so than Icahn). Nelson Peltz has a holding company of sorts.

 

Greenlight instead seems to have started a reinsurance business which they then have contracting them to provide the investment expertise.

 

Bill Ackman tried to have a public vehicle back when he ran Gotham and investors balked because they were going to be left with a combination of illiquid companies (golf courses + others).

 

Mark Schwartz of Newcastle has his fund controlling an insurance biz (HALL) which then controls a fast food franchise biz (PZZI)

 

I've probably missed some people, but those are the ones I can recall off the top of my head.

 

 

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A lot of insurance companies try to use a similar model, but they are not good at investing. Look at Allstate for example. They have a lot of float to work with, and have been simply bad investors over the year. Tons of tech companies use their cash to purchase other companies, but many of them are also pretty bad at it.

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DCG - not that I disagree, but do those companies maintain a flat organization structure?

 

Tech is a little different than Buffett.

 

I think people overthink sometimes too...Buffett is known to invest in durable companies - it eliminates a lot of issues you suggest and what other companies may not have learned.

 

Coke and P&G - not exactly rocket science

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Here is a candidate:

 

1) Smart asset allocator

 

2) Experience with investors

 

3) History of aquisitions

 

The drawbacks are he is kind of obscure and only has a small amount of capital to work with:   :P ::) ;D

 

http://www.bloomberg.com/news/2010-11-02/apple-piggybank-earns-0-75-return-as-investors-ask-for-payback.html

 

Apple Inc.’s piggybank, stuffed with $51 billion in cash and investments, is earning a lower return than a typical U.S. savings account. Some investors say Steve Jobs should put that money to better use.

Apple got a 0.75 percent return on the investments in the past fiscal year, according to a regulatory filing last week. The gain pales next to the roughly 10 percent investors would have earned from the Standard & Poor’s 500 Index and the Dow Jones Industrial Average over that time. Apple’s stock itself also was a much better investment, rising 60 percent.

 

Jobs, Apple’s chief executive officer, said last month that the company has a good track record of using cash, saying it’s holding money for one or more “strategic opportunities,” rather than a dividend or stock buyback. For some shareholders, the cash hoard is overkill, especially considering Apple added about $17 billion to its balance sheet last year, though they don’t want a big, overpriced acquisition either.

 

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The biggest problem in following WEB is that all need to feel that they are in control.  To follow WEB's system you must delegate and have the ultimate faith in your employees.  This isn't as easy as it sounds. I read somewhere that he doesn't even talk to his ceo's for months at a time.  Most folks just are too insecure to do this.  WEB also doesn't do "hostile" take overs.  I don't think Bulgari does "friendly" takeovers.

imho

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Graeme Hart

Albert Frere

Bernard Arnault

etc. etc.

 

In the past we had Floyd Odlum, Gurdon Wattles, Thomas Mellon Evans, Jimmy Goldsmith, Henry Singleton, etc. etc.

 

Though none of them used insurance as a form of leverage the way WEB does.

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You'd think that such a successful strategy would inspire more imitators than Biglari:

 

He purchased Berkshire Hathaway, a dying textile mill. What began as a classic Graham value play became a longer-term investment when the business showed some signs of life. Cash flows from the textile business were used to fund other investments. Eventually, the original business was eclipsed by the other holdings. In 1985, Buffett shut down the textile business, but continued to use the name.

 

How come, for over 45 years, Warren Buffett has been one of the few to do this?  ???

 

On its surface, it seems too simple NOT to imitate!

 

It's subtle but I would argue that everyone who is an investor is "trying" to do the same thing. Every shareholder of every company, every mutual fund, every hedge fund, private equity, anybody who is an investor...the only distinction is are you a public company or a private one? Berkshire is actually a bit of an anomaly. Buffett didn't have any problem raising money, just like any hedge fund has no problem raising private money - so if you can start an investment pool privately why go public? Going public is if you can't get the money privately or you need more than the appetite of any given group. This is a profoundly interesting question, in a world filled with money why is any company public?

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So if public companies offer owners liquidity, the purpose of the market is for owners to sell businesses, not buy them :) We should learn an important lesson here, use the market to cash out.

 

It makes sense, as is actually happening, that in a world awash with money, public companies are being taken private, and many are.

 

 

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Its many of the names listed in other similar threads.

 

What I want is a business lead by a strong capital allocator who owns a chunk of the business. Everything else is a value trade. For me he doesn't have to us float. There are 100s of businesses and as long as he is investing his capital along side mine, sees a margin of safety, understands the business, and either is Management or trusts Management then I am fine.

 

Companies like - L, SSW (though they screwed us on the preferreds), LRE, LUK, BYD.UN (owned a bit back and may rebuy), FUR, LRE, FFH, BDVSY. Even a company like ATSG may eventually get there given how they are doing in terms of running their business.

 

Buffett is a genius not because he uses float, but because he can understand dozens of different businesses and knows when to stay the hell away (Tech). Ashner knows realty. Why knock him because thats all he knows? LUK knows distressed. If a guy can make me money buying realty or land / distressed companies why the hell do I want them using float? If they can then great, but if not, I am not going to move on. Doesnt it all spend the same?

 

For me I want these companies, I want them quality, and I want them Cheap. If the Management is strong and smart I will even hold them when they are slightly overvalued (if I cant find much else) because a smart Manager will use expensive stock to buy stuff. I dont care if its in Insurance or not, as long as they know what they are doing and stick to their knitting.

 

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BYD is of much lesser quality than the rest. I used to work for CGX which was a roll up of print shops started by an accountant who used to work at Aurthur Anderson. Very interesting story. Not a high quality business, but one in a mom and pop space. The guy was able to roll up a decent chunk of the industry and became filthy rich off of it.

 

I sold BYD a few months ago for a decent gain, only to watch it move up 15% + dividends. It was sold to raise capital for doom and gloom and due to the fact that the new tax on trusts has eaten through some of the margin of safety. They have tax loss carryforwards but from a valuation perspective these will be eaten through and they will have to pay up 30% of taxes on earnings / divs. They keep buying assets though and will grow through this. I regret selling and may buy back should we see a sell off. I included it because Management owned a significant amount of stock last time I checked.

 

Business Background

 

Boyd Group is a multi-shop operator (MSO) of auto collision repair stores.  They are the largest MSO in Canada and among the largest in North America. They are a roll up business which is something that is very easy to understand. I believe they have a lot of growth options and should do well overtime.

 

Investment Description

 

○ Investment Analysis  - Boyd is a growing rollup organization in a highly fragmented industry. They distribute 27% of their earnings via distributions, have very low leverage, are reasonably priced at 6 - 7 FCF, and grow a bit each year. The only major downside I can see is 30% of their earnings will soon be subject to tax due to changes in the income trust lows.

 

Filter #3 – Does it have management I can trust? - This was written about 9 months ago. Sense then Management has grown on me. I like the way they talk about things and how they report. I also like the acquisitions they are making and the way they are being financed.

 

Management owns 17% of the stock and appears to have built a nice little company. They have been at the company a while and had 1 slight blow up with the Gerber acquisition. They seem to have learned their lesson and now carry very modest debt. I don’t really know Management, but so far I like what I see and they have skin in the game.

 

 

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/23468

 

http://www.boydgroup.com/i/pdf/2010AGMPresentation.pdf

 

I heard about it on a VIC writeup and liked the idea. Accidents happen and insurance companies like for owners to go to a dealer they know. Everyone knows someone who has taken the insurance company for a ride using their own repair guy (at least I do).

 

I like names like these and tend to collect and watch them (BOBS is another one, but its a fast food Brazilian growth story). The small cap ones get crushed when the market pulls back massively and I will be waiting to buy these owner managers. As long as they stick to their knitting.

 

---

 

Right now I feel that the market will be very volatile and I want to hold onto cash. Due to this my core group of owner managers focuses on ones which are overcapitalized and can invest counter cyclically. In a pullback they can buy low. FUR (though they keep running through cash), LRE (via buybacks), L (something like $4 billion in cash), FFH (will buy back one day), SSW (strong backer), LUK (as Parsad said, the elephant gun is reloaded) are the main ones I either own or will own soon.

 

I dont mind getting screwed. Its a part of life, but I have 2 rules - I wont to know how I got screwed so it doesnt happen again, and I would prefer for the person running the business to get screwed even more. I want him up at night worrying about not getting screwed so I can sleep peacefully. The only way that happens is if he has skin in the game. I know Prem thinks about FFH way more then I care too, and I like that.

 

I hope to have a sable of these, 10% cash, and a handful of deep value investments. Just have to get around to writing it all up and repositioning. The problem is I like my winners.

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On companies with the same model, a partial application of many of the same approaches is evident in little-known British-based global engineering specialist Halma plc (LSE:HLMA), which I've owned for 9 years. It's only a subset of the Berkshire model, in a narrow circle of competence and without any form of leverage (debt or float).

 

  • They stick to one field - engineering - and stick to niche markets where performance and quality are the drivers, not price, and their product is only a small part of their customer's budget, and they're No 1 in most markets.
  • Acquisitions are modest, fit the same model, and are done for cash and almost always enhance earnings from the start.
  • The leader isn't a superstar like Warren, but succession has been handled well.
  • While profits dropped during the recession, they remained profitable. Return on Tangible Invested Capital is well over 50%, and ROE, given the burden of goodwill, is mid-to-high teens.
  • They have a very flat organisation with a lot of autonomy at the subsidiary level. They do encourage cross-selling and collaboration, however.
  • They're debt averse, knowing it can blow up a company, and they pay a dividend, with 2x earnings cover at present. The dividend has over 30 years of risng more than 5%, and in inflationary times, much faster. In short you can sleep well ownng them.
  • They don't hedge currency risk.
  • They are geographically well spread
  • They're boring, in a good, profitable way

 

Net debt is about zero now, and when it rises the total is only a modest fraction of annual free cash flow. That's a key thing I'd watch for a shift in culture - if it gets higher to try and juice ROE I'll be looking for the exit.

 

My model suggests around a 10% IRR for an investor in the long run simply taking dividends, but buying and reinvesting dividends at good 'coupon' when it's offered by Mr Market could boost it considerably (I reckon 12-14% just through waiting to reinvest dividends when the price is right every 5 years or so).

 

Oh, and apparently some years ago a certain Mr Warren E Buffett sent them a letter applauding their structure and management, which is now framed on the wall of the boardroom.

 

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yes, WEB did write to them and yes, they do have it on the wall in their offices. I have seen it.

WEB also mentioned some years ago that Halma was the type of company that he would buy.

Problem is at this level I think it is fully appreciated in the market.

elltel

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Thanks for the confirmation, elltel. I agree it's fully priced now. At the lows of 150p/share in early 2009, it would probably have been a satisfactory buy, but any takeover bid would have required such a premium that it wouldn't have been such a good price, and any purchase over 3% would require Berkshire to register their intentions under UK listing rules and frankly <3% stake would barely move the needle at Berkshire.

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