This post 0 to Warren in Three Buffettisms appeared first on Daily Reckoning.
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…
Buffett-ism #1:
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…
Buffett-ism #2:
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 …read more
Source:: Daily Reckoning feed
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