How Warren Buffett Became Wealthy
When you hear the name Warren Buffett, it is usually followed by Berkshire Hathaway and his $83 billion net worth, but we rarely get any history on how it all started. We know he's the world's greatest investor, but many don't know the investments that got Buffett to where he is today. So we've taken a look at some of the most important investments of Warren Buffett's career as a professional investor.
Warren Buffett started investing a young age, he admits that his father - who was a stock salesman - had a very strong influence on him. In addition to understanding the concept of investing at a young age Buffett also understood the concept of compounding interest at a young age, which I believe is the second reason behind his ability to value assets for his success in the market. At 11 years old Buffett along with his sister made his first stock investment buying six shares of Cities Service. From a young age he had been interested in making money. He had a paper route and sold coca-cola and gum door-to-door. In his teens he purchased a farm and hired a farm hand, and the profits from the farm investment paid for his college education.
In the mid 50s Buffett started his limited partnership with a little over $100,000. He states that he had only contributed $100 to the limited partnership. By the early 60s the limited partnership had an excess of $7 million. With this amount of capital at his disposal Buffett made his most influential investment and the one he feels may be one of his worst investments.
Berkshire Hathaway, Buffett's Most Influential Investment
Berkshire Hathaway (BRK.A) wasn't always the holding company it is today. Founded in the 1830's as Valley Falls Company it later became Berkshire Fine Spinning Associates in the 1920s, and then Berkshire Hathaway after a merger with Hathaway Manufacturing Company in 1955. These company's were mainly textile companies. Warren Buffett made an investment in Berkshire Hathaway in 1962, considering it to be a "statistically cheap stock in a terrible business." The company wasn't doing very well at the time of Buffett's investment, but he purchased shares anyway in hopes to make a quick profit from Berkshire Hathaway's tender offer of it's shares. Berkshire Hathaway's management at the time asked Buffett at what price he would tender his shares, he replied $11.50. Months later Berkshire Hathaway made a tender offer for the shares at a price of 11 3/8th or $11.375. Upset by the 1/8th he was short changed, Buffett bought more Berkshire Hathaway shares and by 1965 he had a controlling interest of the company. Charlie Munger, Warren Buffett's business partner described the controlling of Berkshire Hathaway as an accident, and believes had management not tried to cheat Buffett out of an 1/8th or $0.125 there would be no Buffett/ Berkshire Hathaway as we know it today. Eventually Berkshire Hathaway was transformed from a textile company to an investment conglomerate. As Buffett was shaping the new Berkshire Hathaway he set his sights on newspapers and insurance companies.
Newspapers, Media, and Insurance
Up until the late '90s the newspaper business was a good business to be in if managed properly. Buffett seeing a good deal in The Washington Post Company started investing in the company in 1973. It wasn't the first newspaper he had invested in but it was the largest. In 1978 Warren Buffett invested in the American Broadcast Company (ABC), and in 1985 he invested over $500 million in to Capital Cities to help the company with its purchase of ABC. The deal gave Buffet a 25% ownership stake in Capital Cities/ABC. In 1995 Disney purchased Capital Cities/ABC for $19 billion netting Warren Buffett another huge investment profit. Buffet started investing in insurance in the 50's first purchasing GEICO's stock in 1951. Under Warren Buffett Berkshire purchased National Indemnity Insurance and National Fire and Marine Insurance in 1967. He purchased more Geico shares in the 1970s, and in 1995 he purchased the 49% he didn't own making GEICO a fully owned subsidiary of Berkshire Hathaway. By the late 1960s it was safe to say Warren Buffett understood how to invest successfully, and when you understand how to make good investments, what you crave the most is more money to invest. Insurance companies solve this problem almost instantly because they have lots of cash. When the public pays its premium to an insurance company, the premiums are pooled and invested, this money is referred to as the float. Money is withdrawn from the float to pay claims and expenses, and any unused money is put back into the float to be invested. This makes sense as to why Berkshire Hathaway owns as many insurance companies as they do, giving Buffett access to tons of investment capital.
Coca-Cola, From a Billion to Billions
In 1988 Warren Buffett set his sights on Coca-Cola (KO). In '88 Coca-Cola was trading at under $3 per share. Hard to believe that in 1988, Coca-Cola, a brand name recognized around the world was selling for under $3 per share. Over time Warren Buffett accumulated 7% of the outstanding Coca-Cola (KO) shares. So what warranted Warren Buffett investment in Coca-Cola? Well here is how he explained it during a speech at Notre Dame in the 90s:
“We have 7% of Coke. There are 660 million eight ounce servings of Coca Cola products being served around the world today, so in effect, we’ve got a 45 million soft drink business with our 7%. We think of businesses that way. I say to myself ‘just increase the price a penny and that’s another $450,000 a day for Berkshire.’ I mean, it’s a nice sort of thing. When I go to bed at night I figure that by the time I wake up 200 million Cokes will have been consumed.”
Coca-Cola went on to be one of Berkshire Hathaway's most lucrative investments.
Investment Regrets, You Have to Lose a Few Million to Make Billions
In 1993 Warren Buffett made a $433 million investment into Dexter Shoes. Buffett has called this a bad investment for several reasons. First, he used Berkshire Hathaway stock to purchase Dexter Shoes. Secondly he admits that Dexter Shoes didn't have the competitive advantage or "moat" that he usually seeks in an investment. Dexter Shoes stopped making shoes in the United States and Puerto Rico in 2001 forcing Buffett to roll the company into another shoe company owned by Berkshire Hathaway. In the 2014 letter to shareholders Buffet stated that the $433 million worth of Berkshire Hathaway stock used for the Dexter Shoe purchase was worth $5.7 billion. That was just one of several investment regrets Warren Buffett has discussed. Buffett admitted in the 2014 letter to shareholders that an investment in U.K. grocer Tesco cost Berkshire Hathaway a loss of $444 million after taxes.
Berkshire Hathaway Stock, The Driving Force of Warren Buffett's Net Worth
Ultimately the answer to the question of how Warren Buffett became wealthy is Berkshire Hathaway. The driving force behind Buffett's astronomical net worth is Berkshire Hathaway's Class A stock, the most influential investment made by Buffett. Buffett started buying Berkshire Hathaway's stock in 1955 at $7.50 per share, and as we discussed earlier he invested more money into Berkshire Hathaway in 1962 with hopes of cashing out at $11.50 per share, but that didn't go as planned. Jump forward two decades to the early1980s with Warren Buffett in full control and its textile days long behind it Berkshire Hathaway's stock was trading at over $300 a share. In 1990 the stock reached $8,700 per share, in 2000 the stock price reached $56,000 per share. In 2010 Berkshire Hathaway's Class A stock was trading at over $99,000 per share, and it currently trades at $298,770 per share at the time of this writing. According to InsiderScore Warren Buffett still owns over 250,000 shares of Berkshire Hathaway Class A stock. If we assume that Buffett has exactly 250,000 shares of Berkshire Hathaway at its current price that is $74 billion of Berkshire Hathaway Class A stock owned by Warren Buffett. As Berkshire Hathaway's stock continues to increase so does Warren Buffett's net worth.
What the Average Investor Can Take Away
1. Have an investment plan.
The investment in Berkshire Hathaway in 1962 was made with the hopes of a profit from Berkshire's tender offer. While it didn't work out as planned, there was a plan. Too many investors lose money because they don't have a plan.
2. Once you know what you're doing go all in.
This pertains to investments and everything else in life. Warren Buffett was comfortable with the world investments at a young age. He found something he liked to do, he put forth the effort to become good at what he liked to do, and then he put everything he had into it.
3. Know the business you're investing in.
This ties in with number one and having a plan. Buffett's explanation of why he purchased coca-cola shows that he knew what he was investing in. This kind of "know your business" investing can help the average investor see above average returns.
4. No investor, not even the professionals are perfect
Even Warren Buffett took a few losses, but he still remains the worlds greatest investor. You don't have to bat a thousand to be a good investor. Another lesson that can be gained from Buffett's losses is to stick to the investment plan. After the loss in Dexter Shoes Warren Buffett admitted that the company didn't have the competitive advantage he usually looks for, yet he invested in the company any way. Nothing hurts more than when something goes horribly wrong because you didn't stick to the plan.
What we Learned
This is an abbreviated story of how Warren Buffett from Omaha, became Warren Buffett one of the richest men in the world. What we learned about Buffett through some of his most significant investments is don't attempt to short change him, not even out $0.12 per share. The takeover of Berkshire Hathaway shows how ruthless he can be when he feels he's been shortchanged. We also learned to think of investing not as a stock certificate or a company name with a price moving up and down on our phones or computer screens, but to think of it as our piece of the business. Whether we own 1 share of McDonald or 1000 shares, as a share owner we are in the burger business. As investors it is important to understand what business or businesses we're getting into. We also learned that someone doesn't accumulate an $80 billion plus net worth without making some mistakes along the way. Dexter Shoes and Tesco were just two of several regrettable investments made by Buffett. However these investment's should be a lesson to the average Joe or Jane investor that you don't have to hit a home run on every investment to be considered a successful investor.
This is part one of our look at Warren Buffett. In part two we will look at a few of the criteria Warren Buffett uses and has used to make his investments.
Thanks for checking out the Seville Report may your next investment be your best investment.