Warren Buffett’s Management Principles
In 1983, Warren Buffett merged Berkshire Hathaway with a company called Blue Chip Stamps controlled by Charlie Munger. At the time, Warren Buffet described 13 “owner related business principles” that will guide the investment decisions of Berkshire Hathaway. This post describes what these principles are and how they are applied.
1. Corporate form, partnership attitude
“We do not view the company itself as the ultimate owner of our business assets but instead view the company as the conduit through which our shareholders own the assets.”
Berkshire Hathaway is not a typical investment fund. A management company is not collecting fees for “assets under management”. There is no incentive for Warren Buffett to grow the size of the company to generate fees for himself.
Berkshire isn’t a cow that Buffett as manager will milk for his own benefit. Warren Buffett rides the ups and downs alongside other shareholders without special privilege other than voting control. He wants shareholders of Berkshire Hathaway to be his long-term partners.
“For our part, we do not view Berkshire shareholders as faceless members of an ever-shifting crowd, but rather as co-venturers who have entrusted their funds to us for what may well turn out to be the reminder of their lives”
2. We eat our own cooking
Warren Buffett has invested all his capital in Berkshire Hathaway. He is not hedging his bets. If Berkshire fails, so will he. Warren Buffett is “all-in” Berkshire.
“In line with Berkshire’s owner-orientation, most of our directors have a significant portion of their net worth invested in the company. We eat our own cooking.”
3. We measure per share progress
“Our long-term economic goal is to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per share basis. We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress.”
Simply making Berkshire Hathaway bigger does not necessarily create value for shareholders. If Berkshire were to acquire more businesses by issuing more shares, the size of the company would grow, but shareholders may be no better off.
4. Direct ownership is best
“Our preference would be to reach our goal by directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital. Our second choice is to own parts of similar businesses, attained primarily through purchases of marketable common stocks by our insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine any given year’s capital allocation.”
Warren Buffett would rather own a private business outright than part of a public one. Publicly traded stocks are useful for Berkshire’s insurance subsidiaries because those stocks provide liquidity.
5. Consolidated reports may reveal little
Because of the nature of Berkshire Hathaway’s portfolio of businesses, consolidated reports that regulators require may not reveal the true nature of the company. Warren Buffett pledges to communicate to shareholders in a manner that will illuminate the true state of Berkshire Hathaway.
6. Accounting consequences do not influence investment decisions
“In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains.”
Warren Buffett believes that the true value of a business cannot always be expressed by income statements and balance sheets. In fact, sometimes these statements will obscure the true value of a business. So, being able to understand the core nature of a business is crucial to determining its true value.
7. We use debt sparingly
“To finish first, you must first finish”.
Warren Buffett believes that financial engineering cannot replace sound business fundamentals. Besides, if individual Berkshire shareholders want to juice their returns, they could simply hold their shares on margin.
8. We will only do with your money what we would do with our own
“A managerial wish list will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders. We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolio through direct purchases in the stock market.”
Warren Buffett figures that if shareholders want a more diversified portfolio of investments, they can simply hold a wider portfolio of investments themselves. Berkshire Hathaway’s mandate is not to provide diversification, but superior long-term results.
9. Noble intentions should be checked by results
Warren Buffett believes that a good presentation does not replace actual results. The proof is in the pudding. If Berkshire Hathaway cannot obtain results that are better than investors can obtain investing in the S&P 500, then they might as well do so.
10. No shareholder dilution
“We will issue common stock only when we receive as much in business value as we give.”
Once again, Warren Buffett is acknowledging the primacy of shareholders. Stock in Berkshire, like any company, is a currency. Make acquisitions with shares at any price and this will dilute shareholders. The value of each share matters most to each shareholder’s return.
11. Never Sell a good business
This might be the most fascinating one of Berkshire Hathaway’s management principles. Warren Buffett might be the ultimate “buy and hold” investor. Once Berkshire owns a business generating returns, the company plans to own a business forever!
“Regardless of price, we have no interest at all in selling any good business that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations.”
Let’s unpack this last statement from Buffett just a bit more. He begins the quote by saying “regardless of price”. This means, owning a good business is more important than owning cash. If a good business is worth a certain amount of cash today, it will likely be worth a greater amount of cash in the future. So why sell? You’d just have to find another good business to invest in anyway.
Next, Buffett says that Berkshire is also “very reluctant to sell sub-par businesses” too. In some ways this might sound shocking to some investors. If you owned a crappy business, why wouldn’t you want to sell it? Well, think a little bit deeper. If buyers also understand the sub-par business sucks, won’t they simply want to buy it for a market price? So, you end up back to where you started. Having to find another business to buy with new cash. Why not just milk the cow you already own?
The key point about the “never sell” principle is that, as Buffett alludes to, he wants to avoid what he calls “gin rummy management”. Buffett wants to take the temptation to trade businesses off the table. Instead, he wants Berkshire Hathaway to focus on owning profitable businesses for the long-term. Only focusing on buying businesses frees up head space.
Look at it from another angle, if you forget about selling businesses then you double your time/resources/skills.
12. We will be candid in our reporting
“The CEO who misleads others in public may eventually mislead himself in private.”
Shareholder communications is important at Berkshire Hathaway.
13. We normally will not talk about our investment ideas
When Warren Buffett finds great investment opportunities, he will act in the best interest of Berkshire Shareholders by not disclosing insertions to the public.
How do you apply these Principles?
The average retail investor does too much trading. Many of us are constantly buying and selling stocks in our portfolio when we would be better off investing in profitable companies and holding them for the long-run.
Investors might also use Buffett’s principles to judge their own investment managers. How are your investment managers being compensated? Are they worth the fees you’re paying them? Are they constantly adjusting your portfolio by buying some investments while selling others? You might be riding along with your investment advisor for their benefit, not yours.
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Our investment philosophy is grounded in a buy-and-hold approach to investing. Although we don’t provide advice on which specific investments to make, we do provide advice on how to approach your investment portfolio. This includes being laser focused on ensuring your portfolio matches your goals, and that you have a written Investment Policy to guide your decisions.
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