Monday, October 17, 2011

Buffett on Buying "Small Pieces of the Best Businesses": Berkshire Shareholder Letter Highlights

From Warren Buffett's 1995 Berkshire Hathaway (BRKa) shareholder letter:

The Story of the Man with an Ailing Horse
Visiting the vet, he said: "Can you help me? Sometimes my horse walks just fine and sometimes he limps." The vet's reply was pointed: "No problem - when he's walking fine, sell him." In the world of mergers and acquisitions, that horse would be peddled as Secretariat.

Acquisitions vs Passive Investments
...we face the inherent problem that the seller of a business practically always knows far more about it than the buyer and also picks the time of sale - a time when the business is likely to be walking "just fine." 

Even so, we do have a few advantages, perhaps the greatest being that we don't have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners. In doing that, we always mentally compare any move we are contemplating with dozens of other opportunities open to us, including the purchase of small pieces of the best businesses in the world via the stock market. Our practice of making this comparison - acquisitions against passive investments - is a discipline that managers focused simply on expansion seldom use.

Talking to Time Magazine a few years back, Peter Drucker got to the heart of things: "I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work . . . dealmaking is romantic, sexy. That's why you have deals that make no sense."

The seller of an entire individual business usually knows far more about the company than the buyer and will put it up for sale when it's most advantageous for the seller.

The "For Sale" sign usually goes up at a time when business conditions are most favorable...to the seller.

So an excited and, at least at times, emotion-driven acquirer meets informed and disciplined seller of an entire business. Once a deal gets in motion the process takes on a life of its own whether it makes sense or not.

The result frequently being "silly purchase prices".

In contrast, the price available for "small pieces of the best businesses" tend to swing wildly above and below intrinsic value in an often emotional and increasingly algorithm driven short-term oriented stock market. The situation, reversed. In this case, an informed and disciplined buyer has little difficulty finding sellers that are less so.

Which scenario is more likely to create better opportunities for a buyer?

Adam

Long BRKb
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