Warren Buffett Quotes

Why Warren Buffett invested in Nebraska Furniture Mart (NFM). The Warren Buffett Nebraska Furniture Mart investment was made over a handshake.

Buffett acquired an 80% stake in Nebraska Furniture Mart for $55 million in 1983; the remaining 20% belonged to members of the Blumkin family, who were also responsible for managing the company even after the purchase. Buffett wants his managers to think like owners to ensure that business decisions are made in shareholders’ best interests – giving them actual ownership of the company will be the best way to make this happen.

There are many things that Buffett liked about Nebraska Furniture Mart, including the fact that it was home-grown, from his beloved Omaha:

First, it was run by Mrs. B or Rose Blumkin, an extremely hard-working woman who worked 7-days a week and had impeccable integrity. Her motto: ‘Sell cheap and tell the truth’. Although she never learned to read or write English, she was a hard negotiator and was able to build up an incredible business that had yearly sales of $500 per square foot when Buffett purchased the company. The Warren Buffett Nebraska Furniture Mart investment revealed that it is impossible to judge others simply by their educational backgrounds. Many sound investments can be made with people who have never had the chance to go to college.

Second, Nebraska Furniture Mart had exceptional operating efficiency. Nebraska Furniture Mart’s operating expenses as a percentage of sales was 16.5%. In contrast, one of the other industry players, Levitz, had operating expenses as a percentage of sales of 35.6%. By being the most efficient operator, Nebraska Furniture Mart has more clout in the market and with its suppliers, which in turn improves its long term profitability.

Why Warren Buffett invested in GEO. The Warren Buffett GEICO investment was a home-run for Buffett. Here’s why and how. Buffett made purchases of GEICO in 1976, 1979 and 1980 at an average price of $6.67 per share; he owned 33.3% of GEICO by 1980, and eventually, the entire company by 1986. (As a point of reference, after-tax operating earnings per share had risen to $9.01 by 1987.)

GEICO made costly business mistakes that nearly bankrupted the company. In the early 1970s, GEICO managers made serious errors in estimating their claims costs, leading the company to significantly underprice its policies and almost go bankrupt. The company was saved only because Jack Byrne came in as CEO in 1976 and took drastic remedial measures.

One of these was reversing the strategic direction of the company. GEICO had made a mis-step in aggressively seeking growth by casting its net wide and insuring almost any driver that wanted insurance; this led to the insuring of drivers that were much more accident-prone and hence financially costly. Instead, GEICO needed to step back to what it was good at: insuring only preferred drivers at low cost via direct mail.

Buffett took interest in GEICO again after Jack took over, because he believed in Jack and in GEICO’s fundamental competitive strength.

Investing in GEICO’s Competitive Advantage

GEICO’s competitive advantage lay in its extremely low operating costs. This set the company apart from hundreds of competitors that also offer auto insurance. This was the most important component of GEICO’s moat, as low-cost is often the most important factor someone looking for car insurance would consider. The lower GEICO’s cost relative to its competitors, the wider the moat GEICO enjoyed.

In addition to low cost, the other factor that a car owner looking for an insurance policy would consider is service. Service is a qualitative factor that can be evaluated in many ways, but two of the ways Buffett identified were the number of voluntary auto policies, and the complaint ratio.

GEICO performed well on both these metrics – it had high numbers of voluntary auto policies relative to its competitors, and its complaint ratio was the lowest among the top 5 auto insurers. This allowed it to generate high return on invested capital, making GEICO an excellent Warren Buffett investment.

Why Warren Buffett invested in Illinois National Bank. The Warren Buffett Illinois National Bank investment was one of Buffett’s first investments in financial services firms. Buffett acquired 97.7% of the stock of the Illinois National Bank in 1969. The bank was founded by Eugene Abegg without outside capital, from humble roots of $250,000 of net worth and $400,000 of deposits in 1931. These swelled to $17 million of networth and $100 million of deposits by 1969.

One of the conditions Buffett laid out in his purchase was that Abegg continue as Chairman. This is a characteristic pattern in many of Buffett’s investments. Unlike some aggressive private equity investors who may try to replace its target company’s management, Buffett often insists on keeping the current management intact; he also gives his managers enormous leeway in running their businesses and encourages them to run their businesses as if they were the owners, for that has been proven to be the best way of generating outstanding business performance.

There were several reasons that made this Warren Buffett Illinois National Bank purchase worthwhile:

First, the bank led the industry in earnings as a percentage of total deposits. When Buffett made the purchase, the bank made $2 million in operating earnings in 1969. As a percentage of total deposits and of total assets, this was close to the top even among significantly larger commercial banks in the US. While the Illinois National Bank earned 2% on total assets, the average bank earned only about 0.5%. Its net margin was 27%, while its competitors averaged 7%.

Second, the bank was run in a financially conservative manner. It avoided money market borrowings, and did not use borrowed funds except for reserve balancing transactions that occurred infrequently. The bank also maintained a liquidity position that was significantly above average.

Third, the bank recorded loan losses significantly below average. Its loan policy produced a net charge-off ratio in last two years of about 5% of that of the average commercial bank.

The Warren Buffett Washington Post (NYSE: WPO) investment was a well-placed bet on a business with a wide moat and a strong competitive advantage. Buffett purchased 1.7 million shares of Washington Post at approximately $6 a share in 1973 – this $10.6 million investment made Berkshire Hathaway the second largest shareholder in the Post, second only to the Graham family.

Although the Post was founded in 1877 and had many years of operating history, it only went public in 1971 and was immediately beset with poor performance on the stock market.

What made Washington Post a Warren Buffett Investment

Buffett bought into the Post for several reasons:

First, his personal interest in journalism. He once remarked that had he not found his calling in investing, he would probably have become a journalist. He also worked for the Post as a paperboy when he was a teenager, and saved up much of his initial investment capital that way.

Second, the Post had monopoly-like characteristics. It was the dominant newspaper in Washington, D.C., and had a strong brand-name that was very well-respected nationally.

Third, the Post was selling for cheap during the 1973-1974 stock market slump. Despite going public at $6.50 a share, the Post had dropped to $4 a share. Buffett remarked in a talk to Columbia Business School students that the Post was probably worth about $400 million then, and anyone in the business would probably agree. Yet, the Post was selling for only $80 million when he made the purchase.

What subsequently happened is a reminder that succeeding as a value investor requires a long time horizon. Short-sightedness will not be rewarded. The Post continued to decline in value over the two years after Buffett made his purchase – the value of his investment fell by almost 20 percent. It took three years for the Post to finally gain enough in value to move past Buffett’s initial purchase price. After that, however, the Post proceeded to compound at almost 16% a year, making it one of Buffett’s most profitable investments.

The Warren Buffett See’s Candies investment is one of Buffett’s favorite investments and one that he often talks about in his shareholder meetings. Buffett acquired See’s Candies in 1972. He paid $25 million for See’s on sales of $30 million and pre-tax earnings of less than $5 million.

See’s Candies is an example of a business that enjoys a wide moat as a result of its brand name and share of mind.

See’s Candies’ Mind Share

As Buffett describes in a Q&A session with business school students at the University of Florida, “There was something special. Every person in California has something in mind about See’s Candies and overwhelmingly it was favorable. They had taken a box on Valentine’s Day to some girl and she had kissed him… See’s Candies means getting kissed. If we can get that in the minds of people, we can raise prices.”

This brand value gives the company significant pricing power – under Buffett’s direction, See’s Candies has consistently raised its prices after every Christmas. When Buffett bought the company, its candy was priced at $1.95 a pound. By 2011, they are priced at $20.40 a pound. The product is price inelastic because buyers would not skimp on a few dollars to buy a lesser-known or unknown brand for their loved ones.

High Return on Invested Capital (ROIC) business

See’s Candies also requires little additional capital investment to keep up with sales growth. This allows the business to generate attractive returns on capital. As Buffett describes in his letter to shareholders in 2007, two characteristics of the business made it very capital efficient – “First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories.”

Buffett noted that since making its $25 million purchase in 1972, Berkshire had only invested an additional $32 million between 1972 and 2007. Yet, See’s Candies generated $1.35 billion dollars in total pretax earnings for Berkshire over those 35 years, allowing Buffett to make many times his original investment even after deducting taxes.

The Warren Buffett national indemnity investment allowed Buffett to gain an important foothold in the insurance industry. Buffett used cash generated by his textile operations to fund entry into the insurance business by purchasing National Indemnity Company in 1967.

Insurance companies are attractive because of their float, or cash with a near-zero cost of capital, that comes from the insurance premiums insurance companies collect every month.

There were also tax benefits to doing so, for corporate income tax rates are typically lower than personal income tax rates. Thus, using insurance companies as investment vehicles lowers the tax Buffett has to pay on capital gains.

Nonetheless, Buffett had to weigh the pros and cons of this investment carefully. He observed that National Indemnity Company did not appear to have any attributes that would help it overcome the industry’s chronic troubles – it was not particularly well-known, had no informational advantage over its competitors and was not a particularly low-cost operator.

However, the one crucial factor that differentiated National Indemnity Company and that Buffett very much liked was its managerial mindset – the company had a unique managerial mindset that most of its competitors would find impossible to replicate. It was not afraid of shrinking volume – its policies were consistently priced to make a profit rather than to match that of its most optimistic competitor. In other words, National Indemnity Company had a strict underwriting discipline that was not easily swayed by market competition.

In the industry, the urge to underwrite aggressively is difficult to overcome, as the consequences of poorly underwritten policies may not become apparent for some time. In fact, reported earnings will be overstated in the short-term, and many years may pass before the true costs of aggressive underwriting are revealed.

National Indemnity Company overcame this urge by promising its workforce that no one will be fired because of declining volume, however severe the contraction. This company policy also implies that it has to be especially careful to avoid overstaffing when times are good. The human resource department has to evaluate each hire very carefully, for each hire may stick around for a lifetime despite making only marginal contributions.

The Warren Buffett National Indemnity investment was arguably an important strategic move for Warren Buffett.

Why did Warren Buffett invest in Disney (NYSE: DIS)? The Warren Buffett Disney Investment has paid off handsomely. Buffett first invested in Disney in 1966.

Disney is a diversified worldwide entertainment company. It has five operating segments:

1. Media Networks – this operating segment manages the ESPN, Disney, ABC Family and SOAPnet networks. These cable networks make money from fees paid by cable providers and in some of its networks, sales to advertisers.
2. Parks and Resorts – this operating segmentmanages a variety of parks and resorts around the world, including the Disney World Resort in Orlando, Florida (25,000 acres), Disneyland Resort in Anaheim, California (500 acres), Tokyo Disneyland and DisneySea (500 acres), Disney Resort & Spa in Hawaii, and the Disney Cruise Line.
3. Studio Entertainment –this operating segment produces and acquires live-action and animated motion pictures, musical recordings and live stage plays. The segment serves the theatrical market, home entertainment market and television market.
4. Consumer Products – Disney has a variety of businesses under this operating segment: worldwide merchandise licensing (with properties such as Mickey Mouse, Cars, Winnie the Pooh, Toy Story and Disney Fairies), Disney Publishing (which publishes children’s books and magazines), Disney Retail (which operates Disney retail stores).
5. Interactive Media – This operating segment creates and delivers branded entertainment and lifestyle content such as games based on the company’s studio entertainment productions.

Disney’s Competitive Advantage

Even more so than American Express, Disney carries enormous brand recognition around the world. The Disney brand name was worth an estimated $29.1 billion as of 2011 and was ranked the 9th most valuable in the world by Interbrand. Disney has been able to capitalize on this brand value in many of its operating segments.

Warren Buffett’s Investment in Disney

Disney was valued at only $80 million when Buffett bought his stake in Disney in 1966, although the company earned approximately $21 million in pre-tax earnings in 1965.

Buffett’s partnership made 20% on his Disney investment in a year, but in retrospect he regretted selling it so soon after, for he would have made much more if he simply held on. As he notes, “Had we kept it, that $5 million would have been worth over a billion dollars in the mid-1990s.”

Why did Warren Buffett invest in American Express (NYSE: AXP)? In the mid-1960s, Buffett bought 5% of American Express with 40% of Buffett Partnership capital (approximately $13 million). The Warren Buffett American Express investment has generated spectacular returns for the Oracle of Omaha.

Founded in 1850 as a joint stock association and incorporated in 1965 as a New York corporation, American Express is a multinational financial services corporation best known for its credit card.

American Express has four major operating segments:

1. U.S. Card Services – American Express has two major U.S. banking subsidiaries (Centurion Bank and AEBFSB). Its card business targets a premium customer case and strives to increase average spending per card instead of growth in mere number of cards. Its consumer travel business provides travel services and complements its core card business.
2. International Card Services – this operating segment issues and manages the company’s charge and credit cards around the world.
3. Global Commercial Services – this operating segment offers a comprehensive range of corporate card programs and business-to-business payment solutions.
4. Global Network Merchant Services – this operating segment focuses on broadening the company’s merchant base. It offers point-of-sale, servicing and settlement and fraud prevention services.

American Express’s Competitive Advantage

American Express’s competitive advantage stems from two key areas: its ‘spend-centric’ business model, and its brand.

AMEX’s Spend-centric business model

The company focuses on generating revenues primarily by increasing spending on its cards – finance charges and fees provide only asecondary source of income.

As American Express notes in its annual report, “average spending on our cards… is significantly higher on a per-card basis for us versus our competitors”. This means that American Express is more valuable to merchants, as it has a following of loyal customers that drive higher sales.

This generates a virtuous cycle that perpetuates the company’s competitive advantage: higher average spending per card allows American Express to earn premium discount rates, which combined with higher spending customers increases revenues for the company; the company can then invest in more attractive rewards and incentives for its customers, to generate an even stronger following.

Warren Buffett Liked the AMEX Brand

Few brand names are as globally recognized as the American Express brand name. Many published studies have rated the American Express brand as one of the world’s most valuable brands.

In 2011, Interbrand ranked American Express the 22nd most valuable brand in the world and estimated its brand value to be $14.97 billion. Similarly, Fortune ranked American Express among one of the 20 most admired companies in the world.

Warren Buffett’s Investment in American Express

The Warren Buffett American Express investment has paid off many times over, but when Buffett bought American Express, it was battered by an infamous salad-oil scandal, because of which American Express was held liable for $60 million in damages. Although this scandal had nothing to do with the business economics of American Express, Wall Street bailed for the exits. Buffett correctly recognized that the competitive advantage of American Express’s consumer monopolies was still very much intact and had nothing to do with the scandal. Indeed, the American Express credit card is honored in more than 180 countries around the world. The competitive advantages described above and the franchise value of the company was not impacted by the salad-oil scandal in any tangible way.

Thus, he proceeded to acquire 5% of American Express with 40% of his partnership’s capital at a cost of only $13 million.This investment has produced spectacular returns in hindsight.

Investing in Berkshire Hathaway

Warren Buffett’s partnership owned a majority stake in Berkshire Hathaway (NYSE:BRK.A) by 1967. Considering only its textile operations, this investment was a failure – the company consistently produced net losses; Buffett eventually had to liquidate the company, as he could not find a single buyer. However, Berkshire Hathaway could be seen as a strategic investment, as Buffett used the company’s working capital to make one of his first investments in insurance companies.

Berkshire Hathaway was originally named Berkshire Cotton Manufacturing Company, and incorporated in Massachusetts in 1889. It merged with Valley Falls Company, Coventry Company, Greylock Mills and Fort Dummer Mills in 1929 to form Berkshire Fine Spinning. Berkshire Fine Spinning then commanded significant market share – it contributed to 25% of American fine cotton textile production. Berkshire Fine Spinning then merged with New Bedford textile maker Hathaway Manufacturing Company in 1955 to form Berkshire Hathaway.

One of Warren Buffett’s Earliest Holdings

When Buffett purchased Berkshire Hathaway, it had an accounting net worth of $22 million. He later realized that its intrinsic business value was considerably less, because its textile assets were unable to earn returns that were in proportion to their accounting value. From 1976 to 1985, Berkshire’s aggregate sales of $530 million produced an aggregate loss of $10 million.

At first, Buffett thought that the business could be turned around by good managers. However, this anticipated turn-around never came about, despite occasional improvements in the secular business cycle.

Yet, Buffett remained in the business for several reasons:

First, the textile business was an important employer in many local communities and Buffett did not want to layoff workers unless absolutely necessary.

Second, Berkshire had management that Buffett greatly admired. Ken Chace was an excellent leader in many ways. He clearly identified the problems Berkshire needed to overcome, communicated them to Buffett clearly and was very enthusiastic in trying different remedy approaches.

Third, the unionized labor force was pleasant to deal with. Unlike other unions that may make unreasonable demands regardless of business conditions, Berkshire’s work force was cooperative and understanding in facing common problems.

Fourth, Buffett hypothesized that the business should still be able to average modest cash returns relative to investment. Buffett later realized that this was not true. Berkshire became an alligator that ate a lot of cash, and seemed to have unending losses in sight.

Buffett and his managers tried many things that did not work: they tried reworking product lines, machinery configurations and distribution arrangements; they also tried making acquisitions – Berkshire acquired Waumbec Mills in expectation of important synergies that could benefit both businesses, but nothing substantial materialized.

As Buffett writes in his shareholder letters, there were broad underlying economic forces that made a turnaround extremely difficult. The US textile industry in general was in secular decline. Textile was a commodity business competing in a world market with substantial excess capacity. There was a significant amount of foreign labor competition. Local textile companies found it extremely difficult to compete with foreign textile companies that were able to employ foreign workers paid a fraction of the US minimum wage. Furthermore, the highly competitive nature of the business meant that other competitors quickly copied cost-reducing capital expenditure investments; each investment initially appeared like winners with strong economic benefits, but competitive dynamics soon drove prices down.

In the end, Buffett decided that it was in Berkshire’s best economic interest to admit defeat and sell the business. Huge capital investment would have helped keep the textile business alive, but it was difficult to envision a turn-around scenario where the company would be able to generate significant returns on investment.

Here is the lesson Buffett took away from the entire episode: should you ever find yourself in a chronically-leaking boat, “energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks”.