Berkshire Hathaway in Principle #4 strives to own a diversified group of businesses that generate cash and have an above average return on capital. Their second preference is to have the insurance subsidiaries purchase marketable shares of stock of similar businesses or parts thereof. Furthermore, the price and availability of businesses and the need for insurance capital determine any given year’s capital allocation.
Now clearly this particular goal is unique to companies with large amounts of cash and little or no debt on the books. Although many people purchase stocks to buy into successful companies, few make the size of purchase which would constitute a majority stake in a company.
So lets take a closer look at Mr. Buffett’s statement for his Principle # 4. Consider first that Mr Buffett says that Berkshire Hathaway wants to own businesses that generate cash. In terms of owning companies, Berkshire Hathaway has 10 Insurance Businesses and 67 Non-Insurance Businesses. The insurance businesses range from consumer offerings, re-insurance, liability insurance for commercial enterprises and more. The 67 non-insurance businesses cover a wide spectrum from jet airplane share-ownership and airplane training technology to chocolate, world book, furniture, jewelry, ice cream, underwear, shoes, water systems, vacuum cleaners, energy companies, financial services and more. All in all the total number of employees in 2008 amounted to 28,188 for the insurance businesses and 246,083 for the non-insurance businesses. These companies have varying years of ups and downs in generating cash for Berkshire Hathaway holding company. The excess cash that these companies “throw off” goes to Berkshire Hathaway for Warren Buffett and Charlie Munger to invest. “Throw off’’ is a term that Warren Buffet uses in the 2008 annual report. I assume that he means that each of the companies that generate excess cash over and above their expenses or some profitability level goes to Berkshire Hathaway corporate.
Then he mentions the terms parts of businesses that generate ‘above average returns on capital”. By this I believe Mr. Buffett means purchasing shares in other companies that do well, as identified by him, on an annual basis overtime. Looking at the Berkshire line up for 2008, Berkshire Hathaway owns more than 64 % of the Marmon Company stock which in this year, is about the largest percent ownership of a stock holding that is on BH books. Now in 2010, his purchase of Burlington Northern Santa Fe is most likely his biggest purchase of an entire company.
Surprisingly enough though, this purchase does seem to run counter to Warren Buffett’s interest in acquiring debt free businesses. Since in this acquisition, a significant level of debt was acquired.
It seems that Warren Buffett is catering to some boyhood fantasies in making this sweepingly grand purchase of the railroad. Even Moody’s stock rating did trim Berkshire Hathaway stock to a AA- rating from a AAA.
Perhaps though this purchase is something that Berkshire Hathaway can handle though with no apparent afterthought. After all, what should they care about Moody’s rating, they barely blink an eye. Since Berkshire Hathaway has so many billions sitting in premiums from its insurance companies. They subsequently invest these and enjoy the income from these.