Warren Buffett's Best Buys

Warren Buffett's Best Buys

by Lenny Lubitz (Contact Author | Biography)
Investing like Warren Buffett is neither an art nor a science. Rather, it is a study of human nature and a willingness to follow a mundane path. As the Oracle of Omaha
has proved, boring does not equal unprofitable. His investments often
reflect the most basic products and services, ranging from consumer
goods like razor blades and laundry detergent to soft drinks and
automobile insurance. (For more on Warren Buffett and his current
holdings, check out Coattail Investor.)

A basic tenet of Buffett's strategy is to invest in companies he believes will provide a long-term value investment,
rather than investing in fads or technologies that may be profitable in
the short run but are likely to become obsolete in the foreseeable
future. His investments are guided by his famous words: "It's far
better to buy a wonderful company at a fair price than a fair company
at a wonderful price."

Choosing Investments With Long-Term Value
In
1987, Buffett famously stated, "I'll tell you why I like the cigarette
business. It costs a penny to make. Sell it for a dollar. It's
addictive. And there's fantastic brand loyalty." While he later stated
that the tobacco industry was burdened with issues that made him change
his opinion of it, this statement sums up Buffett's description of the
perfect investment. (To learn more about the value investing strategy
of selecting stocks, check out our Guide To Stock-Picking Strategies.)

Buffett's holding company, Berkshire Hathaway (NYSE:BRK.A), has a portfolio
that contains both wholly owned subsidiaries, such as Geico Auto
Insurance and Benjamin Moore & Co., and sizable blocks of shares in
publicly traded corporations. For example, Berkshire Hathaway is the
largest shareholder of both Coca Cola (NYSE:KO) and Kraft Foods (NYSE:KFT), brands that are ubiquitous throughout America's supermarkets. To find the most recent holdings look for the SEC form 13F.(Learn to assess the systems by which businesses make their revenue in Getting To Know Business Models.)

While
these investments are profitable, Buffett's most ingenuous picks were
his purchases of See's Candy and Gillette. Both were so seemingly
ordinary that they belied their market shares and their capacity to
generate profits that most companies only dream about. Let's take a
look at them in depth.

Example 1: See's Candy: The Perfect Business Model In 1972, Buffett purchased See's Candy from the See family for $25 million. See's has been around since 1921, and its stores, designed to look like they belong on Main Street in a traditional American village, can be found throughout the western United States as well in many airports. Their selection is neither trendy nor flashy; the company offers the type of fare that while not in style, also never goes out of fashion. Over the ensuing decades, Buffett invested another $32 million into the business. Since its acquisition, the seemingly nominal confection and retail manufacturer has returned $1.35 billion to its owners. What attracted Buffett to this investment? Primarily, it was a highly profitable business with extraordinarily attractive fundamentals. Its pretax earnings were 60% of its invested capital. As a cash business, accounts receivable was not an issue. As for cash flow, the rapid turnover of products combined with a short distribution cycle minimized inventories. Operating strategies, such as increasing prices before Valentine's Day, provided extra revenue that went straight to the bottom line. Thus, this seemingly nominal enterprise was a perfect business model. In addition to financing its own growth over the years, See's has proved itself to be a valuable cash cow whose profits offer Berkshire Hathaway another internal source of revenues with which to make other acquisitions. (For related reading, see Spotting Cash Cows.)

Example 2: Gillette: Another Great Success Story Gillette provides another example of Buffett's investment strategy. In 1989, Gillette was a company with core products that were so firmly entrenched in the marketplace that seemingly every household in America used them. Gillette's razors, and more significantly the razor blades that fit them, once provided 71% of the company's profits and held a huge market share as the top brand in the United States. The company's Papermate pens, pencils, erasers and Liquid Paper, equally lacking in glamour, were sold in every venue imaginable, from stationery stores to supermarkets to newsstands. White Rain shampoo, Rite Guard and Dry Idea antiperspirants, and Gillette Foamy shaving cream were all powerful name brands, which together represented $1 billion in sales in 1989. During the 1980s, the razor industry was shaken up as disposable razors initially took away a significant share of sales from Gillette. In 1988, Coniston Partners attempted a hostile takeover of the Gillette company. Gillette won that battle, and in 1989, the company redefined the industry with the introduction of the Sensor Razor, a product that appealed to men's desire for a high quality/high tech product and reinvigorated the company's sales and profits. That same year, Buffett stepped in with a $600 million purchase of preferred stock, making Berkshire Hathaway the owner of 11% of the consumer goods company, a seat on the board and a healthy $52.5 million annual dividend. Through the 1990s, Gillette's stock price gave Berkshire Hathaway a significant paper profit. In less than 24 months, the $600 million investment was worth $850 million. (Learn about the strategies corporations use to protect themselves from unwanted acquisitions in Corporate Takeover Defense: A Shareholder's Perspective.)

Patience Pays
Buffett's
modus operandi is to be patient, so he did not liquidate his holding
and take an immediate profit. Rather, he continued to demonstrate his
confidence in Gillette's management, even as the company invested
millions of dollars in research and development and acquired Duracell,
another classic American brand. In 2005, the acquisition of Gillette by
Proctor & Gamble (NYSE:PG) valued
Berkshire Hathaway's shares at more than $5 billion and made Berkshire
Hathaway the largest shareholder of the world's leading consumer
product manufacturer. Since P&G fits Buffett's parameters as a
company that possesses many of America's favorite brand names, he
assured Wall Street that he would not only hold the shares, but would
increase his position in the company.

If Buffett had invested
the original $600 million in the Standard & Poor's 500 Index rather
than in P&G, its value before dividends would have grown to only
$2.2 billion. (To learn more about dividends, read Dividend Facts You May Not Know.)

While
See's and Gillette are seemingly very different companies, Buffett
recognized that both possessed the most valuable formula a company can
achieve: profitable and timeless name-brand products. Boxed candy has
been a staple of American society for generations, and See's is such a
well-loved product that the company saw growth even during the years of
the Great Depression. Gillette's shaving products serve a need that
will never disappear, and its products have been found in homes
throughout America and the world.

Financially,
both businesses reflect strategies that have proved to be successful.
The cost of producing boxed candy has often been, like perfume, less
costly than the packaging and marketing of the product. This translates
into extraordinary profit. And the razor blade business that Gillette
pioneered and still dominates is the original example of the business
model of giving away a larger, infrequently purchased product (the
razor) in order to sell a smaller, repeatedly purchased product (the
disposable blades) to customers for the rest of their lives. (For more,
read Think Like Warren Buffett and Warren Buffett: How He Does It.)

Conclusion
The
first step in replicating Buffett's investment strategy is to locate
wonderful companies with long-term value and fairly priced stock. The
next step is to get away from the sidelines and invest. See's was
profitable before Buffett purchased it, just as Gillette was already
known on Wall Street as a desirable investment. It is Buffett's
willingness to put his cash down and hold these stocks for the long run
that separates him from those who only watch and wait.

Buffett
has described his strategy as the "Rip van Winkle approach" after the
main character of a famous short story by American author Washington
Irving who falls asleep and wakes up 20 years later. Perfect timing is
difficult if not impossible to achieve, but Buffett explains that "we
simply attempt to be fearful when others are greedy and to be greedy
only when others are fearful."

To learn how to get in on Warren Buffett's profits by using form 13F to coattail his picks, read Build A Baby Berkshire.
by Lenny Lubitz, (Contact Author | Biography)