Investor legend Warren Buffett reveals his “Secret Sauce”
He is probably the best-known investor in the world and has built one of the largest conglomerates in the USA starting with a small textile trade. And that’s why everyone interested in the world of finance and investing reads Berkshire Hathaway’s annual Letter to Shareholders with close attention. As usual, it is written by none other than Warren Buffett, who provides insights into the investment strategy of himself and his long-term partner Charlie Munger.
Buffett, now 92, is the lord of a $300 billion stock portfolio. If something moves there, the entire financial world takes a look and analyzes in detail what is currently being bought or sold there. In 2022, the investment company, which holds substantial stakes in corporations such as Apple, Coca-Cola, Bank of America, and American Express, achieved record sales of $302.089 billion. Operating profit was $30.79 billion last year, well above the $27.46 billion from 2021. However, it should also be noted that the huge stock portfolio also made a loss of $22.82 billion on paper in the crisis year 2022. This is to be seen as an interim result, as share prices can pick up again.
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“It takes just a few winners to work wonders”
In addition to these current business insights, Buffett and Munger also provide insights into how they go about their investments – and even reveal their “Secret Sauce” in this year’s shareholder letter. And it reads like this: “The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.”
If that is too vague for you, you are presented with two examples: Coca-Cola and American Express. Example 1: In 1994, Berkshire Hathway completed a seven-year purchase of 400 million shares of Coca-Cola that it still owns today. “The total cost was $1.3 billion,” Buffett writes. “The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million. Growth occurred every year, just as certain as birthdays. All Charlie and I were required to do was cash Coke’s quarterly dividend checks. We expect that these checks are highly likely to grow.”
Example 2: American Express. In 1995, they completed the Amex stock purchase, also for $1.3 billion. Annual dividends from that investment have increased from $41 million to $302 million, Buffett said. “These dividend gains, though pleasing, are far from spectacular. But they bring with them important gains in stock prices.” At the end of 2022, Coke shares were around $25 billion, and those of Amex – around $22 billion. These positions would each make up about 5 percent of the total portfolio. If the bets on Coca-Cola and American Express hadn’t worked and they hadn’t increased in value, it wouldn’t have mattered as much. “This disappointing investment would now represent an insignificant 0.3% of Berkshire´s net worth and would be delivering us to an unchanged $80 million or so of annual income.”
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“We are not stock-pickers, we are business-pickers”
Berkshire Hathaway generally makes two types of investments: either acquiring 100 percent of companies or buying blocks of (sometimes large) shares. But how do you choose these few winners? Buffett has a clear answer to that, too. “Our goal in both forms of ownership is to make meaningful investments in businesses with long-term favorable economic characteristics and trustworthy managers,” he wrote. “Please note that we own publicly-traded stocks based on our expectations about their long-term performance, not because we view them as vehicles for adroit purchases and sales. This point is crucial: Charlie and I are not stock-pickers; we are business-pickers.”
But you would have made many mistakes over the many years in the investment business. “Consequently, our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy the very good economic characteristics, and a large group that are marginal,” Buffett said. “Capitalism has two sides: the system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon ‘creative destruction’.”
So it’s also clear that Berkshire Hathaway’s portfolio doesn’t work much differently than VCs’ portfolios either: There are a few high performers who bring the profits, several average companies, and many underperformers. This also shows that even investment geniuses like Buffett and Munger have to spread their risk widely in order to have a few winners.
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“Nothing beats having a great partner”
What else do you need to be successful? Munger’s answer: “Nothing beats having a great partner”. He would have found that in long-term partner Munger. And he advocates long-term investment and warns against short-term gambling. “The world is full of foolish gamblers, and they will not do as well as patient investors. Patience can be learned. Having a long attention span and the ability to concentrate on one thing for a long time is a huge advantage.” He and Buffett would always look for good long-term investments and hold them “tenaciously for a long time.”