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Berkshire Hathaway Inc. Message Board

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  • Novalis_97 Novalis_97 Jul 6, 1998 1:27 PM Flag

    Need some advise

    In my view, Buffett's business strategy has two
    components, which are all interlinked.

    First, there is
    Buffett's desire to literally "get money for nothing" and
    then invest that free money for his own profit. A long
    time ago, he bought a company called "Blue Chip
    Stamps" whose scheme was to convince a bunch of retail
    stores to pool a certain amount of money together, give
    that pool of money to Buffett, and then those stores
    would distribute cheesy stamps to their customers that
    could be redeemed for merchandise that would be paid
    out of the pool of money now under Buffett's control.
    Well, it turned out only a certain percentage of
    customers turned in those cheesy stamps to get merchandise,
    so Buffett ended up with all that money -- totally
    cost- and interest-free. And what did he do with that
    money? He invested in stocks and made a profit for
    himself. In effect, he benefited from leverage but without
    the cost of leverage (interest). Insurance companies
    represent the same sort of deal to Buffett -- sources of
    cost-free funds which Buffett can then invest in the stock
    market. While Charlie Munger prefers S&L's as a source of
    funds, Buffett likes insurance companies because, while
    S&L's always have to pay interest for the deposits they
    receive from their customers, insurance companies need
    not pay anything for the right to play with their
    customers' money. To reduce claims, Buffett's insurance
    companies underwrite only those insurance policies with a
    low likelihood of ever being claimed. For instance,
    Buffett's Geico Auto Insurance company will only cover the
    safest of drivers. When you hear Geico commercials on
    the radio offering to quote you not only their but
    other insurance companies' rates (which might be lower
    than Geico's rates), Geico is not doing this as a
    favor to you but because it wants to avoid high-risk
    drivers, as well as maintain its profit margin. A focus on
    minimizing the likelihood of ever paying claims also
    explains Buffett's love of the reinsurance business. The
    probability that a reinsurance company will ever have to pay
    out claims is significantly reduced by the fact that
    all of its policies have already been screened or
    vetted once for risk by the primary insurance company,
    which is being insured in turn by the reinsurance
    company. In summary, Buffett views insurance companies
    merely as investment vehicles and, unlike most other
    insurance companies, he does not try to make money from the
    underwriting side of the insurance business (which often leads
    to unprofitable price wars), but focuses on merely
    preserving the profit margin the underwriting side provides,
    as profit margin is the source of
    "float."

    Then, Buffett invests that float in stocks using his
    "intrinsic value/margin-of-safety" methodology. I won't go
    into that. It is enough to say that Buffett's modus
    operandi is a two-component system consisting of: 1)
    exploiting insurance companies for their "float"
    (essentially a huge interest-free loan) and 2)investing that
    float in companies like Coke and buying out companies
    like Dairy Queen, which have favorable, enduring
    prospects.

 
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