Buffett What Has The Master Been Up To? Finally Berkshire's chairman finds the market moving his way. He's been snapping up building-products firms and enjoying great yields on junk bonds.
(MONEY Magazine) – While the sound of the tech crash was like nails on a chalkboard for many of us, it apparently sounded more like a rallying cry to Warren Buffett. Berkshire Hathaway's famously tech-phobic chairman survived the wreck unscathed, and now he's using his ample cash to snap up a variety of companies.
Berkshire's stock outperformed Standard & Poor's 500 by about 30 percentage points over the past 12 months (it traded recently at $67,400 a share). Thanks to the 1998 purchase of reinsurer General Re, Buffett now has some $27 billion in "float"--money from premium payments that Berkshire can invest until it is needed to pay insurance claims. With valuations more reasonable and lenders getting more cautious as the economy slows, "Berkshire's large pool of liquid assets means it may be the only bidder at the table," says Morgan Stanley Dean Witter's Alice Schroeder.
And Buffett has been busy. Since last May, he's bought eight businesses for a total of about $6 billion in cash. Purchases included brick maker Justin Industries, carpet maker Shaw Industries, paint maker Benjamin Moore and building-products manufacturer Johns Manville, which offered Berkshire a huge tax break stemming from its asbestos liability.
Buffett found value in smaller positions too, including a stake in USG, the building-materials company, and in White Mountains Insurance Group. (Several smaller purchases, including a stake in auto-parts maker Superior Industries International, were probably initiated by Louis Simpson, who runs a portfolio for Berkshire subsidiary Geico.)
The junk bond market also caught Buffett's eye. Late in 2000, he bought the high-yield bonds of specialty finance companies Finova Group and Conseco. Buffett recognized that the spreads--the gap in interest rates--between risk-free Treasuries and junk bonds had reached a record level. "Unless the economy tanks, that's probably a slam dunk," says David Braverman, a senior investment officer at Standard & Poor's.
Do Buffett's recent equity purchases suggest that we should run out and buy stock in carpet, paint and brick makers? Not necessarily. Buffett is playing a game most of us can't. "Over the years, his willingness to buy even average companies, when he can buy the entire company, has increased because he gets control of the capital-allocation process," says Robert Hagstrom, manager of Legg Mason Focus Trust.
Here's the strategy: When Buffett buys a company that throws off a lot of cash and has low reinvestment needs, he can absorb the company's retained earnings on the corporate level and redirect them to higher-returning investments. Also, the companies he buys are "no longer subject to short-term shareholder pressures, and this may eventually result in lower costs and other efficiencies," says Schroeder.
In essence, Buffett can take cash from companies where it's earning 4% to 5% after-tax returns on capital and invest it where he can get 8% to 10% returns, notes Tom Russo of money managers Gardner Russo & Gardner. So while Berkshire has been viewed as a closed-end mutual fund that holds big stakes in a variety of companies, Russo says it makes more sense to view it as "primarily an insurance company with a very large portfolio" of low-risk assets that achieve equitylike returns.
Obviously, that's not a strategy an individual investor can use. But you can learn something from Buffett's discipline. When everyone else was frenetically buying tech stocks, he sat on his hands. When the market tumbled far enough, Buffett pounced. His long-term record shows the merit of that approach.