How to Apply to Your Portfolio: You can apply Buffett’s use of float to your own portfolio by investing in proven insurance companies with a history of profitable underwriting and growth. Cincinnati Financial Corporation (NASDAQ:CINF) and AFLAC Incorporated (NYSE:AFL) are two Dividend Aristocrat insurers with long growth histories. Aflac also has a long history of profitable underwriting operations.
Management Matters
“We follow an approach emphasizing avoidance of bloat, buying businesses such as PCC that have long been run by cost-conscious and efficient managers.
After the purchase, our role is simply to create an environment in which these CEOs – and their eventual successors, who typically are like-minded – can maximize both their managerial effectiveness and the pleasure they derive from their jobs.
(With this hands-off style, I am heeding a well-known Mungerism: “If you want to guarantee yourself a lifetime of misery, be sure to marry someone with the intent of changing their behavior.”)”
Warren Buffett makes it very clear that he looks for businesses run by “cost-conscious and efficient managers”.
Buffett looks for businesses that have intelligent and competent managerial teams. Established large businesses with strong competitive advantages can see their competitive position erode from poor management.
Many brands have decades of good will built up. It can take just one (severe) mistake to ruin this brand equity forever.
How to Apply to Your Portfolio: Look for businesses that focus on efficiency and cost-cutting. Businesses with a history of rising margins show a focus on efficiency. Margins do not rise on their own. It takes careful strategy and diligent execution from management to improve efficiency.
On The Value of Retained Earnings
“If Berkshire’s yearend holdings are used as the marker, our portion of the “Big Four’s” 2015 earnings amounted to $4.7 billion. In the earnings we report to you, however, we include only the dividends they pay us – about $1.8 billion last year.
But make no mistake: The nearly $3 billion of these companies’ earnings we don’t report are every bit as valuable to us as the portion Berkshire records. The earnings our investees retain are often used for repurchases of their own stock – a move that increases Berkshire’s share of future earnings without requiring us to lay out a dime.
The retained earnings of these companies also fund business opportunities that usually turn out to be advantageous. All that leads us to expect that the per-share earnings of these four investees, in aggregate, will grow substantially over time. If gains do indeed materialize, dividends to Berkshire will increase and so, too, will our unrealized capital gains.”
The ideal management team would invest only in projects with market beating returns, and return the rest of money to shareholders in the form of dividends (or share repurchases).
Earnings not paid out as dividends are called retained earnings.
When a company’s management is focused on maximizing shareholder value, every dollar of retained earnings is just as valuable as a dividend.
That’s because the money is being reinvested into the business to make it larger (more dividends later) in the future.
Of course this is only true when earnings are invested intelligently. Businesses that squander profits on ‘long shot’ investments or ideas outside their circle of competence would be better paid out as dividends.
