It’s been a couple of weeks since Warren Buffett’s annual shareholder letter was released, and hundreds of financial writers have written thousands of words about it. No other CEO’s letter is more anticipated and widely read — or written about — than Buffett’s.
And for good reason. Buffett has spent almost 60 years building Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) into one of the strongest, most profitable companies on earth, minting thousands of Berkshire millionaires (and a few billionaires) along the way. Buffett has made himself a lot of money, too.
And as much as Buffett’s stock-picking and business-buying acumen are responsible for much of the massive compounding — up more than 3.7 million percent from 1964 to 2002 — there’s one number from his letter that is responsible for a massive portion of that result.
The $8.6 million acquisition that changed (almost) everything
When Buffett took control of Berkshire in 1965, it was a struggling textile manufacturer with few prospects to recover. Much ink has been spilled about Buffett’s choosing to close his partnership and focus his efforts on turning Berkshire into the holding company that we know and love today. The story largely goes something like this:
- Berkshire’s CEO, Seabury Stanton, undercut the offer to buy Berkshire shares back.
- Buffett took control of the company in anger over this slight (and later said it was a terrible mistake).
- Buffett turned Berkshire into a financial holding company, using asset sales and its cash flows to invest in better businesses.
- He’s been doing it for 58 years, and everyone has made money.
In part that’s true, but there’s more to the story, and a very early acquisition might have made all the difference: National Indemnity Company. This was Berkshire’s first major acquisition under Buffett, and a clear step away from putting more capital into its failing textile business.
According to Roger Lowenstein’s Buffett: The Making of an American Capitalist — one of the very best books written about Warren Buffett — the acquisition of National Indemnity in 1967 wasn’t just about investing Berkshire’s capital in a better business than textiles. From the book:
[Buffett] thought that float from insurance could be as dynamic as rocket fuel. Float was merely money, and an insurance firm was, in effect, a conduit for investable cash.
In other words, it wasn’t just the potential profits from the insurance business itself that powered Buffett’s thinking. It was that float — the money from premiums an insurer holds and can invest until needed to pay claims — that became a game changer. From Buffett’s most-recent letter:
With disciplined underwriting, these funds have a decent chance of being cost-free over time. Since purchasing our first property-casualty insurer in 1967, Berkshire’s float has increased 8,000-fold through acquisitions, operations and innovations. Though not recognized in our financial statements, this float has been an extraordinary asset for Berkshire.
Berkshire’s float is up 8,000-fold and funded some of Buffett’s best stock picks
Berkshire ended 2022 with $164 billion in float across all of its insurance holdings — 8,000-fold higher than it started with after buying National Indemnity.
What makes float so powerful? It is essentially interest-free, perpetual capital that the owner can allocate to generate even greater returns. Of course, for float to truly be perpetual money to deploy, the underlying insurer must be a good underwriter with a history of generating underwriting profits. That’s been the case with Berkshire’s many insurance subsidiaries over the years.
As the result of profitable underwriting, Berkshire and its shareholders have benefited even more from Buffett’s skill as a stock picker. That $164 billion in float has proved to be low-cost, perpetual capital that Buffett and his stock-picking counterparts, Todd Combs and Ted Weschler, can put to work. The evidence is on the Berkshire balance sheet, which holds some $300 billion in stocks, much of which is owned via investing that float.
Buffett’s $1.4 billion Coca-Cola investment is one example. Worth over $25 billion today, Coke pays Berkshire more than $700 million in dividends — half its cost basis — every year. Were Buffett limited to just the operating earnings its subsidiaries generated, that Coke investment would almost certainly been much smaller and less lucrative for Berkshire shareholders.
Another example of Buffett’s wealth-creating genius
Buffett has cautioned investors many times about the risks of leverage, but also realizes the amazing power of leverage to generate much bigger returns. And at its core, float is a kind of leverage: Using money that will likely have to be repaid, in order to invest for a bigger return.
In the case of Berkshire, investors have benefited greatly because Buffett saw both the potential for leveraging float, but also the risks. Berkshire’s huge returns have been made greater because Buffett acquired insurers that could underwrite profitably first — meaning the float would be stable — and then made prudent investments with it that would pay off over time.
Millions of investors continue to profit from this seminal step for Berkshire away from textiles and into its much more profitable future.
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Jason Hall has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.