![]() “I have other places I can put the money.” “I’d rather have a $10 million business making 15% than a $100 million business making 5%,” Buffett told his new managers, according to Roger Lowenstein’s masterful biography, Buffett. No more would Berkshire’s capital be allocated to looms and mills. Showing the adaptability he remains famous for, instead of trying to sell Berkshire, Buffett installed new management and instructed them to squeeze the company hard for cash. It was good for only a few puffs-there was no lasting value in it. It was a classic “cigar-butt” investment, the kind that Buffett’s Columbia Business School teacher, Ben Graham, favored. While the inventory was indeed worth something, there was little hope that the business would ever be consistently profitable. ![]() ![]() Although Berkshire was cheap, it was cheap for a reason: It continued to be hammered by low-cost competition. Soon after, however, Buffett realized that he had made a poor capital-allocation decision-making Berkshire “the dumbest stock I ever bought,” he would later tell CNBC. However, it was cheap: Its stock was selling at a wide discount to both its net worth, or book value, and its current assets less its current liabilities, or net working capital.īuffett began buying Berkshire shares on the open market and became so intrigued with the bargain that in 1964, he bought a controlling interest in the company through his investment partnership. Over the previous 15 years, Berkshire had been vitiated by lower-cost competition it had lost all but two of its mills and 80% of its employees. The birth of Berkshire as we know itīuffett was a young and hungry stock picker running a series of small hedge funds from his hometown of Omaha when, in 1962, he stumbled upon a struggling, publicly traded New England textile mill called Berkshire Hathaway. I own Berkshire for my clients, and the story of how Buffett transformed Berkshire is both a good case study in capital allocation and a good way to show why the stock is attractive today. No one understands and illustrates this better than Warren Buffett, who 55 years ago bought a struggling New England textile mill called Berkshire Hathaway, and later turned it into the world’s sixth-most valuable company simply by dint of capital allocation. If a company has poor allocators, the best business in the world will eventually founder. If a company has good allocators, even a mediocre business will prosper. Earnings, cashflow and growth rates are like the waves you see on the ocean’s surface capital allocation is the deep-sea groundswell that produces them.Ĭapital allocation is in fact simple to define: It’s what managers decide to do with the cash available to them. Every financial data point emanates directly from the wellspring of capital allocation. This is unfortunate, because for both businesspeople and investors capital allocation is the key to building great wealth. ![]() As for investors, they may understand it in theory, but most are so obsessed with short-term earnings and growth rates that they give it almost no weight. Businesspeople love to chuck it around, but very few know what it means. Capital allocation is a term that’s as important as it is poorly understood.
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