Capital allocation: One of the secrets to Warren Buffett’s (shortform ‘WB’) success is how he structures his holdings, putting them together in a way that gives him enormous advantages.
A great example is his insurance business, which he uses as a float that partly finances his investments in publicly traded stocks. The structure of the insurance
business provides a steady source of financing and allows him to leverage his stock-picking ability.
This is relevant for managements running businesses as well. Those who know how to deploy capital in a manner that adds the best possible value will certainly deliver superior returns on capital to shareholders over the long term.
Focus on your strengths: Be really good at one thing and exploit it to the maximum. Don’t dabble.
As the last 50 years have clearly shown, WB’s strength is picking strong companies at attractive prices. He would not have been half as successful had he focused on some other profession. Do you think Tendulkar would have his reputation had he decided to become an engineer instead of a cricketer?
WB calls this sticking within your circle of competence. The concept can be applied to stock picking as well. That is, focus on good quality businesses that you understand. Don’t branch into sectors beyond your competence.
Reputation matters: WB’s integrity and fairness have stood him in good stead when buying stakes in companies. And his focus to keep the interests of Berkshire Hathaway above all others has certainly gone a long way in bolstering the fortunes of the company. It’s no wonder, then, that he expects the same from the management of the companies he invests in.
Right people deliver: WB has always emphasized picking the right people to run his businesses. Over the years, he has built a team of CEOs who know how to run the show smoothly and profitably. Always look for companies that boast of a sound management and strong corporate governance practices. Weed out those who don’t serve the interests of minority shareholders.
Focus on your best ideas: WB believes in picking the best investment ideas and accumulating more of them. In that sense, he’s not a fan of diversification, calling it a practice investors follow when they don’t understand what they are doing.
Not all positions in portfolio of 10-12 stocks will do well. If you’ve done your homework, most will perform well. But your best ideas will post strong gains, offsetting the under performers and ensuring great overall returns.