Warren Buffett is undeniably and singlehandedly the world’s greatest investor. With a great amass of companies under his belt, all which are popular and famous big companies, there is little that goes amiss from Buffett’s eyes. His attitude towards the markets, sharp eye, and shrewd knowledge keeps Buffett on top of his game, and the third richest man in the world. Along with Buffett clearly being a great investor, his outperformance comes from his being able to finance his investments from within the premium pool of insurance companies that he owns.
Warren Buffett uses leverage in all of his investments to help to gain spectacular returns. Researchers estimate that Berkshire, on average, leveraged its capital by 60%, significantly boosting the company’s return. Better still, the firm has been able to borrow at a low cost; its debt was AAA-rated from 1989 to 2009. However a third of Berkshire’s funding comes from insurance and reinsurance operations, which is often deemed to be the underappreciated element.
Borrowing from policyholders, an insurance company generally takes premiums upfront and pays out claims later on. This is regarded as an expensive strategy, if Berkshire undercharged the risks it was taking. However, due to the profitability of its insurance operations, Berkshire’s borrowing costs from this source have averaged 2.2%, more than three percentage points below the average short-term financing cost of the American government over the same period.
To put it simply, insurance companies are basically just large investment funds that happen to run insurance premiums. Premiums may be held for a period for a few months to a few years depending on the specific insurance markets that you have placed your funds into. Furthermore, the real profit in the business comes from the performance of that investment fund. What Berkshire Hathaway has succeeded to do is to act as an reinsurance company, and Buffett has been able to hold on to premiums for a decade or more.
And this really is the great big secret about insurance companies. To some extent they’re really just large investment funds that happens to run insurance premiums through their books. It depends which specific insurance market you’re in but you might get to hang on to those premiums for a few months or a few years.
And the real profit in the business (to the point that it’s not unusual at all to see an insurance company making a loss on the actual insurance and underwriting side of the business) comes from the performance of that investment fund. By the time you get to being a reinsurance company (which Berkshire Hathaway also is) you might hang on to the premiums for a decade or more. Making the performance of the investments really just about the only thing that matters to the company.
The aforementioned is just one type of leverage that Mr. Buffett has used. Apart from this, he went to buy a few insurance companies in the first place. Being able to make good money as an investor initially, he further allocated the funds from these investments into insurance companies.
Once gaining control of insurance companies, Buffett invested into larger investment funds that the insurance companies controlled, where these funds were several times more worth its weight than the initial purchase price of these companies. Imagine, just as a made up numerical example, that Buffett outperformed the market every single year by 1%. Another made up number, he started with $1 million. He’s going to, over the decades, make himself a very rich man that way.
But look at it this way: if he uses the $1 million to purchase control of an insurance company with $10 million to invest, then he gets that 1% outperformance on that $10 million, then he’s going to be making himself richer ten times faster than by not leveraging up by buying the insurance company. For of course the outperformance in the investments flows to those who own the insurance company. Buffett has been using insurance companies and leverage techniques to amass wealth and a lucrative capital gain year by year.
(ii) As a securities analyst, what can you learn from Mr. Buffett? According to the Wall Street Journal, there are many methods and investment strategies that I could learn and apply into my own projects. First of all, is ‘keeping it real’, where it is ideal to not be so focused onto leverage, and try to be patient in investment. Being short on time, the man himself has advised to invest in index funds.
Secondly, Mr. Buffett has advised to ‘invest like a woman’, basically stating that by using patience, the ability to learn from mistakes, and to invest only in what we know, we can make sound judgment and avoid making mistakes. Thirdly, would be his advice to ‘not be swept by the crowd’. In short, it reiterates the idea that although many investors tend to stick to a ‘game plan’ and strategy throughout their time as an investor, Buffett tends to change strategies according to different scenarios, and time as it changes.
Many investors too would prefer to get a ‘quick get rich’ scheme, where they may speculate and invest quickly in hopes of a large attractive gain. However, in Mr. Buffett’s opinion, if there are not many good opportunities openly available in the market, it is better to just sit still on cash and wait until a better opportunity arises. Another sound advice would to be ‘fearful when others are greedy, and greedy when others are fearful’. The ideology behind this phrase places value on not following the rest of the crowd like a sheep, such as when investors pour large sums of money into the market when prices are at a peak, and then when the prices begin to start, sell quickly. Mr.
Buffett would never do this, and once again falls under the idea of being a patient investor, who understands long term investment cycles and trends. Following up on this, another strategy is to ‘take a long-term approach’ to investing. If short-term growth in a company is not excessive, it shouldn’t be a concern if the outlook and fundamentals of investing into this company remains in place. Although short-term growth may be at a slow moving pace, if the outlook of the company’s growth is expected to rise increasingly in the next 5 to 10 years, then it would be wise to be patient and wait for fruition.
As a securities analyst, these are some of the methodologies and strategies that I would try to emulate to achieve my own success in investments.