How Warren Buffett Made Berkshire Hathaway

If you're wondering where Berkshire Hathaway's (BRK.A) profits lie, it would save time to count the industries where the Omaha-based company doesn't make money.

Railroads? Hardly. BNSF Railway, the second largest freight line in North America, is a wholly owned Berkshire Hathaway subsidiary.

Auto insurance? Not even close. GEICO, a Berkshire Hathaway subsidiary, comes in at second in its industry.

Men's apparel? Berkshire Hathaway's Fruit of the Loom Inc. sells more men's underwear in the United States than any other company.

In fact, if you go down the list of the nation's leading sectors, Berkshire Hathaway has its bases covers. Business jet rental (NetJets), jewelry (Borsheim's Fine Jewelry, Helzberg Diamonds, Ben Bridge Jeweler, Inc.), furniture (RC Willey Home Furnishings, CORT), candy (See’s Candies), trucking (McLane Co., Inc.), modular houses (Clayton Homes), newspapers (The Buffalo News) are all represented in the company's growing portfolio. There’s seemingly no limit to the number of diverse businesses under the $508 billion Berkshire Hathaway umbrella as of November 2, 2018.

Founded in the 19^th Century as two separate Massachusetts cotton mills, Berkshire Fine Spinning Associates and Hathaway Manufacturing Co. merged in 1955. Warren Buffett first bought into the declining company in the early '60s and eventually ended up in control of it on May 10, 1965. Two years later, Buffett officially made Berkshire Hathaway a conglomerate, using textile proceeds to purchase National Indemnity, the first of what would become many insurance acquisitions for the company.

Berkshire Hathaway's lifeblood is what industry insiders call a "float." Also known as “available reserve,” floats refer to money paid to Berkshire Hathaway’s insurance subsidiaries in premiums but that has yet to be paid out to cover any claims. Technically this money does not belong to the insurance company, but it remains on hand to be invested as its managers see fit. Berkshire Hathaway’s float of over $100 billion is not only one of the largest in the world, but 50 times what it was a generation ago. It has allowed Berkshire Hathaway to make quick purchases of temporarily wounded companies and breathe life into them. Case in point: Fruit of the Loom was purchased for a mere $835 million in 2002 after its stock had lost 97% of its value.

One of the prime tenets held by Buffett’s mentor, Benjamin Graham, is that dividends are an investor’s secret weapon. Many of the Fortune 500 companies that Berkshire Hathaway has large positions in — Apple Inc. (AAPL), The Coca-Cola Co. (KO), and American Express Co. (AXP), to name a few – have a steady history of maintaining or increasing dividends every year. Coca-Cola, for example, has increased its annual dividend 55 years in a row. While imprudent speculators chase hot stocks whose prices are rising, those speculators’ patient brethren instead load up on the stocks of companies with fundamentals formidable enough to allow regular cash payments to shareholders.

Financial news outlets rarely showcase dividend data the way they do stock price and price movement figures, even though dividends provide one of the surest measures of a company’s potency. After all, management will hand cash over to owners only when operations turn a large enough profit to make said payments feasible. As much as any other factor, Warren Buffet's pursuit of dividends has made Berkshire Hathaway so consistently successful.

Somewhat unsurprisingly, the same Warren Buffett who invests in companies that pay dividends eschews paying them out to his own company’s investors. At first, this seems so self-evident that it barely counts as an observation – it makes sense to take the cash that other companies offer you, but never to pay cash out yourself unnecessarily. Berkshire Hathaway has actually paid a dividend once before. In 1967 the company paid its only dividend of 10 cents a share. To this day, Buffett claims that he must have been in the bathroom when the dividend was authorized.

That being said, it would be short-sighted for any Berkshire Hathaway shareholder to complain about the company’s refusal to pay dividends. The stock price has skyrocketed over the past 51 years, trading at $275 in 1980, $32,500 in 1995, and over $308,530 as of November 2, 2018 market close, a track record without comparison.

Berkshire Hathaway’s rationale is simple and hard to argue with. If you’re an investor, would you rather have a dividend payment to spend, or would you prefer to see that money reinvested by the team that turned a humble textile investment into one of the largest, most respected, and most financially robust companies to date?

Since a single share of Berkshire Hathaway Class A stock (that’s the class quoted above) is equivalent to several years’ worth of the average American salary, it’s no wonder that shares trades infrequently: approximately 300 or 400 change hands a day. Buffett has never entertained the notion of a Class A split, as doing so could encourage speculation.

Buffett did, however, authorize the creation of Class B (BRK.B) stock several years ago, valued at 1/30 the value of Class A stock. After a 50-for-1 split of BRK.B in 2010, the Class B stock replaced BNSF on the index. The lower price and concomitant liquidity make Class B stock suitable to be included in an index that attempts to gauge the value of the market. Class A stock is too expensive and too sparsely held to make an effective index component.

Some investors look for value, then purchase shares of companies that fit their criteria. Berkshire Hathaway takes a similar approach to doing business — only, instead of buying a few shares, it buys the whole company. After more than 40 years of applying that strategy, the result is a global conglomerate without match.