Tricks of the trade. Lessons from Berkshire’s latest acquisition

Warren Buffet, the chairman of Berkshire Hathaway (a large multi-national conglomerate), has a reputation for being an extraordinarily skilful and meticulous investor. Warren Buffet started investing at the age of 11. His lessons in investing have changed the landscape of fundamental analysis and value investing.

Warren Buffet and his partner Charlie Munger have used Berkshire Hathaway as an investment vehicle to put their lessons into practice over the past few decades.

They have made many notable and diverse acquisitions under the conglomerate with companies engaged in producing chocolates (See’s Candies) to producing crude oil most recently. They have an investment strategy which they posit to small-time retail investors and a large conglomerate making acquisitions worth billions of dollars.

Buffet’s most recent purchase of a petrochemical manufacturing company named Occidental Petroleum for billions of dollars highlights not only the Berkshire way of investing aptly, but also acts as an indicator of general market sentiment.

One of Berkshire Hathaway’s qualification criteria when investing is to purchase companies with a long history. Occidental Petroleum, incidentally, is over a hundred years’ old and was founded in 1920. Secondly, Warren Buffet and Charlie Munger tend to only gravitate towards companies with business models they can understand (circle of competence).

Familiar models

Crude oil and petrochemical production are relatively simple business models that Munger and Buffet are familiar with; therefore, Occidental Petroleum passed the criteria.

Additionally, Buffet and Munger favour companies with a moat or a business edge that prevents competitors from entering the industry and driving down profits. Occidental Petroleum happens to control key areas in the United States and elsewhere, which pose them to gain from any positive extraneous oil shocks, such as the Russia-Ukraine war in 2022, which caused oil prices to skyrocket past $100 a barrel.

Finally, Buffet and Munger prefer companies that are out of favour, leading them to acquire them at dirt-cheap valuations. Occidental Petroleum’s stock was reeling from COVID-19, wherein oil prices dropped, leading to enormous losses.

However, their net income growth was 375.58% in 2022 and 120.24% in 2021. Moreover, the earnings per share (EPS) grew by 686.44% in 2022. Additionally, they brought down their long-term debt by over 32% in 2022 post the rise in crude oil and petroleum product prices. These and other factors, such as trust in management (specifically Occidental’s CEO Vicki Hollub), propelled Buffet and Munger to purchase 14% of Occidental Petroleum in just two weeks in 2022.

They had recently increased this stake to more than 24% and could purchase $5 billion worth of additional shares at $59.25 if they wished to. Furthermore, they have expressed an interest to continue raising their ownership stake in Occidental without pushing for control of the company.

‘Firms play gamblers’

Warren Buffet and Charlie Munger stated that the U.S. markets, especially when it came to companies with large market capitalisation, acted as gamblers trading their stocks like chips in a casino.

He indicated that 40% of Occidental Petroleum was owned by index funds and other passive players who would not react to Berkshire’s intent to purchase the company — for a market to provide 14% of a company to acquire out of 60% of its outstanding shares trading in the market meant a lack of serious long-term retail investors. This increase in gamblers rather than investors can be attributed to excess market liquidity. Benjamin Graham, the father of value investing and Warren Buffet’s mentor stated that Mr Market (Graham’s personification of U.S. stock markets) bought and sold shares in a frenzy and in ways that rational investors would not.

Buffet embraced this idea by purchasing Occidental Petroleum at a relatively cheap valuation realising that the company would eventually recover from its COVID-19 losses.

Retail investors benefit from uncertain times and murky waters by purchasing shares of companies from Mr Market when he is irrational.

A long-term investor will find exceptional investment opportunities by focusing on one’s circle of competence, company fundamentals and longevity, and management quality. The current market, which happens to be filled more with speculators and gamblers rather than long-term investors, makes for fertile grounds for retail investors.

To be an extraordinary investor, one must keep in mind and strictly adhere to ordinary rules when deciding on the companies to invest in.

(Anand Srinivasan is a consultant, Sashwath Swaminathan is a research assistant at Aionion Investment Services)

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