This is the third post in a series that will explore the successes, failures, and teachings of Warren Buffett through his annual Berkshire Hathaway letters to shareholders. To start at the beginning, click here.

What you will learn

• How do businesses use their extra cash?
• How did Warren Buffett choose to use his extra cash in the early years?
• Warren’s personable approach with his managers and workers.

What to do with your extra cash

Readers of Warren Buffett’s early shareholder letters will be aware that Mr. Buffett was frustrated at the prospects of Berkshire’s primary business, textiles. It seemed like no matter how much money you throw into increasing efficiency, you could never count on increasing your returns. 

He notes in the 1970 letter:

“Four years ago your management committed itself to the development of more substantial and more consistent earning power than appeared possible if capital continued to be invested exclusively in the textile industry.”

On Oct. 1st, 1966, Berkshire had working capital of $23 million dollars ($173 million in July 2020 dollars). There are only a few ways a CEO can choose to use these funds. Some of the major ways include:

1) Expanding business operations
2) Acquiring other businesses
3) Purchasing securities (such as stock buybacks)
4) Paying a dividends

Diversification

In Berkshire’s case, they chose to use this money to diversify out of textiles in two ways. The majority of their funds were invested in the stock market (other companies) while waiting for attractive business acquisitions to materialize. Buffett writes that between 1968-1969 their entire holdings were liquidized at a profit of more than $5 million after taxes.

Assuming the entirety of $23 million was used, this is a return of approximately 10% annually – or more than double the rate they achieved through textiles (less than 5%).

With these earnings, Berkshire both expanded their stronger performing business (insurance) and diversifying into publishing and banking.

1) Sun Newspapers and Blacker Printing Company in 1969
2) The Illinois National Bank in 1970

Personal Touch:

This may not mean much to some, but I am encouraged how Buffett often describes the people he works with in glowing terms. This is not a man who often exalts himself, and I’ve certainly not seen him disparage others to make himself seem more important. As opposed to how the Berkshire acquisition transpired, the management teams of these subsequent acquisitions are often retained and praised. As he signs out the 1970 letter, Mr. Buffett lauds,

“After almost a year of ownership, we are delighted with our investment in Illinois National Bank, and our association with Mr. Abegg (Chairman).”

This praise wasn’t limited to management. On discussing why he stayed in the textile business so long, Buffett expressed “incidentally, we had a workforce that was terrific. I mean, it— it was— we weren’t done in by anything except competitive dynamics.”

I’m reminded of a Vince Lombardi quote:

“A leader must identify himself with the group, must back up the group, even at the risk of displeasing superiors. He must believe that the group wants from him a sense of approval. If this feeling prevails, production, discipline, morale will be high, and in return, you can demand the cooperation to promote the goals of the community.” 

Final Thoughts:

I have greatly enjoyed getting to “know” Mr. Buffett through writing this series and the reading that’s been required. I must admit, I had no idea of his commitment to his shareholders and management teams. I love his personal writing style and wry humor. He seems to be a man of integrity and humility.

Let us all endeavor to invest in companies with CEOs committed to maximizing their shareholder’s returns – after all, we are their bosses – and the furtherment of their employee’s careers. You can learn a lot from the way they express themselves in their writings.

Questions:

If you had an extra $20 million lying around, would you feel confident investing it in the market? Would you diversify using ETFs/mutual funds? Or would you perhaps go with the more guaranteed return option of bonds or even a bank account? Let us know in the comments below!