If you’re anything like me, you read The Snowball (number 17 on the Uproar Reads list) and probably loved it more than you ever thought it was possible to love a book. I loved how Buffett was a complicated man, almost childlike in a lot of ways, while being extraordinarily intelligent and hard working. I loved how Buffett barely tolerated his kids when they were young, choosing to spend his spare time upstairs staring at annual reports. I even enjoyed reading about the affair he probably had with Katherine Graham, and the fact that he ate about 25 different foods over his entire life (an exaggeration, but barely).
Most investors should read the book. Not because it’s entertaining, and shows a side of Buffett that the public never gets to see, but because it busts a few Warren Buffett myths. I’m not talking about little stuff like how he was a certified badass in his teen years, but big stuff, like exactly how he made his money and the nature of his business.
So without further adieu, here are 4 Warren Buffett myths that need shattering.
1. Buffett is just a regular investor, just like you and me
Holy crap, that’s so wrong. If that was a website, it would be located at wrong.com. I’m not linking to that. Who knows what lies at the darkest corner of the internet. I’d rather just assume it’s pictures of bunnies.
You know how people hate debt? Well, Buffett did too. If I recall correctly, the only time he owed anybody anything was on the mortgage of his house. But he knew the power of leverage, so he utilized it in a different way.
In the early 1960s, Buffett convinced people to invest with him. But instead of taking their money and charging a management fee, he did it slightly different. Each investor and Buffett were partners, with Buffett taking a cut of the profits as his payment. He then reinvested those profits back into buying more shares for himself. These partnerships went on for years, finally stopping when Buffett moved the whole operation into Berkshire Hathaway, a company he would later recall as one of his worst moves. But that’s another story for another day.
These partnerships enabled Buffett to have a huge advantage. Not only was he investing his own money at something like a 25% annualized return, but he was also getting something like 10% of the profits from all the other money in the partnerships. The dude lived frugally for a decade, and boom. He was a millionaire.
2. Buffett is a dividend growth investor
This might be the worst Warren Buffett myth of all. Dividend growth investors have leeched onto this like a ringworm onto your colon, refusing to let go. But they’re still wrong. Buffett thinks dividends don’t matter either.
Dividend growth investors think Buffett is one of them because they all buy the same types of companies. Some of Buffett’s biggest holdings include names like Coca-Cola, Wells Fargo, IBM, Proctor and Gamble, and so on. These names also appear on most dividend growth wish lists, so boom. The investment philosophies MUST intersect, right?
Nope. Not. Even. Close.
Around 40 years ago, Buffett first became acquainted with Charlie Munger. One of the things Munger changed about Buffett is both the size and quality of company to be considered for investing. Buffett, like me (and other deep value investors), used to look for the cheapest companies on the market, and not really care how good they were. He knew eventually they’d return to something close to book, netting him a nice return in the process. Buffett’s mentor, Benjamin Graham, called these “cigar butt stocks,” because they were like cigar butts with one puff left.
After meeting Munger and partnering up with him, Buffett’s style changed. Suddenly the quality of the business became the most important metric. Sure, Munger and Buffett still bought when shares were cheap, but they were much more interested in other metrics, like return on equity, the company’s moat, and so on.
It just so happens that these types of companies also tend to be able to pay rising dividends. But is the dividend the reason for buying the stocks he does? Hardly.
3. He’s a pro at tax avoidance
Here’s another reason why his supposed dividend growth bias is another Warren Buffett myth. The man’s company doesn’t even pay a dividend.
There’s one simple reason why Berkshire Hathaway doesn’t pay a dividend. It’s because Buffett knows that buying solid businesses and letting them grow forever is a great way to defer tax.
Berkshire first bought shares in Coca-Cola in the mid-1980s. For years it’s held, as shares have risen more than 1,000%, and that’s not even including dividends. Berkshire is sitting on some huge capital gains, and has no desire to ever pay them. Why do you think his favorite holding period is “forever?”
Since Buffett has traditionally held most of Berkshire’s shares, why would he pay himself a dividend? That’s taking money out of the company, and using it to pay himself. If he keeps more cash in the company, the whole thing will grow faster. This isn’t that hard.
4. The huge insurance advantage
Perhaps the biggest Warren Buffett myth is just how big of an advantage Berkshire’s float is.
Insurance works like this. A whole bunch of people collectively pay into a giant pool. Sometimes, that pool will have losses, and the company will be forced to pay out. But most of the time, the float is just there, ready to be invested.
Most insurance companies don’t have somebody of Buffett’s caliber picking stocks. So they stick to mostly fixed income with a little equity exposure mixed in. Besides, if you’re any good at picking stocks, the last place you’re going to work is an insurance company.
Because Berkshire has such expansive insurance operations, Buffett has a float worth billions that he can play with. Apparently these days it’s worth something like $50 billion. Berkshire is a great company, and using the float to his advantage is perhaps the biggest reason why Buffett has turned himself into the greatest investor of all time, and not just a great investor.
And that’s it. Join us next time on busting Warren Buffett myths, when we finally tackle the two wives question.