17 Aug Berkshire Hathaway’s Acquisition Criteria – Buffett and Munger at Their Very Best
Warren Buffett is the world’s best investor. Together with his partner Charlie Munger, they run investment holding company Berkshire Hathaway. They have returned an average of 23% per annum for almost four decades.
I came across their investment checklist in the 1995 Annual Report for Berkshire Hathaway and thought that it is important enough to reproduce it here in full.
Berkshire Hathaway Inc
We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
1. Large purchases (at least $25 million of before tax earnings),
2. Demonstrated consistent earning power (future projections are of no interest to us, nor are ‘turnaround’ situations),
3. Businesses earning good returns on equity while employing little or no debt,
4. Management in place (we can’t supply it),
5. Simple businesses (if there’s lots of technology, we won’t understand it),
6. An offering price (we don’t want to waste our time or that of the seller by talking, even preliminary, about a transaction when price is unknown).
The larger the company, the greater will be our interest: We would like to make an acquisition in the 3 to 5 billion range. We are not interested however, in receiving suggestions about purchases we might make in the general stock market
We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer — customarily within five minutes — as to whether we’re interested. We prefer to buy for cash, but would consider issuing stock when we receive as much in intrinsic business value as we give.
Charlie and I frequently get approached about acquisition that don’t come close to meeting our tests: We’ve found that if you advertise an interest in buying collies, a lot of people will call hoping to sell you their cocker spaniels. A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: “When the phone don’t ring, you’ll know it’s me”.
The Acquisition Criteria remains almost totally unchanged in the 2013 Annual Report. The only differences though, is that somewhere along the line Buffett and Munger raised their definition of ‘large purchases’ from $25 million to $75 million, and their preferred range of acquisition size from 3 to 5 billion to 5 to 20 billion.
What is the big deal about the criteria?
I am a big fan of Buffet and Munger. Between the two of them I think they posses more wisdom than the entire faculties of Ivy League Universities and more business acumen than Wall Street and Silicon Valley combined. I know that I will never be able to invest like they do, yet it does not stop me from learning the very best of them.
I see great wisdom in them publishing and sticking to their criteria.
Self help experts discovered that 42% of people are more likely to achieve their goals by simply writing it down. By putting Berkshire’s acquisition criteria to paper, they have articulated very clearly what they want (and more importantly what they do not want). This very narrow definition allows them to act within their circle of competency and acts as a filter for all the noise they would otherwise have to put up with. They have found a strategy that works for them and they are not afraid of sticking to it year after year.
Also by putting it out into the open, they have set themselves up for scrutiny. Imagine the fallout if one day if there were to announce that they are buying a tech company such as facebook. They cannot, no matter how much it seems like a good deal, because of the very public commitment they have made. The best investment decisions are made based on rational rules, and there is no better way to ensure rules are adhered to than to announce them to the people around us. In the case of Buffett and Munger it is the entire world of finance – these will be hard rules to break indeed.
We are our worst enemy
It is chilling to read the clarity in which Buffett an Munger summarizes their investment criteria into these three hundred words. They are, after all at the helm of a business empire worth 330 billion dollars. If they can simplify and reduce their strategy to six points despite the billions at their disposal and all the options available to them, should we as retail investors not be able to do better?
In investing, we are often our worst enemy. We flutter amongst different strategies hoping to find the holy grail. We get attracted by huge promised returns and distracted by noise. We keep our cards close to our chest, changing them (often retrospectively) to justify an investment decision.
Buffett and Munger have shown that all we need is one good strategy that is applicable to us and the fortitude to stick with it in good times and bad. Have you found your strategy? Will you shout it out to the world?
Are you ready to make that commitment?