Act Like the Owner of the Entire Business

(02001) James O’Loughlin says: 

Managers act differently from owners. There are a different set of priorities and disciplines at work. The key to Warren Buffett’s success with Berkshire Hathaway, however, has always been that he acts and makes decisions consistent with an owner’s perspective rather than trying to apply a manager’s viewpoint. That frees him to act efficiently rather than with one ear listening to what the analysts and commentators are saying.

Business owners and business managers look at the world differently. They have a completely divergent set of interests and responsibilities. To be more specific:

1. Motivation
Business owners are interested in growing the value of their business over the longer term. By contrast, business managers are mainly interested in increasing the stock price and market valuation of the company. This is reflected in the fact many managers have bonuses, options and compensation packages which are linked directly to the stock price of the company.

2. Time frame
Business owners intend to own their business indefinitely. Therefore, they are perfectly happy to forgo short-term earnings in order to build long-term competitiveness. Business managers, on the other hand, are usually reluctant to do anything, which will not bear fruit for a number of years.

3. Accounting procedures and policies
Many managers view generally accepted account procedures (GAAP) as an obstacle to be overcome as they seek to dress up results for public view. Business owners don’t let accounting consequences influence their operating decisions, but view the accounting procedures as a standard to be met.

4. Performance criteria
Managers evaluate their performance in terms of earnings per share (EPS) and consistency of the gains made in that area. Business owners try and maximize the growth of the intrinsic value of the business — as reflected in year-to-year growth in earnings-on-equity-capital-emplooyed.

5. Performance targets
Managers frequently commit to short-term targets like: “To increase the company’s stock price by 15% over the next year or so.” By contrast, business owners judge performance over a much longer time period. They understand there is considerable volatility, which will adversely impact on one year every now and then, so they judge a performance record over the space of much longer periods of time.

As a result of these mindsets, business managers and business owners will often make decisions that are quite different. Warren Buffett has an excellent track record of making decisions, which are consistent with the owner’s viewpoint. In addition, he encourages the managers of the various businesses owned by Berkshire to do the same. Buffett also teaches his shareholders to think like owners as well. That allows him to make sound decisions based on logic rather than being forced into making no-so-good decisions on the back of a need for expediency. Plus, by acting like an owner, Warren Buffett can be entirely consistent rather than chasing the “strategy-du-jour.”

As a business owner, Warren Buffett has succeeded in building Berkshire Hathaway into an impressive cash generating machine. The cash which is generated in two ways is then allocated to three basic areas:

Cash Source
1. Cash from insurance company float
2. Cash from excess cashflow from operating companies

Investment Allocation
1. Acquisition of stakes in listed companies
2. Purchase of operating companies
3. Acquisition of a controlling interest in other companies

Notably, building such an entity as Berkshire takes an enormous amount of discipline. There are periods when the cash flow will be small, and other periods when the cash flow is enormous. Similarly, there are extended periods when no suitable investments are available, and Berkshire simply sits on its cash reserves. This generates returns that are lumpy rather than forecastable. In addition, there must be the confidence the company will be able to invest its capital at some advantageous stage in the future rather than pay it out as a dividend to Berkshire’s stockholders. If Warren Buffett was acting as the manager of the business rather than as its owner, Berkshire Hathaway would not be in any sort of position to generate the exceptional returns it has achieved.

The Real Warren Buffett

Measuring Buffett’s Worth

Charlie and I don’t consider ourselves to be richer or poorer based on what the stock does. We do feel richer or poorer based on what the business does. We look at the business as to how much we’re worth, not the stock price — because the stock price doesn’t mean a thing to us.

–Warren Buffett

Generating Floats that Earn

We’re like the hedgehog that knows one big thing. If you generate float at 3% per annum and buy businesses that earn 13% per annum with the proceeds of the float, we have actually figured out that’s a pretty good position to be in.

–Charles Munger

Responsibilities according to Buffett

We’re only responsible for two functions. First, it’s our job to keep able people who are already rich motivated to keep working at things they don’t need to do for financial reasons. It’s that simple. Secondly, we have to allocate capital.

–Warren Buffett