secret of Buffett's success

I've figured out the secret of Buffett's success. As is well known, he chose to house his insurance operation in a textile stock. This had a number of advantages, chiefly that it depressed the price of the stock for a number of years while Buffett was acquiring shares. But he wasn't buying the shares and retiring them. The shares were bought by the insurance company within Berkshire. This created a reflexivity within Berkshire, which owned Berkshire: as Berkshire appreciated, the insurance float appreciated, leading to more float and capital, more earnings and higher stock price, and so on. Likewise, when the stock declined and sold below intrinsic value, the insurance company bought more shares, essentially shrinking the float and increasing the book value. Of course none of this self-dealing was reported and no shares were retired because the insurance company is not Berkshire, it is a separate entity, but the effect is the same.

Buffett did the same with Blue Chip Stamps. He owned shares of BLue Chip Stamps, which was also buying shares of Berkshire and other companies with the stamp float. As Berkshire appreciated, Buffett bought more shares of Blue Chip Stamps, essentially buying more of his own stock via BCS. It is similar to a closed end fund owning its own shares. As the fund buys in its own shares at a discount, the NAV increases, and this is magnified by the self-ownership. As the fund appreciates, it can also increase NAV by selling shares above NAV, but this does not show up as an increase in shares outstanding as the shares were already issued, just owned by the fund itself. So essentially Buffett is trading in and out of Berkshire's own stock, buying below and selling above NAV via the insurance company, which are guaranteed positive return trades. Buffett's biographer describes this as the "homeostatic" effect of the insurance float within Berkshire, without laying out exactly how it worked.

 

Assuming the above is true, is it legal ? Morally dubious though.

 

You have proof of this?

 

What would proof look like? Berkshire reported securities holdings in SEC filings. Not clear whether those filings include all of the holdings of the many insurance subsidiaries. It is possible for the subsidiaries to own shares of the parent company, for instance National Indemnity received shares of BRK when Berkshire bought BNSF with Berkshire stock.

It is known, from Alice Schroeders biography, that Buffett admired a man named Wattles, who ran a company called American Manufacturing, which owned partial stakes in a number of below-NAV closed end funds. Those funds in turn owned shares in discounted closed end funds, and as he bought them in, it was a guaranteed way to compound wealth. He also admired an insurance company in California (run by a family called the Ahmannsons) that created a successful company in a publicly traded stock and bought the stock back from unsuspecting investors, who thought the shares were worthless, for pennies on the dollar. So he had the idea in his head that buying back shares cheap within a holding company structure or from unsuspecting investors was a very powerful way to compound wealth. He bought 5000 shares of Berkshire from his mother at pennies on the dollar, for instance.

 

I'm sorry. Your basic premise is wrong. The Berkshire Hathaway, the textile company and the insurance company are one and the same. It has been stated as one of Buffett's mistakes not to buy the insurance company in a separate business entity.

 

The great genius of including the insurance company within Berkshire is that Berkshire benefits from the cheap float of the insurance company, and vice versa, the insurance company benefits from the financial strength of the operating company. Berkshire was not initially a great business, but the insurance-company-within-operating-company innovation was a huge factor in his success.

 

Insurance is an inherently very risky business. More insurance companies bite the dust each year than most other types of businesses. For someone with Buffett's temperament, it could be made to work with his investment expertise and underwriting discipline etc.

Even if the insurance entity buys shares of the Berkshire Hathaway, that doesn't shrink the shares outstanding, nor automatically increase book value. Thus, your assumption in this case is wrong.

 

There is no difference between a) Berkshire buying the shares and retiring them and b) National Indemnity buying the shares. Exact same thing. Different pocket, same trousers.

 

From Forbes:

"BUFFETT:
Imagine if you owned grocery store and you had amanic-depressive partner who one day would offer to sell youhis share of the business for a dollar. Then the next day because the sun was shining or for no reason at all wouldn’tsell for any price. That’s what the market is like and why youcan’t buy and sell on its terms. You have to buy and sell whenyou want to."

In the case of Berkshire, the "partner" in this case are the minority shareholders.

 

So, National Indemnity could have bought shares of other undervalued companies and held on as well. This would have increased their float over the years, just as how the Berkshire shares would have. And since the shares outstanding are not reduced, it would not benefit the Berkshire Hathaway in any way. Thus, it is a wash. The National Indemnity investing its float in Berkshire in no way takes away from the economic performance of Berkshire Hathaway as a business.