“Price is what you pay. Value is what you get,” declared billionaire investor Warren Buffett. These words carry profound wisdom.
Unfortunately, many investors focus solely on price, neglecting the vital consideration of value—the cash flow or dividends each share can generate. This oversight often leads to overpaying for shares of stock.
Most stock market participants are not true investors; they are speculators. Their decisions hinge on price movements. If a stock’s price rises, it’s deemed a sound investment; if it falls, it’s viewed negatively.
When a stock’s price declines, speculators may see it as a bargain due to its lower price compared to several months prior. Yet, sometimes a stock continues to plummet. For investors who grasp the concept of value and understand what returns they’ll receive, price is seen within this broader context.
Investments That Generate Cash
Buffett embodies a long-term investment approach. “Our favorite holding period is forever,” he stated in his 1988 letter to Berkshire Hathaway shareholders. An advantage of this strategy is that it allows him to avoid capital gains taxes.
He seeks investments that generate cash continually, leading to profits he can enjoy indefinitely. Using this methodology, Buffett has built an impressive legacy; under his leadership, Berkshire Hathaway has achieved a compounded annual growth rate of 19.8 percent in book value per share over nearly 50 years.
Recently, it was announced that Buffett would acquire H.J. Heinz…
“After hinting at a $20 billion deal for nearly a year, Warren Buffett of Berkshire Hathaway targeted H.J. Heinz in one of his largest acquisitions to date,” reported MSN Money.
“Berkshire announced a purchase of the iconic ketchup maker for $72.50 a share in cash, valuing the company at approximately $28 billion, including debt.” At this price, Buffett is acquiring H.J. Heinz when shares are near an all-time high. But that’s not the whole story…
“The proposed deal reflects a roughly 20 percent premium to its Wednesday closing price. Shares in the company had surged nearly 17 percent in the 12 months leading up to Thursday’s agreement.”
Warren Buffett’s Unique Challenge and Approach
To an outside observer, purchasing shares of a company at near all-time highs, plus a 20 percent premium, might not seem like a strategic investment. However, when Warren Buffett, the most successful investor of all time, makes such a move, it’s clear that the numbers must align for it to be a worthy acquisition.
“Heinz has robust, sustainable growth potential due to its high-quality standards, continuous innovation, strong management, and delightful products,” Buffett articulated in a statement about the deal. It’s evident that Heinz is a solid business, with a dominant position in the ketchup market. However, Buffett may have had additional motivations for this acquisition…
Buffett faces a unique predicament that few will ever experience. He has accumulated so much wealth that finding practical ways to spend it sensibly is challenging. This necessity to invest wisely can be surprisingly complex.
Having substantial wealth can sometimes be burdensome; it can reveal flaws in one’s character in unexpected ways. For instance, without vast wealth, who would know that an individual like Steve Wynn could accidentally damage a Picasso painting?
In Buffett’s scenario, he found himself with a staggering $47 billion in cash just as the U.S. Treasury and Federal Reserve aimed to devalue the dollar. In such a context, holding $47 billion in cash becomes a significant liability. Consequently, he sought practical methods to invest this enormous amount of money.
Buying Heinz was a strategic move to address this challenge. Ownership of Heinz will help preserve his wealth more effectively than holding dollars, as Heinz will continue generating profits regardless of how the dollar performs.
In time, Buffett’s acquisition of H.J. Heinz is likely to be recognized as another one of his exemplary investment successes. Eventually, the nominal price he paid will appear minor compared to the value he will reap.
Sincerely,
MN Gordon
for Economic Prism
Return from Warren Buffett’s Unique Problem and Solution to Economic Prism
