In 1972 Warren Buffett (Trades, Portfolio) and his partner, Charlie Munger (Trades, Portfolio), made one of the most important deals of her career. Munger had convinced Buffett to buy See’s Candy for Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B), at what Buffett thought was a high price tag of $ 25 million. This was above the book value of the group and a multiple of 5.2 times the profit at the time. That might not seem expensive by today’s standards, but it was back then for Buffett.
In the years leading up to the deal, Buffett only bought stocks that traded at a deep discount to book value. Buffett followed in the footsteps of his teacher and mentor Benjamin Graham and pursued a strategy called net-net investing, which sought to buy stocks that were trading at a discount to the value of their net worth.
If a company were to trade at a discount to the value of its net assets, the buyer of that company would theoretically pick up the rest of the company for free (excluding the net worth). Buffett’s adherence to this mindset, however, began to wane after the deal of the lake.
Buffett and See’s Candy
In Janet Lowe’s book, “Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger,” the author gave an insight into why the deal was so transformative for Buffett and his partner.
“It was acquired at a premium over book [value] and it works, “Munger said in an interview with Lowe.” Hochschild, Kohn, the department store chain, was bought at a discount from the book and liquidation value. It didn’t work … Those two things together helped shift our thinking to the idea of paying higher prices for better companies. “
The book also stated that as their business grew, Buffett and Munger realized they needed to deviate from bottom fishing. It was becoming increasingly difficult to find investments and buy those who found them in sufficient quantities to make a difference. As Munger said to the author at the time: “You could find value if you just rummaged through the pink sheets in the less traveled parts of the world – you would find many options.”
When Munger and Buffett realized how easy it was to run an excellent ongoing business that was generating steady profits when compared to the previously purchased high value stocks they had previously bought, their investment strategy changed completely.
“If we hadn’t bought See’s, we wouldn’t have bought a Coke,” Buffett said. “So thank you See’s for the $ 12 billion. We were lucky enough to buy the whole business, and that taught us a lot. We had windmills, well, I had windmills. Charlie was never in the windmill business. I ‘we had top notch Department stores, pumps and textile factories … “which in his opinion were almost as bad as problematic as the windmills.”
The book added a comment from Munger who stated that the duo should have noticed the benefits of paying for quality much earlier: “I don’t think it’s necessary to be as stupid as we are.”
I think Munger’s comments that the pair are “stupid” are a bit of an exaggeration as the markets are slow to change and it is not always obvious at first when your old strategy used to work so well. Even so, we shouldn’t overlook how important this deal has been in all of Buffett’s history. With the acquisition of See’s, the Oracle of Omaha bought its first “quality” business. He quickly realized how much easier it was to be an investor who bought good companies and just sat on them rather than constantly looking for new opportunities.
Since then, this mentality has defined his investment style. Today, both Buffett and Munger specialize in finding and sitting on good companies. This strategy has worked incredibly well over the years.
Disclosure: The author owns no mentioned part.
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About the author:
Rupert is a committed value investor and regularly writes and invests according to the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter for institutional investors.
Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers all value investing for ValueWalk and other freelance websites.