Why I Like to Study Conglomerates

Cross pollination with an Operator Edge

I have been spending a lot of time with conglomerates lately. Well, not lately. The conglomerate to me is my White Whale. In a sick way, I find enjoyment in digging deep into the 10Ks of companies with multiple business lines. Dissecting each of them into their respective categories and then going one by one attributing value to each and seeing what they add up to in the end. Usually, from there I don’t make an investment decision right away.

These things take time and eventually, I feel like the time will come when the market will be in a bad mood and price the company for drastically less than it’s worth. The prior preparation allows me to put on my big boy pants and make an investment with strong conviction.

There is another feeling inside me that feels safer when you buy a conglomerate at a drastic discount because, by their nature, there is more than one engine flying the plane. That is to say, there seems to be more room for error when you buy a solid conglomerate at a discount than other companies who will commonly live by the sword and die by it as well.

Let me be clear though, I am not knocking the business that operates in a single line and dominates it. They are much more straightforward to understand and are a breath of fresh air. I can’t tell you how great it felt to write about AutoZone after spending 7,000 words with Berkshire. When there are a lot of moving parts, it’s easy to get lost in the maze.

I have found it beneficial for my own learning curve to study conglomerates for more than one reason. Honestly, as a self-taught investor, beginning with these mazes might have been one of the best ways for me to sharpen my business acumen. The reason is simple, it introduces you to a wide variety of companies and when there is a well-written investor letter to go with it you can begin to understand concepts in business you would have never been able to wrap your head around had it been just you out in the ocean of numbers and metrics alone.

The added benefit of being so deeply involved with a conglomerate is you can begin to see the reason why some legs do better than others and understand the deeper nuances of a certain business line that could carry over to other companies. This ability to take the big picture and stronger variables from one business line and then carry them over or copy them onto another can be a compelling idea.

There is also a depth of knowledge that comes with operating a business in a given arena. It gives you insight that goes deeper than the day-to-day movements of the price that can easily distract someone with a short-term mindset from the powerful and sturdy long-term value of the company. I call this operator edge.

For example, Buffett wrote about his investment in Safeco in their 1978 letter to shareholders where he said the following:

In some cases our indirect interest in earning power is becoming quite substantial.  For example, note our holdings of 953,750 shares of SAFECO Corp. SAFECO probably is the best run large property and casualty insurance company in the United States.  Their underwriting abilities are simply superb, their loss reserving is conservative, and their investment policies make great sense.

SAFECO is a much better insurance operation than our own (although we believe certain segments of ours are much better than average), is better than one we could develop and, similarly, is far better than any in which we might negotiate purchase of a controlling interest.  Yet our purchase of SAFECO was made at substantially under book value.  We paid less than 100 cents on the dollar for the best company in the business, when far more than 100 cents on the dollar is being paid for mediocre companies in corporate transactions.  And there is no way to start a new operation—with necessarily uncertain prospects—at less than 100 cents on the dollar.

-Warren Buffett. Berkshire Hathaway Letters to Shareholders, 2017.

My question: how did Buffett know it was the best company in the business? The obvious answer: he ran an insurance company and understood what made a great insurance company great. I am willing to bet with this type of insight he was willing to put chips on the table with a solid degree of conviction that he wouldn’t have had if he wasn’t involved in the insurance business for so long.

It is the cross-pollination of ideas that I have found to be very valuable. The conglomerate operators take their knowledge gained by operating a business in the space and then leverage that understanding to make larger investments in organizations that are better than your own. In what other arena can the #10 team hitch part of their success to the #1?

This is why I love to study conglomerates with shareholder-friendly management. If I am able to study one of their lines of business, understand the economics, and the main drivers of value, the framework can be lifted and applied to others in a similar space.

If you’re interested I’ve enjoyed the 70s-80s Berkshire letters, The Boston Omaha Letters, and Nelnet Letters. They discuss their various operations and it can help you generate many more organic places to look.

Peace and Love,
Michael

Please be advised, Wall St Gunslinger is not an investment advisor and does not give personal investment advice. All content is for educational and entertainment purposes only and should not be interpreted as anything other than such. Investing entails a lot of risks and should be managed appropriately. Please do your own research and consult with an investment professional before making any investment decisions. Thank you.