“I do more than pick stocks, you know.”
Is Warren Buffett a great stockpicker, or is he a great CEO?
A team of economists did the heavy lifting, concluding that Warren Buffett’s success came from investing savvy rather than his management abilities.
But as with anything in academia and in research, the study relied heavily on the quantitative — numbers thrown in a calculator to tell a story. A qualitative study of Berkshire Hathaway Inc. (NYSE:BRK.A) would reveal Buffett is just as much a great CEO as he is an investor.
Some great examples of Buffett’s leadership
One of Berkshire Hathaway Inc. (NYSE:BRK.A)’s best businesses is insurance company National Indemnity. Buffett acquired it for Berkshire Hathaway Inc. (NYSE:BRK.A) in 1967.
National Indemnity’s history is anything but perfect. In 1980, it generated $80 million of premium revenue. By 1986, business had more than quadrupled, and it took in $366 million in premiums that year.
But after 1986, business went downhill. By 1999, National Indemnity took in only $54 million in premiums. Why was this high-flying insurance company falling off a cliff? Berkshire Hathaway Inc. (NYSE:BRK.B) thought the insurance market was underpricing policies, so it refused to write new business.
All while its business was in decline, Buffett refused to fire a single worker. It would have been easy to lay people off, especially against the backdrop of an 80% decline in revenue. At the 2004 annual shareholders meeting, Buffett explained his seemingly counter-intuitive reasoning:
The key is you can’t fire people if they don’t write business, or they’ll write business. You must be able to tell them that if they write no business, their job is not in jeopardy.
National Indemnity was a no-name company when we bought it, and has no copyrights, patents, etc. to distinguish it, but they have a record like no-one else because they had discipline.
Buffett understands the psychology of his employees. If he lays off workers when they can’t write profitable policies, workers will write bad policies just to keep up revenue and their jobs. Paying workers to do nothing is better than encouraging them to make bad decisions.
This isn’t the only time Buffett has cited operating reasons for acquiring a company.
Why Buffett bought a homebuilder
Homebuilding is a fiercely competitive business, one that you wouldn’t expect Warren Buffett to invest in. However, in 2003, Warren Buffett bought Clayton Homes, the largest manufactured home company in the United States.
At the 2003 shareholders meeting, Buffett explained that most manufactured housing companies were losing money, but Clayton Homes was making money. How did Clayton Homes do so well when the rest of the industry was in the red? It’s simple: It understood its employees.
Buffett elaborated further:
Managers are in a 50/50 profit split with Clayton. This is unlike what was going on in the industry a few years ago, whereby dealers would have a floor plan and the company would finance 130% of the purchase price, so the dealer would bring in any warm body. The system was designed for disaster. At Clayton, if a dealer takes in inadequate down payments, it’s his problem and he has to take care of repossessing it. This creates the right incentives.
Because Clayton Home’s employees are paid based on profitability, not sales volume, they won’t sell homes to people who can’t afford one. Thus, Clayton Homes has a very low default rate, and its managers are very well compensated for making decisions that benefit the company in the long run.
Why Warren Buffett deserves more respect
Very few CEOs would refuse to lay off workers when revenues fall by more than 80%. Even fewer would agree to hand over 50% of their profits to their managers. But Warren Buffett is different.
He understands that businesses that align the interests of employees with their owners may have a bad quarter, or even a bad decade, but over periods spanning generations, these great businesses will easily beat the competition. Buffett isn’t just a great investor; he’s also one of the world’s best CEOs.
The article Warren Buffett: The Most Underrated CEO in the World originally appeared on Fool.com and is written by Jordan Wathen.
Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway.
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