When people are thinking about Berkshire Hathaway's future after Warren Buffett left the scene, consider a thought experiment. For example, let's say Buffett just turned 45, not 90. If he knows his skills, which companies would be a good fit for a younger Buffett CEO?
Here's the bottom line: these will be the highest quality companies and the highest quality shareholders.
This experiment is useful for anyone looking to start or invest in such a business.
A critical factor in the CEO's fit is the match between the executive's skills and the company's needs. The capital allocation was Buffett's biggest lawsuit at Berkshire Hathaway
and while every company should make capital allocation an explicit operating principle, only a minority do so. That limits our job search for the younger Buffett.
Another requirement is the correspondence between the values of the CEO and the prevailing corporate culture. Buffett succeeds in a trust-based culture where leaders allow great autonomy and create a decentralized structure. In view of the command and control culture that prevails in American companies, this further weakens the search.
The decisive measure concerns the philosophy of the CEO and the shareholders. The dominant shareholder cohorts today are indexers and short-term, transient traders. But Buffett cultivated a majority of Quality Shareholders (QA), that exacting corps that are picky and patient. Buffett always knew what any venture capitalist would advise: It takes such focused, long-term investors to build a great business.
In Berkshire, the cultivation of such QA comes through the celebrated annual meeting and Buffett's signature of the letter to shareholders due out this Saturday. Buffett shaped the shareholder base of Berkshire through the 1996 recapitalization that created Berkshire's dual tier structure.
Which companies value capital allocation and a trusting culture and at the same time attract QA? With joint rankings in each of these categories, which were compiled by the Quality Shareholder Initiative with the help of EQX Investor Capital, 15 companies stand out. Call them quality companies:
Emerson Electric Co.
Fairfax Financial Holdings
Illinois Tool Works Inc.
Post Holdings Inc.
Roper Technologies Inc.
Excellent insights into these companies are the CEO's letters to shareholders and annual meetings. While none meet the gold standard set by Berkshire and Buffett, the letters are widely read and the meetings well attended. In both media, you will find indications of a conscious cultivation of QA, often by explaining the company's approach to capital allocation, the characteristics of its culture and long-term value creation. A young Buffett would be at home in such places.
Some of these quality companies are in the insurance business, a sector that tends to attract skilled capital allocators who think long term. Insurance is also a trust-based industry, where policyholders pay premiums based on their trust in the insurer to keep promises in the distant future.
The companies listed own formidable insurance goods – Markel's brand names, Alleghany's TransAtlantic Holdings, Canada-based Fairfax Allied World – and notable non-insurance companies ranging from the ornamental leader (Markel) to the legendary Peppa Pig (Alleghany). A young Buffett would love such business.
Three quality companies share a common ancestor: venture capitalist George Ohrstrom (1927-2005) incubated and transformed Carlisle, Dover and Roper. These companies, like Berkshire, go against the prevailing fashion by maintaining a diverse collection of stores. All use slightly different approaches to managing and justifying scaling, but the common characteristics are trust and a long-term view.
Every quality company has its own method – for example the Danaher Business System or the ITW Business Model. Illinois Tool Works has typically preferred many small acquisitions and left management alone, while Danaher has ultimately made larger acquisitions and has a rigorous company-wide system of recruiting and training managers.
In response to shareholder pressure from activists, ITW has spun off some companies in a selective fashion, while Danaher has spun off large ones. But both stay true to the fundamentals that Buffett would appreciate.
Another recurring theme in these quality companies is long tenure as CEO. Prem Watsa has been CEO of Fairfax since 1985; Garry Ridge has been with WD-40 since 1997; Shantanu Narayen has been responsible for Adobe since 2007.
Among the companies, Alleghany had five CEOs in 80 years, Emerson Electric had three CEOs in 66 years, and Amphenol's current and former CEO combined 25 years. While no one comes close to Buffett's in Berkshire – nearly 60 years old – a younger Buffett would appreciate the chance of such longevity.
But while Buffett would be a good fit to run one of these quality companies, let's conclude this thought experiment by observing that none of them need his help. Not only are they already run by great managers, but they have become quality companies as their executives put in place policies that attract quality shareholders.
By the same token, long after Buffett left the scene, Berkshire is poised to thrive for creating such an institution and creating such a shareholder base. The lesson for other managers is clear: Quality creates quality, and a clear path to a quality company is to attract quality shareholders.
Lawrence A. Cunningham is Professor and Director of the Quality Shareholder Initiative at George Washington University. His books include Quality Shareholder, Dear Shareholder, and The Essays of Warren Buffett. Cunningham owns shares in Berkshire Hathaway and is a shareholder, director and vice chairman of Constellation Software.
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