How Buffett Got Rich

A lot is made of Buffett’s approach to investing but it can be simplified to a level even a 12-year old understands.

While it’s easy for sophisticated investors to get caught up in the weeds of price-to-earnings multiples, competitive advantages, book values, and balance sheets, there is arguably a much simpler approach Buffett has taken to investing that can be applied by just about any investor willing to spend a little time musing on the topic.

At an early age Buffett pondered how much money he could make if he were able to capture just a small amount of money from each car passing on the road. Over time, governments figured out the answer with toll roads. But Buffett extrapolated the idea to other industries.

For example, long before the crash in 2020-21, we surmise that he asked the question, how do I capture a portion of the economics from each person traveling by plane? And the answer might surprise you, because it wasn’t simply to find a good airline stock.

Buffett’s Big Idea

Buffett’s big idea wasn’t to figure out whether American Airlines was better than Delta, or if both were better than JetBlue. Instead, he concluded that if he owned a share of the largest four airlines, he would largely capture a portion of the economics of the whole industry.

It’s not particularly different when he decides to buy Apple or Coca Cola or American Express. The same principle can be applied in those cases.

For example, if you had no phone and had to buy one, which would you buy. It wasn’t even 20 years ago you had a myriad of choices from Blackberry to Nokia to Ericsson.

These days, you are largely restricted to two operating systems, because most apps are built on them: Android and iOS.

While Android serves a greater volume of phones, iOS and Apple own the lion’s share of the revenues. And for Buffett that means to capture a portion of those economics, the best bet is Apple.

So too, in the beverage industry, Coca Cola is akin to the toll road that most consumers must drive through to pick up their favorite soda. While PepsiCo is a serious rival, it focuses heavily on snacks. Coke is more of a pure play on the beverage industry and still has the leading share.

So what should you do?

What Stock Should You Buy?

When you’re looking for the next stock to buy and hold for the long-term, consider whether it acts as a toll road for its industry. If it’s like Coca Cola or Apple, the stock alone can be purchased and reward you.

If no clear leader exists, the airline approach Buffett employed works well too, meaning buy the top 2 or 3 or 4 players in the industry and if one loses market share, another will likely pick up market share.

By so doing, you too can realize the aspirations Buffett had early on to earn a nickel from each car passing by, so to speak. Whether that’s a share of each beverage consumed, each phone bought, or each plane boarded.

The approach of buying what is already dominant tends to fare much better than the strategy of buying what will one day perhaps take the lead.

Buying into potential growth that hasn’t yet materialized has proven very costly for some money managers in recent years, like those at ARK Invest, whereas sticking with what’s tried and tested, buying leaders who produce massive cash flows is a time-tested approach that put the odds in your favor.

Indeed, this is the approach that led to Buffett’s success.

How Buffett Got Rich

Warren Buffett got rich primarily through owning shares in Berkshire Hathaway, a company of which he owns 16.45% of all shares outstanding.

Remarkably, the company was founded 185 years ago but it wasn’t until Buffett figured out how to turn the ailing textile mill into a conglomerate holding company that wealth accrued rapidly to shareholders.

By aggregating a collection of companies that all had dominant market positions, Berkshire naturally rode a wave higher because its holding produced higher returns on capital than the average company in the S&P 500.

It’s also a reason why the returns of Berkshire are likely to persist for some time at market or above-market rates over the long haul. After all, if Buffett continues to hold Coca Cola that dominates the beverage industry and Apple in the technology sector and Chevron in energy, it will be very difficult to underperform unless those sectors underwhelm relative to the market too.

And that’s where Buffett’s strategy shines brightly because he has exposure to everything from railroads to candy companies, from big tech to energy and even some AI plays, such as Snowflake.

So, if oil prices shoot up, and other holdings dip in price, his energy stocks, like Occidental Petroleum, are likely to rise and offset the downturn elsewhere. By employing such smart diversification, selecting wide moat companies across many leading sectors Buffett has naturally limited downside risk for Berkshire Hathaway shareholders.

Add to that the $276.9 billion in cash and equivalents on the books and you can see just how hard it will be to dislodge Berkshire Hathaway from the top of the pecking order of leading companies. Even in a crisis, Berkshire has the deep reserves to ride out economic storms. 

It’s Buffett’s ability to both limit risk and ride winners to near unimaginable gains that have led to Berkshire Hathaway’s successes, approaching a trillion dollar market capitalization and made Buffett one of the richest men in history.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.