Warren Buffett likes elephant hunting. The kind of "elephant" he likes to hunt, though, isn't the four-legged kind with trunks. Buffett is always on the lookout for big acquisition targets to add to his Berkshire Hathaway (BRK.A 0.16%) (BRK.B 0.11%) empire.
There haven't been many acquisition candidates that Buffett liked over the past few years. However, he recently found one. Last week, Berkshire announced plans to buy insurance company Allegheny (Y +0.00%).
A megadeal between Berkshire and Allegheny might not seem to have any relevance to the decisions made by ordinary investors. But it does. Here are three lessons you can learn from Buffett's $11.6 billion elephant buy.
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1. Understand what you're buying
Another legendary investor, Peter Lynch, popularized the idea of buying what you know. Buffett adheres to the principle, as well. And he certainly understands Alleghany's business.
For one thing, the company's property and casualty insurance operations are a great fit with Berkshire's own insurance and reinsurance businesses. Buffett has been a longtime fan of the cash flow generated by insurers.
His understanding of Alleghany runs even deeper, though. Buffett stated in the press release announcing the acquisition that he has "closely observed" Alleghany for 60 years. He referred to Alleghany CEO Joe Brandon as his "longtime friend."
You don't need to have watched a stock for 60 years or be on speaking terms with its CEO to buy it, of course. However, it's important to understand the underlying business before investing in its stock.
Buffett himself emphasized in his latest letter to Berkshire shareholders that he and his business partner Charlie Munger "are not stock-pickers; we are business-pickers." Every investor would do well to share this philosophy.
2. Don't overpay
Buffett isn't the die-hard value investor that he was years ago. However, the lessons that he learned under the mentorship of Benjamin Graham have stuck with him. He doesn't like to overpay for an acquisition or a non-controlling interest in a publicly traded company.
The $11.6 billion price tag for Berkshire's acquisition of Alleghany reflects a 29% premium to the insurance-stock's average price over the 30 days prior to the announcement of the deal. It was even 16% higher than Alleghany's 52-week peak closing price.
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Key Data Points
Did Buffett overpay? Not at all. The price is only 1.26 times Alleghany's book value, as of the end of 2021. Berkshire appears to be getting exactly what he has stated in the past that he likes -- "a wonderful company at a fair price."
This concept is one that ordinary investors would do well to heed. Even great businesses are sometimes overpriced.
3. Wait for the right opportunity
Why has Berkshire been sitting atop a massive cash stockpile for quite a while? Buffett and his investment managers haven't found any elephants that met their criteria until the Alleghany opportunity.
BRK.B Cash and Short Term Investments (Quarterly) data by YCharts.
Buffett doesn't actually like to have such a large cash position. He wrote in the latest Berkshire shareholder letter that he'd prefer to invest more heavily either in acquiring entire businesses or in buying stocks. But he added: "Charlie and I have endured similar cash-heavy positions from time to time in the past. These periods are never pleasant; they are also never permanent."
You could accurately compare Buffett to a seasoned hitter in Major League Baseball. Such a hitter knows to wait for his pitch before swinging. That's exactly what Buffett has been doing over the past few years as he waited for the right elephant-sized deal.
Patience is a virtue that all investors should have. The good news is that the recent stock market sell-off has made some stocks more attractively priced than they've been in a while. Unlike Buffett, you don't have to wait for an elephant to come along.
