Warren Buffett has cemented his position as a financial legend over his long investing career. Since he assumed the role of Chief Executive Officer at Berkshire Hathaway (BRK.A 1.18%) (BRK.B 1.30%), Buffett has delivered incredible returns of 3,787,464% -- or nearly 20% compounded annually. Buffett's success can be attributed to a few factors, including his astute investment strategy and surrounding himself with intelligent individuals like longtime partner Charlie Munger.
Another crucial aspect of Berkshire Hathaway's approach is its ability to generate consistent cash flows, providing Buffett and his team with a reliable source of capital. This financial strength allows him to hold investment positions for a long time while always having cash available to take advantage of discounted stock prices.
Remarkably, one key metric under Buffett's leadership has grown 863,732% since he took over at Berkshire Hathaway. Here's what that crucial metric is and why it makes Berkshire Hathaway a money-making machine.
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Insurance is "a very large chunk of Berkshire's value"
When Buffett took over Berkshire Hathaway, it was a failing New England textile business. Berkshire's fundamental transformation began when National Indemnity became available in 1967 and shifted toward insurance and other non-textile operations.
Berkshire has a massive portfolio of publicly traded stocks and wholly owned private businesses. Those privately owned businesses include the insurance companies GEICO, General Re, Berkshire Hathaway Reinsurance, and National Indemnity.
Buffett told investors in his annual letter that insurance is "a very large chunk of Berkshire's value." What he likes about these companies is that their products "will never be obsolete, and sales volume will generally increase along with both economic growth and inflation."
Well-run insurance businesses are a steady source of cash flows -- and a consistent source of funds for Buffett and his team to put to work in other investments. Insurers collect premium payments upfront and pay out claims at a later date. This collect-now, pay-later model gives insurers huge sums of money called "float" that Berkshire Hathaway can put to work in investments in the meantime. As insurance policies lapse and premiums exceed claims, Berkshire keeps that cash and can invest freely wherever it seems fit.
Berkshire's cash position has rocketed higher since 1967
Berkshire Hathaway's float is crucial to its long-term success. Since acquiring National Indemnity in 1967, its float has grown from $19 million to $164 billion -- a whopping 863,732% increase. Last year Berkshire acquired Alleghany, which boosted this figure another 12% year over year.
Data source: Berkshire Hathaway. Chart by author.
Float is crucial to Berkshire Hathaway because it provides a steady stream of cash for long-term investments, allowing them to compound over time. While funds come and go as its various insurance businesses pay out claims, the aggregate amount of these funds is "immune from a precipitous decline," Buffett told investors. For this reason, this float is considered "sticky," giving Berkshire a big cash pile that it can put to work acquiring quality companies at good prices.
Why Berkshire Hathaway can continue to thrive
Investors can learn from Buffett's strategy at Berkshire Hathaway. Keeping some cash available is always important, so you can take advantage of investment opportunities. Putting away cash in your investment account every month is a great way to build wealth, and leaving some cash available to take advantage of discounted prices during bear markets is a great way to supercharge returns.
Berkshire Hathaway does an excellent job of this. At the end of the first quarter, the company had nearly $128 billion in cash and cash equivalents and short-term Treasury bills, allowing it to take advantage of further potential declines in asset prices.
Berkshire Hathaway's insurance business ensures it will always have a significant cash position, which is why the company should remain an excellent long-term investment -- even after Buffett and Munger pass the reins to their successors.
