Warren Buffett doesn't keep his investing strategies a secret. He spills a lot of his thoughts in his annual Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) shareholder letter, and investors carefully scour it for Buffett's nuggets of wisdom. But despite his immense success, his advice often comes across as contrarian to standard Wall Street beliefs. That's one of the reasons it's so valuable.
He sprinkled plenty of insightful comments throughout this year's letter, reiterating many of the ideas he usually tries to hammer home. He clarified a particular feature that Berkshire favors for its portfolio -- but he says that companies with this feature are "rare enterprises."
Delivering "wealth beyond measure"
What's this magic feature? These are Buffett's words:
At Berkshire, we particularly favor the rare enterprise that can deploy additional capital at high returns in the future. Owning only one of these companies -- and simply sitting tight -- can deliver wealth almost beyond measure.
Deploying capital is using the capital you have to invest in the growth of your business. There are three basic capital deployment strategies. Companies that are just getting started often invest heavily in their businesses even when they're not pulling in much money. They often have to raise capital at this stage, but if they impress investors with their potential to make money, they'll get funding to make it happen. If a company is still doing this well into its lifetime, that's not a great sign.
The second type is when companies are operating smoothly, but they're deploying capital to make back a little more. Many companies work this way.
The third type is when a company is deploying capital so effectively that it leads to exponential returns down the line. This kind of company doesn't need to raise capital later on, and investors benefit from years of returns from their initial investments.
The magic of compounding
This is the power of compounding in the context of building, or investing in, a great business -- $1 invested today leads to a long-term future earnings stream. For investors, it's the idea of buying low and seeing gains compound over years. For businesses, it's the idea of deploying capital correctly so that each dollar spent leads not only to more than a dollar returned, but to years and years of returns on each dollar.
Image source: The Motley Fool.
The mediocre company will get back more than it spent. The excellent "rare" company will get a future earnings stream that compounds over time, or exponential growth from wisely invested capital.
This is one of the reasons Buffett loves Coca-Cola (KO). It achieves high profits without high capital redeployment. Dollars spent in years past have led to an industry-leading business that relies on a strong brand value and exceptional distribution network to do the heavy lifting.
The power of dividends
Buffett illustrated this idea when he talked about American Express' (AXP -0.62%) and Coca-Cola's dividends in last year's letter to shareholders. While Berkshire Hathaway purchased each of those stocks for $1.3 billion in total, it made more than $1 billion from their dividends in 2022 alone, and more in 2023.
Berkshire finished buying these stocks in 1994 and 1995, and while sitting tight over the past 30 years, its share of each business has grown while the stocks' value compounds over time. This year, Buffett called his investments in these companies a "Rip Van Winkle slumber that has now lasted well over two decades," and said both companies "rewarded our inaction last year" by providing it with ever-increasing earnings and dividends.
Buffett's track record speaks for itself, and if you want to enjoy the "wealth almost beyond measure" that can come from wise investing, you might want to follow his lead.
