Warren Buffett, the billionaire chief executive officer of Berkshire Hathaway, says he rates businesses on their ability to raise prices and sometimes does not even consider the people in charge.
“The single most important decision in evaluating a business is pricing power,” Buffett told the Financial Crisis Inquiry Commission (FCIC).
“If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10%, then you’ve got a terrible business.”
Buffett (80) accumulated the world’s third-largest personal fortune through a career of stock picks and takeovers.
He has bought companies such as railroads and electricity producers, whose pricing power stems from a dearth of competitive options available to clients. Buffett has also built stakes in firms like Coca-Cola and Kraft Foods, which rely on the appeal of their brands to attract and keep customers.
The FCIC investigators focused on Buffett’s investment in Moody’s Corporation, the bond rating firm blamed by lawmakers for handing out inflated credit grades during the housing boom.
Buffett said he held stock in Moody’s because the company’s leading market share, along with that of rival Standard & Poor’s, gave the two firms flexibility in setting prices.
“I knew nothing about the management of Moody’s,” said Buffett. “If you owned the only newspaper in town, up until the past five years or so, you had pricing power and you did not have to go to the office.”
But a dominant position could not prevent a bad manager from destroying a company over time, said Benjamin Hermalin, a professor of economics at the Haas School of Business.
“If you have a really dominant position you can survive for quite a long time with bad management, but eventually it will catch up to you,” said Hermalin. “In the short run I would agree with Buffett, but in the longer-run perspective there is something to be said for having a good manager.”
Burlington Northern Santa Fe, the railroad Buffett bought last year for $26.5 billion (R189.9 billion), owns more than 48 000km of track across the western US, connecting producers and distributors of coal, grain and consumer goods.
Omaha-based Berkshire’s power company, MidAmerican Energy Holdings, sells electricity to homes in the Great Plains region and transports natural gas from Wyoming to California.
Buffett routinely singles out and praises managers of Berkshire’s more than 70 operating companies. MidAmerican chairperson David Sokol and Gregory Abel, the unit’s chief executive, are “two terrific managers”, Buffett said last year in his letter to shareholders.
The acquisition of Burlington Northern had the “additional virtue” of bringing the railroad’s chief executive, Matthew Rose, to Berkshire, Buffett said.
Buffett criticised Kraft chief executive Irene Rosenfeld last year for her takeover of Cadbury and the sale of the foodmaker’s pizza brands. “Both deals were dumb,” Buffett told Berkshire investors last year. Berkshire is the biggest shareholder of Kraft, with a stake valued at $3.3 billion at the end of December last year.
“In the short run, good management can make a stock pop, but I follow what Warren is saying, especially because his point of view looks at the fundamentals,” said Terry Connelly, dean of the Ageno School of Business at Golden Gate University in San Francisco, and a former managing director at Salomon Brothers. “Good management can’t do anything with a bad case,” he said.