Warren Buffett speaks during the Forbes’ 2015 Philanthropy Summit Awards Dinner (Photo by Dimitrios … [+]
Last month, Warren Buffett lamented in his annual letter to shareholders that Berkshire Hathaway “found little that excites us.” He was referring to ways to use their $144 billion cash position to make an acquisition.
That all changed today.
Buffett’s exciting acquisition target is not GameStop, Zoom, Tesla or anything else that has recently captured investors’ attention. Today, Berkshire Hathaway announced that it was buying…a reinsurance company.
In the same letter, Buffett wrote of the insurance business that it “will never be obsolete, and sales volume will generally increase along with both economic growth and inflation.” That might help explain today’s announcement that Berkshire was buying reinsurance company Alleghany Corporation for $11.6 billion.
It’s a classic Buffett move: invest in what you know, be patient and concentrate your position when appropriate. In this case, Buffett was as patient as a glacier, saying that Alleghany was “a company that I have closely observed for 60 years.”
Buffett has formerly said that “Diversification is a protection against ignorance. [It] makes very little sense for those who know what they’re doing.” No one knows the insurance business better than Buffett, so it makes sense for him to buy more.
Alleghany is similar to Berkshire in that it’s an insurance conglomerate that also has a division, Alleghany Capital, composed of non-insurance companies. Those include steel fabricator WWSC Holdings, top ten toymaker Jazwares and Wilbert Funeral Services (talk about a recession-proof business!).
As of this writing, Alleghany’s forward P/E ratio is 12.11 compared to the S&P’s forward P/E of 18.2. Barron’s recommended Alleghany last November, quoting a JPM Securities analyst that said it was undervalued. Buffett must have agreed, offering a 29% premium to buy the company.
In the press release announcing the acquisition, Buffett said, “I am particularly delighted that I will once again work together with my long-time friend, Joe Brandon.” Let’s discuss Brandon, the new CEO of Alleghany, for a moment.
Brandon formerly worked under Buffett as CEO for Berkshire’s General Re business and was mentioned as a possible successor to Buffett. However, he was forced to resign in 2008 after four former General Re executives were convicted for fraud and prosecutors pressured Buffett to replace Brandon.
Now that the smoke has cleared, Buffett will be happy to have his long-time friend working under him again. Berkshire is known for being hands-off and allowing CEOs to run their businesses. There’s no reason to believe Alleghany and its divisions will be treated differently.
Buffett’s love of the insurance industry can be summed up with one word: float. In short, float is the cash collected from premiums that insurance companies hold before paying out claims. Buffett calls float “money we hold and can invest but does not belong to us.” No one in history has been better at investing that money than Buffett, and Alleghany should significantly add to Berkshire’s float.
Berkshire’s purchase of Alleghany may not excite the meme stock crowd, but it should ensure its company is well-positioned to continue its successful run.