We all know The โOracle of Omahaโ and his undisputed position at the top of the finance world as the most successful investor alive. His current net worth figure of $87.3 billion will probably be inaccurate by the time you get to the bottom of this page, all thanks to his cash printing machine known formally as Berkshire Hathaway.
For a bit of background, the company cleared more than $24 billion in net earnings for the 2016/2017 financial year โ thatโs straight cash. Fundamentally, Berkshire Hathaway actually has far too much cash on its balance sheet as the money is technically wasted not being invested at a higher rate of return than the rate of the bank in which it sits. We know Buffett has an uncanny ability to pick great companies, but surely there is a hidden weapon that gives him an edge over the finance worldโs stiff competition?
The answer is leverage and the way he uses it.
Using other peopleโs money does wonders for your return on investment, but whilst you and I might pay 5-8% to do it, Buffett pays nothing. The key to Berkshireโs interest-free loans lies in its insurance businesses: each time customers make a payment on their insurance policies, Buffett gets to use the money until it is paid back out in claims. Between these time periods, Buffett enjoys the full use of interest-free financing and the returns that come from his investments. With this strategy, the Oracleโs investments need not even be spectacular because if you can borrow below market and make only market returns then youโre going to outperform the market in your returns on equity.
Over time, the amount borrowed has grown from $30 billion in the year 2000 to more than double that today, with approximately 36% of Berkshireโs borrowings between 1976 and 2011 coming from the insurance float. A study by some smart people at the USโ National Bureau of Economic Research found that in 21 of those 35 years Berkshire Hathawayโs insurance float actually had a negative cost. That means the company was paid to borrow money, which in 2013 resulted in a cool and clean $3 billion profit all while the cash could have just been under Buffettโs mattress.
If your inner investor is feeling inspired, check out 10 of Buffettโs pearls of wisdom for motivation.
