Warren Buffett telling the rest of us about the advantages of conglomerates is like Willie Mays arguing for the no-look-over-the-shoulder catch while running full speed.
It can happen, and those who do it will command a premium, but your wealth or retirement should not depend upon it.
While first acknowledging the deservedly lousy reputation conglomerates have with investors, Buffett in his annual letter to Berkshire Hathaway shareholders goes on to make a full-throated defense, at least of his version.
“If the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital growth,” Buffett writes.
The astonishing, and very possibly true, basis for his argument boils down to the idea that Buffett does capitalism better than everyone else.
“In contrast, a conglomerate such as Berkshire is perfectly positioned to allocate capital rationally and at minimal cost. Of course, form itself is no guarantee of success,” Buffett writes.
He simply believes that he is better at allocating capital and that the conglomerate structure gives him the ability to do this more efficiently. Capital is reallocated from slowing sectors to ones with better prospects. Further, Berkshire can buy shares of businesses when they are available at attractive prices. Finally Buffett sees his company as the home of choice for owners who want to sell out but who want their firms to escape the tender mercies of private equity chieftains.
It is hard to argue with Buffett’s track record. But putting Berkshire aside for a moment, let’s look at conglomerates as a group. The sector trades at what has to be considered a structural discount to intrinsic value. This phenomenon has gone on so long it even has a name, the “conglomerate discount.” This discount in 2012 stood about 10 percent, according to Boston Consulting, compared with a 14 percent or so average since 1990.
In short, conglomerates have a track record of subpar capital allocation. And, as Buffett points out, conglomerates have a history of issuing too much equity to fund acquisitions, not to mention a fair amount of creative accounting along the way.
Finally, there is the fact that conglomerates are, by definition, a mismatch with the desires of everyone other than the people who built them. Buffett is a hugely exceptional person, someone possessed of great judgment, great patience and a huge ability to put off very large current rewards for even bigger future ones.
So, invest in conglomerates, but first find your angel.