Why following Buffett’s business model brings success
I’ve wondered why Wesfarmers is always on the news here in Australia. Wesfarmers is a conglomerate. It’s in hardware, retail, online shopping, chemicals, lithium and even beauty.
Nothing about their business model really makes sense other than they make a lot of money from their flagship hardware store and pour it into other investments.
But, as I read the Wesfarmers’ annual report, it felt strangely familiar to how Berkshire Hathaway is structured but at a smaller scale — although we’re still talking tens of billions of dollars in market cap.
Complete autonomy
What makes Wesfarmers and Berkshire Hathaway different from other companies are their hands off approach. Every business in their portfolio is autonomous.
There’s no integration and synergies. Each business runs on its own and shares its profits with the parent company, but in return the parent provides the capital.
Bunnings, Kmart and Officeworks all fall under the Wesfarmers banner but there’s no special integration between the separate businesses other than the same reward system — Flybuys.
And, I think this is how businesses should be run.
For example, at work, I hate micromanaging by managers, especially by non-technical managers, since I’m a technical person — a developer to be precise.
It’s better to leave me alone and let me figure out how to work with other teams than have a manager figure out how I should co-operate with other teams.
Businesses are the same. Don’t integrate businesses together just because you think it’s a bright idea.
If it ain’t broken, don’t fix it — This is what makes Wesfarmers and Berkshire successful.
A focus on return of capital employed
I read in The Essays of Warren Buffett that Buffett focuses on return on capital employed as the best indicator that a company is doing well with its capital.
Read the Wesfarmer’s footnotes and there’s a section dedicated to return on capital employed. — This makes me think that Wesfarmers does model itself after Berkshire Hathaway.
I can’t say for sure if return on capital employed is the ‘best’ profitability metric to look at but it’s one that fits Buffett’s long term view approach, and my guess Wesfarmers’ approach too.
Return on Capital Employed is EBIT/(Total Assets — Current Liabilities)
Personally, I look at a company as a whole rather than rely solely on a single metric. I read all of a company’s footnotes to see if I understand a company and consider if profitablity metrics such as Return on Capital Employed, Invested Capital or Equity are being truly represented or if managers are gaming the accounting.
Offloading losers and keeping winners
I remember listening to a story from legendary investor Peter Lynch that Warren Buffett once called him so Buffett could use one of his sayings:
Let your winners run, and cut your losers. It’s easy to make a mistake and do the opposite, pulling out the flowers and watering the weeds.- Peter Lynch
Berkshire doesn’t hold onto losers and drops them when their businesses turn out for the worse. For example, Berkshire unloaded all of its IBM shares by 2018. It would’ve been a difficult sell off since Berkshire invested heavily into IBM.
Wesfarmers is no different. In 2018, the company divested its supermarket portfolio (Coles) and sold off all shares, acquired after the demerger, in 2023. This was a difficult demerger especially considering that Wesfarmers owned one of the two largest supermarket chains in Australia.
I think it was a good decision. After reading Coles’ annual report, I was convinced that it’s not a stellar business. Supermarket retail is too competitive and the margins too low.
Conclusions
Just because I can liken Wesfarmers to Berkshire Hathaway none of this means that Wesfarmers will grow as big. — But, it’s still a very successful company in its own right.
Rather, I think it shows how successful the Berkshire Hathaway model is and that if you find another company emulating the model, then maybe it’s worth a look.
