To Investors,
I’ve been studying how and why Warren Buffett picks his investments. This is a long journey because contrasting where we are in terms of our careers, Buffett has probably forgotten more than I've learned about capital allocation. But we move.
I recently wrote two letters, the first titled “Why Does Warren Buffett Like Apple and Coca Cola,” and the other titled “Why Does Warren Buffett Like Bank of America and Amex.” In detailing my learnings in that period, I found that he picks the category winner in each industry or sector, and that the company must have been around for more than 30 years at least and must be a globally recognised brand.
Why?
That way the company has exposure to every country and is also at the mature stage of its company life cycle, to afford him stable and high dividends as a shareholder, as well as to be able to withstand economic systemic shocks.
His interest in Japanese trading companies Mitsui & Co, Marubeni Corporation, Sumitomo Corp, Mitsubishi Corporation, and Itochu Corp is no different. Each of these companies have been around for 50+ years, have operations in different regions globally, and are systemically important companies for Japan through business operations in energy provision, manufacturing, local trading, retail, infrastructure, technology, import and export, agriculture, mining, and financial services.
This means they can and will continue to withstand economic shocks and can and will continue to pay Berkshire Hathaway high and stable dividends.
The most fascinating part however is how he bought shares in these Japanese trading companies.
When he started buying over 2020 and 2021, the average bank lending rate in Japan was ~1%. So, instead of converting US dollars to Japanese Yen to buy the shares, he issues Japanese debt at a 1% interest rate.
I did some back-of-the-envelope maths to show what this would look like.
At a 1% rate, the dividends he received as a shareholder more than cover the coupon he had to pay, and he pockets the difference.
So why issue Japanese debt instead of just buying shares with his existing cash balance?
Answer: exchange rate exposure.
If he converts his U.S dollars to yen he exposes himself to exchange rate fluctuations, and when he converts his dividends received, he exposes himself again. So, to reduce that double exposure, he bets that the U.S dollar would continue to appreciate against the Yen and exposes himself only once.
If the U.S dollar appreciates against the Yen, the U.S dollar value of his Yen denominated dividends received would be more valuable when he converts.
What if the U.S dollar depreciates against the Yen?
Well, then the value of his holdings of these Japanese companies would appreciate because generally investors want to hold assets of a country with a stronger currency. So, he still wins.
Long term, he remains less sensitive to exchange rate risk because 1) the value of the trade continues to appreciate no matter where the exchange rate goes; 2) these trading companies have exposure to a range of currencies including the euro, U.S dollar, Australian dollar, and the Japanese Yen, so the value of the companies’ foreign currency revenues can remain unaffected.
For example, if the Yen appreciates vs the U.S dollar, the value of the companies’ dollar denominated revenues will be higher when they convert those revenues from dollars to Yen.
That’s why Buffett is the G.O.A.T
I hope you found this letter interesting.
On the journey to becoming a master capital allocator - one lesson down, a billion more to go.
Respectfully,
-Mansa
READER NOTE: If you liked this post, feel free to hit the subscribe button and share with someone who might also find this interesting.
What did you think about this letter? Let me know in the comments 👇🏾