December 7, 2021

Berkshire Hathaway is taking a multibillion dollar write-down on Kraft Heinz, a recent major acquisition. This is surprising for fans of Berkshire’s legendary leader, Warren Buffett. Known as the Oracle of Omaha, Buffett is famous for his fantastically successful use of fundamentals-driven value investing. When the legendary Warren Buffett makes a mistake, there must be a lesson to learn.

Berkshire buys steady, established businesses with regular cash flow and strong brand value. They’re major investors in Coca Cola, Apple, Wells Fargo, GEICO, and many other iconic American companies. Buffett is also famous for using his elephant gun — billions of dollars of cash, kicked up to Berkshire from many different operating subsidiaries — to buy entire companies and add them to the portfolio. Kraft Heinz fits this MO perfectly.

So why did the Kraft Heinz deal produce a write down when Berkshire usually sees great returns? Buffett’s value investing approach missed something important: steady cash flow and historical brand value are great, but they don’t tell the whole story. Decades of Kraft and Heinz dominating their packaged food markets is butting up against changing consumer preferences. Mac and cheese from the box is losing ground to organic, gluten free, all natural, etc.

If value investing has a weakness, this is it. All Heinz’s past sales don’t matter if people are eating fewer hamburgers and french fries and shifting to other kinds of foods. Healthy and natural are increasingly sought-after brand characteristics, and that’s eating into the business of old school processed food makers like Kraft Heinz. Historical cash flow analysis needs to be balanced with an appreciation of how markets change.

Alliance uses many of the same value investing principles as Berkshire does to help determine the value we put on an investment property. We also always develop a detailed view of future demand. Other sources, like census data, help us see how changing demographics might affect the market. Changes in consumer tastes are another key indicator of where the market is headed. If we can’t form a clear thesis of the central trends in a market, we’re a lot less likely to make a purchase.

This approach has lead us to a lot of deals in the south and the midwest, and we usually see exactly the kind of growth we were looking for. Sometimes the trends we’re looking for happen on a smaller scale — by neighborhood, rather than region. The point is, the rigorous science of value investing needs to be balanced with the art of reading changing preferences and market trends.

Buffett’s error is a reminder that every deal is unique, and we always need to seek new sources of information. No single valuation framework or dataset tells the whole story of an asset. That’s why investing is both a science and an art.

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