Before the housing bubble burst, those mortgage-backed securities were being shopped to Buffet. Buffet said he wouldn't buy them because they were bundled millions of loans and he had no way of knowing what the health of those loans actually was. Not rocket science. Not new age, high tech or too young for him. Just no different than anyone should even be with their money.

Would you buy a car for $25K if you did not know what year the car was, what model, what it looked like or what condition? But that is essentially what they were asking Buffet to do. And he didn't...but several people did.

Saying something is overvalued is buffet speak for saying "not cheap enough to be troubled" which is when he traditionally invests in things.

He buys lots of family businesses upon death events, and some heavy industry suffering capital issues. Generally speaking, this precludes young firms from crossing his radar even. "Suffering capital issues" is similarly something you will rarely see in todays tech environment.

Because a person is good at something doesn't mean he does everything perfectly. There are lots of great investments out there Buffet is not going to go anywhere near, that are conservative even. He definitely has a profile far more constrained than "proven business model"

He's a good businessmen, no doubt about it, but because he dislikes something does not mean it's not a good bet, it just means it doesn't clearly fit into his "Nothing a little money can't fix" investment profile.

You are right, he rarely replaces people. But when a business owner dies, and heirs need cash, guess who's there looking at the business to buy it?

Also, it's not like a simple 3 line answer completely encapsulates his entire investment strategy. I'm just pointing out a typical thread that runs through many of his investments.

And you do have a good point about distressed shareholders vs distressed businesses. But either one can drop the sell price (aka, make them undervalued).

Nebraska Furniture Mart http://en.wikipedia.org/wiki/Nebraska_Furniture_Mart (Sold at age 90).

Dairy Queen: (35% of it was owned by a 75 year old named John Mooty when BRK bought it in a takeover)

Ben Bridge Jewelers (Chairman and a majority owner was 75 when sold to Berkshire: http://www.historylink.org/index.cfm?DisplayPage=output.cfm&...)

Flight Safety http://www.beezernotes.com/wordpress/?p=4229#comment-30045 (Sold at age 89)

1) The business wasn't distressed and was doing great. 2) Mrs. B was growing old and her son Louie had taken over most of the work, she was still active in managing the carpet section 3) They were looking at a German company to take them over; their offer was $90.0 mn 4) Buffet told them they would get a higher valuation if they waited and then laid out the pros and cons of Berkshire being in charge. Also pointed out that many other firms would have managers which would inevitably try and run the show. 5) BRK wanted them on as partners to run the firm, without bringing someone in from the outside, which is something both Louie and MRs. B wanted. She didn't want to sell to a German company, being a Russian immigrant. 5.1) T His is generally BRK policy, it invests in strong, track record proven companies and teams, after doing massive amounts of diligence on them. 6) She then told him she wanted $55.0 mn in cash, for 90.0% of the company. 7) Buffet signed, with the caveat that if she wanted to change the deal she could. She said no. 8) Her son and his grandson stayed on and helped grow the business. 9) At some point Mrs. B got very irritated with her growing lack of control, and when her son/grandsons overruled her on a carpet purchase decision she got mad and left. 10) She started her own business opposite the road and began to beat Furniture mart. Since Buffet did not take sides she was quite hurt and betrayed. 11) BRK pays her $5.0 mn for the name of her new mart, makes sure shes happy and in charge of furniture mart, and ensures her non compete clause is bullet proof.

Its an interesting story to read about, as is Mrs. B - she also had a laser focus on her expertise; she didn't care to go beyond it, and was extremely effective within it. She also made decisions quickly and never looked back.

Funnily, 20% of the stake was held by her daughters, and her sons-in-law came to sign the deal. They were aware they would get more if they signed with the Germans but Mrs. B basically harangued them into submission - "how much do you want, I'll pay ya".

Her management style was... interesting - Buffet had been told that she wanted to sell the place 20 years earlier. When he got there to sign the deal, Mrs B. had part of her office (may have been sons/in laws) lined up, just so that she could yell at them and call them a bunch of bums. Once she abused them enough, Buffet was allowed to walk away.

As tpateck pointed out, the correct scenario is that the owners are distressed, aka, need to sell to get through the estate tax.

The businesses are fine.

In 2008, he said:

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt. Twice. (http://www.berkshirehathaway.com/letters/2007ltr.pdf)

Tech is also weird in that software development has significant diseconomies of scale, while software operations has significant economies of scale. Small teams can develop a product faster, but once the product exists and has been proven in the marketplace, it's cheaper to scale from 100 servers to 100,000 servers than it was to go from 1 server to 100 servers. This has historically fueled the cycle of small tech startups being founded, gaining traction, getting bought, and then the founders quitting to found other small startups. It's economically rational for them to do so, because they can develop a product faster with a small team than inside a big organization.

I'm curious how the existence of cloud-hosting like Amazon EC2 will change this market. That's had the effect of splitting software development and software operations into separate markets: before, it used to be cheaper to integrate them into one firm, but now a commodity product exists that makes it feasible for the development firm to remain independent and simply pay a fee for all the operations support.

I suspect it's actually bad for startups in the long run, much like the power loom was bad for textile manufacturers. Since there're economies of scale to operations, that side of the market will tend to a few big players (right now Amazon has a virtually monopoly, and only a couple others even have the capability to offer something like that), while the startup side will tend towards many small firms. In a situation like that, the big firms have all the bargaining power, and so most of the profits will accrue to them.

Of course, software development doesn't have to start out capital intensive. A couple of kids working on their startup in a cheap apartment can work cheaply. They can defer the capital intensive part until they are successful. An airline doesn't have that option.

The costs of servers scale extremely well, while the costs of airplanes and jet fuel don't. So web companies have much higher potential profits than airlines, and they're consequently worth a lot more.

...that was the point all along.

So web companies have much higher potential profits than airlines, and they're consequently worth a lot more.

This isn't a competition between tech companies and airlines. Airlines merely act as an example an industry which, at least as of 1995 when Buffett first brought them up, had a net loss over the entirety of the industry's existence. What's the net lifetime profit of the tech sector? What will be the lifetime profit of social websites in another ten years?

There is also a lot of synergy in his investments, if you look at Geico part of the reason they are able to offer such low rates is that they park most of their excess funds with Berkshire or other similarly outperforming investments.

Or look at BNSF and their trackage to the Powder River Basin. He doesn't want to be in a company like Facebook because he doesn't know that they will be around in 20 years, nor are their competitive advantages (network effect) durable within the industry. Look at a company like Coca-Cola, their advantages are durable and customer base loyal. Coca Cola doesn't need frequent drinker miles to get their customers to remain loyal.

One of the highly overlooked benefits of long term investing is the tax implications and associated transaction fees. If you buy and sell stock frequently you pay capital gains so any other investment needs to be better than the one you currently have by at least the capital gains you'll pay on the sale plus the brokerage fees.