Many business owners and managers believe that growth is the single most crucial factor in defining a company’s success.
Nowhere is this trend more evident than the tech sector. Companies like Uber and WeWork have filled the past few years spending tens of billions of investors’ capital growing their top lines without any prospect of a positive return on this investment.
These are not the only companies spending billions without any visible return. Companies of all shapes and sizes regular try to branch out into different sectors or markets in the hopes of being able to boost growth. Most fail. UK retailer Tesco famously lost billions trying to conquer the US market before eventually pulling out, even though it dominated its home market.
The point is, growth is not always the best solution. It is better to be really good at one hobby than average at five, and that’s where many companies make a mistake.
Berkshire Hathaway’s See’s Candies is a fantastic example of this principle in action.
Warren Buffett decided to buy See’s Candies in 1972. He paid $25 million for a business with roughly $30 million in sales and $4.2 million in pre-tax profit.
Over the last few decades, the business has been a powerhouse for Berkshire. At the 2019 annual meeting of shareholders, Buffett declared that since the deal, “it’s given us over $2 billion of pre-tax income, well over two billion.” Not bad for a $25 million outlay.
See’s Candies has been able to achieve this success by sticking to its core markets. According to Buffett himself, the business has tried to expand outside of its home market of California, “many, many, many, many times.” However, each attempt has failed. So, the candy maker has stuck to what it knows best, and the results speak for themselves.
Buffett went on to give some more insight into See’s Candies business model at the 2019 meeting:
“If we were the typical company and had bought that business and tried desperately to use all the retained earnings within the candy business, I think we’d have fallen on our face.
I think that it just illustrates that all these formulas, you know, you learn or that having a strategic plan to use all the capital or something… some businesses work in a fairly limited area…
You know, candy bars… you mentioned Hershey. I mean, Cadbury doesn’t do that well here and Hershey doesn’t do that well in the UK And here we are, we all look alike. But somehow, we eat different candy bars. It’s very interesting to observe.
And the idea that you have some formula for businesses that each one should pursue the course they’re on because they made it in X, they should try to find other ways to make it in X. We’re quite willing to find it in A, B, C, D, E, or F… the money is fungible.”
See’s is a great business in its home market, but throwing millions at trying to expand outside of its home market has and will be a waste of money.
This isn’t the only example in Buffett’s portfolio. Nebraska Furniture Mart has similar qualities. The company has done exceptionally well in its home market. There’s no guarantee that it will be able to repeat this success anywhere else in the country or world.
The lack of growth does not mean that these bad businesses. In fact, Buffett’s right-hand man Charlie Munger has previously declared that these are some of Berkshire’s best investments. From the 1994 Berkshire Hathaway annual meeting of shareholders:
“Some of our best businesses that we own outright don’t grow. But they throw off lots of money, which we can use to buy something else. And therefore, our capital is growing, without physical growth being in the business. And we are much better off being in that kind of situation [than] being in some business that, itself, is growing, but that takes up all the money in order to grow and doesn’t produce at high returns as we go along. A lot of managements don’t understand that very well, actually.”
The list of businesses that have ignored this logic and charged ahead with unprofitable growth is endless. However, some public companies have managed to avoid the temptation. Coca-Cola, Big Tobacco, and Apple are some companies that do one thing well and have not lost shareholder funds on wasteful growth.
Shareholders have reaped huge rewards as a result. Last year, Coca-Cola, Apple, Altria, and Philip Morris returned a total of $109 billion to shareholders.
These companies don’t use much capital in their day-to-day operations, and they are not burning through vast amounts of capital to grow. Therefore, all excess profits are returned to investors.
That’s why some businesses should stay small and stick to what they do best. Expansion might seem attractive at first, but it can bring unwanted consequences, as well as unforeseen costs, which could bring a health company to its knees.
The author owns shares in Berkshire Hathaway.