A Huge Hint (Courtesy of
Warren Buffett)
By Dan Ferris
February 17, 2007

Warren Buffett's portfolio contains a huge hint about the one industry where you're most likely to find stocks just like the ones that have made him the second-richest man in the world.

There are 36 different stocks in Berkshire Hathaway's latest form 13F-HR, released on February 14, 2007. A 13F-HR is the SEC form where Berkshire Hathway reports its stock holdings.

Of those 36 holdings, 13 of them are financial services companies of one type or another. More than one-third of the time, Berkshire Hathaway finds what it's looking for in financially oriented businesses.

That's a big hint for us as investors...

Buffett wants to compound his money at arm's length from the taxman for the longest possible period of time. So he looks for companies that have the best chance of performing well for a long time, of fending off competition for as long as possible.

There are a lot of financial services companies that make good returns and have durable competitive advantages. Another attractive quality these businesses have, from the point of view of a business owner, is that they are mostly financed with other people's money. Depositors' money. The Federal Reserve's money. The bank's money. Shareholders' money. Debtholders' money. Cardholders' money. Even wage earners' money. The financial stocks Berkshire Hathaway owns are:

Just think of some of the greatest money-making machines of the last decade or two. Two companies come readily to mind: Credit-rating agencies Dun & Bradstreet and Moody's. Moody's is protected from competition by its status as one of only four Nationally Recognized Statistical Ratings Organizations, or NRSROs. The other three are Standard & Poor's, Fitch Ratings, and Dominion Bond Ratings. Credit ratings are deeply embedded in our economy. This will be a great business for a long time. Both Moody's and Dun & Bradstreet have businesses with high barriers to entry and low capital requirements. 

Then there's Automatic Data Processing, the company that processes America's paychecks. It earns interest by handling nearly $900 billion of other people's money before forwarding it to insurance companies and governments. That's called float, just like insurance companies have. The interest from all that float is pure profit.

Berkshire Hathaway – due mostly to its insurance holdings – has around $50 billion of float to invest. Float is wonderful stuff. Neither debt nor equity, it's other people's money that they frequently pay you to take off their hands for an indefinitely long period of time. Float is another great thing you find in the financial industry.

Last year, I learned of a money manager, Tom Brown of Second Curve Capital, who only invests in financial services companies. Brown gave a talk in Los Angeles last May about student-loan processor First Marblehead. Since then, the stock has risen from the mid-$20s to as high as $57. It's $49 now.

Though the financial services industry contains many businesses with durable competitive advantages, it also gives you ample opportunities to earn big returns by investing at cyclical lows, when sentiment is negative. Money manager stocks got hit hard by Eliot Spitzer a few years ago, creating opportunities to buy stocks, like Janus Capital Group, at discounted prices. 

The catastrophe reinsurance stocks presented ample opportunities for outsized returns when Katrina took its toll a couple of years ago. Today, the subprime mortgage lenders are getting hammered. I bet there's at least one that's safe and cheap enough today to produce an outsized return over the next couple of years. J.P. Morgan shares fell a couple of years ago, as it digested its acquisition of Bank One. It was a good deal several months ago, trading just above book value. Today, it's at about 1.54 times book, and it still has room to move higher.

If you're looking for publicly traded companies to invest in, it can be hard to know where to focus your attention. There are tens of thousands of possibilities to choose from. Where do you start?

Well, one great place to start is with banks, money managers and other financial companies. If you spend time getting to know those businesses, it'll probably make you rich a lot faster than trying to find another oil or gold stock.

Editor's note: Dan Ferris is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

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