[caption id="attachment_2295" align="alignright" width="150" caption="Photo by Eneas"][/caption]
I have been thinking about this for a while. Some time back, Warren Buffett started buying over mum-and-pop businesses that have grown tremendously over a long span of time from its original owners. These owners have painstakingly built their empires over the years, they are now old, they want to cash out some of the future earnings of their business, so they go to Buffett. But how do they determine price? Buffett being Buffett, is not going to undercut them by paying them just 10x earnings. But he definitely will not overpay as well.
In the stock market, Mr Market determines the price, which some times go crazy and the owners of businesses (ie shareholders) have no choice but to sell at basement prices. Buffett takes this opportunity to buy from these willing sellers. Well, in the first place, some of these market participants never regarded themselves as the owners of the firms which they hold stocks. They are in for the quick gamble. So Buffett gladly profits from their fear.
However, in private transactions, Buffett knows these sellers. Some of them are his friends in Omaha. He is not going to shortchange them. So the logical conclusion is that Buffett pays a reasonable price for these businesses he buys, Maybe 18x earnings. We can think of it as the sellers get 18 years of future cashflow from their business. Thereafter, the profits will be what Berkshire shareholders stand to gain from. There is bread from everybody. Nobody gets shortchanged. Read more...