In 1921, 71-year-old Mary See and her son Charles left their home in Ontario to start a new life in Los Angeles. Charles soon found a business partner in James Reed and they opened their first See’s Candies store, selling chocolate made using recipes that Mary had developed while running their family hotel in Ontario.
Little did they know that 51 years later one of the world’s greatest investors, Warren Buffett, would not only buy See’s Candies but also describe it as the perfect business.
So why is See’s Candies the perfect business?
The first reason is the quality of its product. When See’s first set up shop, it had hundreds of competitors so it had to focus on building a reputation based on quality. Mary See had a basic principle of ‘Quality without compromise’ and as such set standards high, making chocolates using only the finest ingredients. See’s immediately distinguished itself and, within a few years, had opened ten shops.
Although sugar was rationed during World War II, See’s continued to make as much high-quality chocolate as the rations would allow. People would queue around the block to buy See's chocolates, which were often sold out by noon. Despite this, all the sales staff were paid a full day’s wage.
This demonstrated See’s Candies' old fashioned philosophy that ‘if we take care of our employees, they’ll take care of the customers’. See’s customer service was every bit as good as the chocolates they created, resulting in significant customer loyalty. Chuck Higgins, See’s long-time chief executive, used to measure the company’s success by how well it satisfied its customers and See’s soon became a much loved Californian institution.
As its candies were purchased mostly as gifts, See’s would often be first in mind when Californians bought an anniversary or birthday present.
Untapped Pricing Power
A further attraction to Buffett’s purchase in 1972 (for his investment company Berkshire Hathaway (NYSE: BRK.A)) was that See’s had untapped pricing power; given the quality of See’s brand, it was selling its chocolates far too cheaply.
Berkshire Hathaway vice-chairman Charlie Munger later recalled: ‘When we bought See's Candies, we didn't know the power of a good brand. Over time we just discovered that we could raise prices 10% a year and no-one cared. Learning that changed Berkshire. It was really important.’
See’s was bought by Berkshire (via Blue Chip Stamps) in 1972 for US$25m and had US$8m of net assets. At the time, it was the company's biggest acquisition and with sales of US$31m and after-tax earnings of around US$2m, it was bought on a price-earnings ratio of around 12.5 times. Within three years, after-tax earnings had risen to US$5.1m and by 2011 pre-tax annual profit had risen to US$83m.
While See's is an excellent business, the only drawback is that it’s always going to be a small one. It might offer huge returns on capital but there is limited potential to invest additional capital through opening additional stores or building more factories. Even so, increasing profit around thirty-fold under Berkshire's ownership is no mean feat.
Despite See’s qualities, the transaction almost didn’t happen. Berkshire’s initial offer was low and Buffett and Munger were close to walking instead of increasing their offer. Happily for Berkshire shareholders a friend of Charlie Munger, Ira Marshall, intervened by saying: ‘You guys are crazy – there are some things you should pay up for, like quality businesses and people. You are underestimating quality.’ Buffett and Munger listened to the criticism and changed their minds.
Good-bye cigar butts, hello quality
The purchase ended Berkshire’s ‘cigar-butt’ investing style (that is, buying heavily discounted stocks with the hope of making one last puff of profit) and signalled a major turning point in Berkshire’s investment strategy in favour of higher quality stocks. As Buffett said, it was, ‘Good-bye cigar butts, hello quality’ and this change in strategy changed Berkshire forever.
See’s not only provided Berkshire with enormous amounts of cash to help fund further acquisitions but also provided a valuable education. As Buffett continued: ‘through watching See’s in action, I gained a business education about the value of powerful brands that opened my eyes to many other profitable investments.’
For his part, Munger believes that if it weren’t for See’s, there’s a large chance that Berkshire Hathaway wouldn’t have bought its stake in Coca–Cola (NYSE: KO). Purchased for US$1.3bn, this investment is now worth US$17bn.
So why would we want to learn about this Californian boxed-chocolate business? Investing is a lot about seeing and recognising patterns. If we know what the perfect business looks like, when one with similar qualities comes along it should certainly pique our interest.
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Disclosure: the author owns shares in Berkshire Hathaway.