To The Moon

When Warren Buffett acquired See's Candies in 1972, the annual sales of candy pounds only increased by 3% until 1983. However, profits grew by 19% annually. How did See's Candy achieve such incredible economic success from such modest growth?

The answer lies in the low capital intensity, pricing power, and operating leverage of the business. From 1972 to 1983, See's Candy's capital base grew by only 8% per year. With the average inflation rate at 8% per year, the actual capital expenditure growth was zero.

Pricing power played a significant role. The price of each pound of chocolate increased by 10% annually. With 3.4% growth in sales volume and 10.4% growth in price, revenue increased by 14%. This is where operating leverage came into play, converting 14% revenue growth into 19% profit growth.

All of this occurred in a low-capital business with a net tangible asset return of 45%. Buffett acquired See's for $25 million, which was 12.5 times its earnings. In 1983, See's after-tax operating profit was $14 million, which may have been worth $245 million (18 times earnings). With See's annual free cash flow, Buffett's compounded annual investment return in the first 11 years may have reached 28%.

For investors, the success of See's Candy provides valuable lessons. First, it is essential to identify businesses with low capital intensity, strong pricing power, and operating leverage. These businesses can generate significant profits even with modest growth. Second, investors should focus on a company's free cash flow, which allows for reinvestment in the business or distribution to shareholders. Finally, it is essential to consider a company's valuation, paying attention to factors like earnings and cash flow.

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