In his 2020 Berkshire Hathaway Annual Letter, Warren Buffett discussed his criticism of traditional conglomerates, and why Berkshire differs from the prototype conglomerate. His criticisms of traditional conglomerates include:

• Buying “so-so” companies with hefty premiums using inflated stock valuations
• Deceptive accounting and promotional tactics to maintain the illusion of success
• Inevitably ending in failure and reputational damage

Berkshire’s strategy:

• Focuses on acquiring exceptional businesses, even if it means not owning 100%
• Prioritizes long-term value creation over short-term dealmaking frenzy
• Maintains a conservative financial approach and avoids overpaying or manipulating valuations

Here’s an excerpt from the letter:

Berkshire is often labeled a conglomerate, a negative term applied to holding companies that own a hodge-podge of unrelated businesses. And, yes, that describes Berkshire — but only in part. To understand how and why we differ from the prototype conglomerate, let’s review a little history.

Over time, conglomerates have generally limited themselves to buying businesses in their entirety . That strategy, however, came with two major problems. One was unsolvable: Most of the truly great businesses had no interest in having anyone take them over. Consequently, deal-hungry conglomerateurs had to focus on so-so companies that lacked important and durable competitive strengths. That was not a great pond in which to fish.

Beyond that, as conglomerateurs dipped into this universe of mediocre businesses, they often found themselves required to pay staggering “control” premiums to snare their quarry. Aspiring conglomerateurs knew the answer to this “overpayment” problem: They simply needed to manufacture a vastly overvalued stock of their own that could be used as a “currency” for pricey acquisitions. (“I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats.”)

Often, the tools for fostering the overvaluation of a conglomerate’s stock involved promotional techniques and “imaginative” accounting maneuvers that were, at best, deceptive and that sometimes crossed the line into fraud. When these tricks were “successful,” the conglomerate pushed its own stock to, say, 3x its business value in order to offer the target 2x its value.

Investing illusions can continue for a surprisingly long time. Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, also, the soaring price of a promoted stock can itself become the “proof” that an illusion is reality.

Eventually, of course, the party ends, and many business “emperors” are found to have no clothes. Financial history is replete with the names of famous conglomerateurs who were initially lionized as business geniuses by journalists, analysts and investment bankers, but whose creations ended up as business junkyards.

Conglomerates earned their terrible reputation.

You can read the entire letter here:

2020 Berkshire Hathaway Annual Letter