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Why Wesfarmers Ltd’s conglomerate structure is a winning formula

Coinciding with this week’s opening celebrations to mark Wesfarmers Ltd’s (ASX: WES) centenary, The Australian Financial Review (AFR) has published an article discussing the historic events which led to Wesfarmers becoming Australia’s seventh-largest company with a market capitalisation of nearly $50 billion.

Three themes stand out from the article which is particularly interesting for investors who try to emulate Warren Buffett’s approach to investing.

Firstly, Wesfarmers’ conglomerate structure. Those familiar with Warren Buffett’s Berkshire Hathaway Inc (NYSE: BRK.A) will know that it is a concoction of disparate businesses that have been acquired over the years because they have the right mix of quality and price at the right time. The type of thinking employed by Warren Buffett in building Berkshire appears in tube with that at Wesfarmers.

In the AFR’s article former Wesfarmers’ managing director Trevor Eastwood states that “to make money, you have to buy at the right price and sell at the right price. Making money is all about price and performance.”

Wesfarmers has been opportunistic – waiting patiently to purchase quality businesses at appealing prices over the years and in the process creating a rock solid conglomerate structure.

Secondly, like Buffett, Wesfarmers remains focused on shareholder returns above all else. Unlike many companies who prefer to highlight to shareholders less meaningful metrics such as earnings before interest, tax, depreciation and amortisation (EBITDA), Wesfarmers provides its shareholders with both divisional and group return on capital figures – a meaningful metric by which to judge the company’s and management’s performance.

Thirdly, nurture management. Buffett has gone to pains over the years to emphasise the importance of outstanding management to a company’s success. Wesfarmers has similar thinking. It’s one of the reasons that there have been only seven chief executives in the past 100 years with none of them external appointments.

Foolish takeaway

In any business it is important to maximise the returns to owners. It’s this aim which has led to Wesfarmers taking on Woolworths Limited (ASX: WOW) in the supermarket business and why it recently offloaded its insurance underwriting operations to Insurance Australia Group Ltd (ASX: IAG). The company’s ability to operate under a conglomerate structure allows management to focus and grow the business where it sees the potential for the highest returns given an acceptable level of risk.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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