Warren Buffett’s Investment in Shaw Industries

Warren Buffett purchased Shaw Industries in 2001 and 2002 for Berkshire Hathaway.

This article will analyse the investment, highlighting the key reasons Buffett and Munger added this business to their portfolio.

Key facts about Buffett’s Shaw Industries Investment

When did Berkshire Hathaway buy Shaw Industries?

2001 and 2002

How much did Buffett and Munger pay for Shaw Industries?

$2,424m ($2,100m in 2001 and $324m in 2002)

What price to earnings multiple did Buffett and Munger pay for Shaw Industries?


In 1999, Shaw Industries earned roughly $382m in operating profits which resulted in $228m in net income after taxes. Therefore, the P/E ratio was approximately 11x.

Why did Buffett buy Shaw Industries?

This case study will be divided into the four core Buffett and Munger-style investing checklist items. These are explained in the following Charlie Munger quote:

(1) We have to deal with things that we are capable of understanding. Once we’re over that filter, (2) we have to have a business with some intrinsic characteristics that give it a durable competitive advantage and (3) of course we would vastly prefer a management in place with a lot of integrity and talent, and finally, (4) no matter how wonderful it is, it is not worth an infinite price, so we have to have a price that makes sense and gives a margin of safety considering the natural vicissitudes of life.

(1) Understanding the business: What does Shaw Industries do?

Shaw is a carpet and rug manufacturer and markets its products for residential and commercial application under a variety of brand names. This is how Shaw described their business in the 1999 annual report:

The company manufactures, markets and distributes a broad range of soft floor covering products primarily consisting of broadloom tufted carpet. The company also distributes hard surface floor covering products through its highly developed sales and distribution channels. The company operates in a business environment comprised of numerous small customers in several large retailers and buying groups. The company’s customers in turn market floor covering another products to retail and other wholesale residential and commercial end-users. The company experiences demand for its products primarily as a result of single and multi-family residential and commercial floor covering replacement; new commercial multifamily residential construction and to a lesser extent, new single family residential construction. This demand is driven by such end-user factors as consumer spending on durable goods in general consumer confidence.
Shaw Industries’ 1999 Annual Report

Here are their recent financials from their 1999 annual report, with some accompanying graphs.

Shaw Industries 1999 Annual Report

As we can see, Shaw has been consistently growing each year. They were growing organically, through acquisitions and also through diversifying their products to include other flooring types.

Shaw’s gross profit margin was very consistent over the past 15 years. Their net profit margin was much more volatile, but note that the years 1996, 1997 and 1998 had many one-off costs involved with shutting down unprofitable retail operations and closing down some operations in the UK.

As we can see above, Shaw’s return on invested capital was roughly around 10% over the past decade and their return on equity hovered around the 15% mark (except for 1995-1998). Note that excluding non-recurring costs, Shaw’s 1997 and 1998 ROE would’ve been 11% and 16% respectively.

If we subtract goodwill from equity to attain tangible equity, Shaw earned a 51% and 33% return on tangible equity in 1999 and 1998 respectively (removing non-recurring costs in 1998). Shaw’s return on tangible assets averaged 10% from 1998-1999. Even though carpet manufacturing is a cyclical business, Shaw doesn’t employ a large amount of tangible capital to earn its income. Therefore, in a cyclical downturn, we wouldn’t expect their fixed costs to be very high, and hence, Shaw should be able to remain profitable in this scenario. In fact, in 2009, Shaw managed to earn $144m in operating income even though its sales reduced by 31% from $5,834 in 2006 to $4,011 in 2009.

(2) Durable competitive advantage. What moat did Warren Buffett see in Shaw Industries that helped them outperform competitors over such a long period of time?

Shaw Industries had a durable ability to produce carpets at the lowest cost. Peter Lynch discussed Shaw in his 1992 book, “Beating the Street”.

There hasn’t been a worse business in contemporary America (than the carpet business). In the 1960s, when the Shaw brothers got into it, so did everybody else who had $10,000 to invest in a carpet factory. The area around Dalton was stippled with small mills, as 350 new carpet makers revved up their looms to meet the nation’s demand for a carpet on every floor. Demand was great, but supply was greater, and soon enough the carpet makers responded by cutting prices. This ensured that neither they nor their rivals would make money.
Then in 1982, homeowners rediscovered the wood floor and the carpet boom came to an end. Half the top 25 manufacturers were out of business by mid-decade. Carpet has been a nongrowth industry ever since, and Shaw has thrived as the lowcost producer. With every competitor that fails, it picks up more business.
Shaw pumps every available dollar into improving operations and cutting costs even further. Tired of paying a high price for yarn, it acquired a yarn-making facility and eliminated the middleman. It has its own distribution network with its own fleet of trucks. In its never-ending quest for economy, Shaw opted not to maintain an expensive trade showroom in Atlanta. It sends a bus to Atlanta and transports its customers to Dalton.
Peter Lynch in “Beating the Street” from 1992

Shaw owned its own yarn-making facility and distribution network which gave them the ability to incur lower costs in both the manufacturing and distribution of the product. In their 1994 annual report, Shaw also described another competitive advantage they have:

The Company believes its strategically located regional customer service centers and redistribution centers provide a competitive advantage to the Company by enabling it to supply carpet on a timely basis to customers. The Company’s long- standing practice in investing in modern, state-of-the-art equipment contributes significantly to its ability to compete effectively on the basis of quality, style and price.
Shaw Industries’ 1994 Annual Report

This essentially meant that Shaw could offer the lowest cost products in the timeliest manner to customers, which would naturally lead to them increasing their market share consistently over time. By 1999, Shaw had grown to such a size where they were likely able to source raw materials at lower costs than their competitors too, due to economies of scale.

They are also operating in a stable industry, meaning threats of innovation and drastic changes negatively impacting Shaw’s business were very small.

(3) Ensuring the management team has integrity and talent

At the time Buffett invested, Shaw was led by Robert E. Shaw and Julian D. Saul. Robert was a member of the founding family. Saul served as President and CEO of Queen Carpets following his father’s death and built Queen into the fourth-largest carpet manufacturer. When Queen merged with Shaw in 1998, Saul became the President.

Clearly, the senior management had alignment with the interests of shareholders.

A characteristic Buffett likes to see in management which displays talent is how capital is allocated in the business. The best managers are able to take the free cash flow of the business and deploy it in projects, acquisitions or dividends/share repurchases in such a way that maximises the long-term benefit for the business and its shareholders.

The quote below demonstrates how Shaw’s management thought about capital allocation:

As a result of our performance in 1999, we generated record setting cash flow of $393.8m which we directed toward capital investment for future productivity, share repurchases totalling 9.3 million shares, debt reduction, and cash dividends. The resulting return on shareholders’ investment exceeded 27 percent in 1999. Although the stock market did not respond favourably to our performance, we made the financial decisions and achieved the financial results in 1999 that will eventually drive value for our shareholders. We will continue to do the same in 2000…Going forward, we will continue to evaluate conditions in the marketplace and compare repurchase decisions to alternative investments while effectively managing our balance sheet for future success.
Robert E. Shaw and Julian D. Saul in Shaw Industries’ 1999 Annual Report

As we can see, Shaw’s management did not care about short-term stock price movements. They had a long-term mindset and evaluated all capital allocation decisions with a shareholder value creation yardstick.

Another example of Shaw’s management talent is the closure of their retail business. In 1998, Shaw sold all of its retail stores, removing its involvement in this unprofitable business. We can see that the retail operations lost $8m and $20m in 1998 and 1997 respectively (since the gross margin was less than the selling expenses).

Shaw Industries 1999 Annual Report

Even though this involved short-term costs which hindered recent profit figures, Shaw’s management understood that in the long run, exiting this unprofitable division will increase Shaw’s long-term earnings power, and thus, its intrinsic value.

(4) Buying the business at a fair price

Warren Buffett and Charlie Munger have emphasised that paying a fair price for a wonderful business is the ideal path to follow in investing.

Shaw Industries earned $228m in 1999 and Buffett paid a total of $2,424m for the business. Shaw’s maintenance capital expenditures (assumed to be “additions to property, plant and equipment from the cash flow statement), averaged roughly $100m over the past three years. This is roughly the same as their depreciation figure, so we can assume that their net income is essentially free to be deployed in any way.

Shaw Industries 1999 Annual Report

If Shaw could average $200m in net income into the future, Buffett would’ve earned an 8.3% return on investment ($200 / $2,424). Any growth in net income would add to this return. Shaw’s market share was roughly 35% in 1999 after the Queen Carpet acquisition, so through product diversification, general industry growth and continual market share increases, Shaw could likely increase their earnings by 3-5% per year, giving Buffett a likely return of 11-13%, consistently over the long-term.

Although Buffett couldn’t see the future, Shaw’s net income averaged $250m from 2001 to 2009 assuming a 35% tax rate. This included two very low years, 2008 and 2009.

Therefore, we can conclude that Buffett’s investment in Shaw Industries generated a return greater than 10% per year. The business had strong fundamentals and operated in a stable industry with long-term-oriented managers who were determined to maintain Shaw’s low-cost producer competitive advantage and grow the business further into the future.

Key lessons from Buffett’s Shaw Industries Investment

(1) A cost-based competitive advantage is often built before the business benefits from economies of scale

Shaw’s cost-based moat was built in the early days, which could’ve been seen in their earlier annual reports as described by Peter Lynch above. After they developed this, they were then able to remain profitable when the industry cycle caused other players to lose money. This then allowed them to acquire more market share over time and benefit from economies of scale. The lesson here is to ensure we understand the reasons a business was able to develop a low-cost moat beyond simply being the largest player in an industry.

(2) A business in a slow growth industry can still be a great investment if they have the ability to grow their market share

Carpet is largely a commodity-style product, meaning product differentiation is relatively low and most competition is based on price. It is also an industry that was not rapidly growing. However, Shaw’s low-cost operation allowed them to grow their share of this industry’s revenues as explained above. This gave them a powerful ability to continue to prosper even though the industry itself might not be growing very rapidly.


Related posts

Subscribe to receive regular investing insights directly to your inbox!