The Gist: The origin story of an investing superhero.
The first of a two-part review of multiple Buffett biographies.
Access the second part here: Warren Piece.
A few years ago, a close friend invited me to a weekend enjoying the finest that his home state of Nebraska had to offer: steak, a unicameral legislature, and the Berkshire Hathaway annual shareholder meeting. We ate well, ran into the Governor while he was out walking his dog, and mostly had a great time shooting guns and talking by the evening fire at the farm.
Figure 1. Sadly, we missed Carhenge, a Nebraskan’s reconstruction of Stonehenge using cars.
But the weekend opened with a visit to the Woodstock of capitalism. By the time we arrived at the basketball arena where it was held – before 6 AM, more than an hour before doors were to open – the line circled the million-square-foot building several times and appeared to include the entire population of Nebraska (and perhaps a couple neighboring states). Once finally inside, you could partake in the Berkshire conglomerate’s diverse products: Dairy Queen Blizzards, cowboy boots, auto insurance, private jet gift cards, and much more. Yet the real treat was being able to ask any question you’d like of Warren Buffett, one of the greatest investors of all time. In this email, we’ll explore the origin story of this investing superhero.
Figure 2. The vibe was a bit different than 1969. Less hippies, more yuppies. Less heroin, more ritalin. Less free love, more free markets.
Warren was born in Omaha in 1930 and his earliest “hobbies and interests revolved around numbers.” He saw their magic everywhere, even becoming skeptical of religion when he calculated in church that hymn composers did not live longer than average. Wall Street Journal reporter and biographer Roger Lowenstein relates that the jump from math to money was early: “When Warren was six, the Buffetts took a rare vacation to Lake Okoboji, in northern Iowa, where they rented a cabin. Warren managed to buy a six-pack of Cokes for twenty-five cents; then he waddled around the lake selling the sodas at five cents each, for a nickel profit.” By age 7, Warren begged Santa to give him the nearly 500 page then-definitive book on bonds. At age 10, his father Howard offered to take him on a trip to the east coast (something he did with each of his kids) and Warren naturally wanted to see the New York Stock Exchange. At 11, Warren was confident enough to buy his first stock – and got his sister in on the deal. She tormented him as the stock price dropped and, when it recovered, he sold at $40 for a small profit. The price then zoomed to over $200 and he vowed never again to be so oriented toward the short term.
There was one idea in particular that gripped Warren’s young mind: compound interest. He understood and appreciated early on what Albert Einstein called the most powerful idea in the universe: every nickel he saved might, with enough time, benefit from growth and growth on that growth, and end up being worth much more in the future. Warren would imagine his future riches and ask, “Do I really want to spend $300,000 for this haircut?” With that in mind, Warren soon announced he would be a millionaire by 35 – the equivalent of a kid today saying he’d be worth $18 million.
Figure 3. Presumably back then each strand of hair was individually cut with bejeweled gold scissors by specially imported barbers who required luxury accommodations and all-expenses-paid during the multiple day process. No wonder kids wound up growing their hair out!
Warren’s hero was his father Howard, whose portrait would hang prominently in his office. Howard’s principal passion was politics and he had wanted to become a journalist but his father Ernest, having paid his college tuition, insisted that he get a more commercial job. So Howard joined a bank – which turned out to be not to be as stable as imagined once the Great Depression took hold. When the bank failed, Howard asked for a job at his father’s grocery store. Ernest replied he already was employing one son and couldn’t hire another – but he’d let Howard run a tab at the store so his family could eat. Howard then made the extraordinarily bold move to start his own stock brokerage at a time when no one wanted to buy stocks. Despite the headwinds, the business quickly turned a profit and served as an early hangout for young Warren, who often fled the house to escape the wrath of his mother, who had significant mental health issues.
Figure 4. The Buffett clan was known for their God-fearing debt-fearing pinch-every-penny austerity. After a long day’s work, Ernest would dictate to Warren a memoir – “How to Run a Grocery Store and a Few Things I Learned About Fishing, feeling these were “the only two subjects about which mankind had any valid concern.” Buffett reported that “I’d write it on the back of old ledger sheets because we never wasted anything at Buffett and Son.”
In 1942, Howard volunteered to be the sacrificial Republican nominee for Congress and, to the surprise of everyone, including the candidate, won. Richard Nixon would soon be the Buffetts’ neighbor but Howard was the Ron Paul of his day and “considered only one issue in voting on a measure: ‘Will this add to, or subtract from, human liberty?’” Concluding that most proposals were subtractions, Howard voted for very little, instead hopelessly crusading for a return to the gold standard and a more humble foreign policy. Above all, Howard was known, in politics and out, as a man of unflinching ethics, refusing “a raise because the people who elected him had voted him in at a lower salary.” He always carried a piece of paper inscribed “I am God’s child. I am in His Hands. As for my body—it was never meant to be permanent. As for my soul—it is immortal. Why, then, should I be afraid of anything?”
Warren initially did not like Washington but soon made the most of it by insisting that his father get him every book – literally, the number ended up being in the hundreds – the Library of Congress had on horse handicapping. While Warren made some money at the tracks, he made far more with a paper route, eventually delivering “almost 600,000” papers. Not content with merely delivering the Washington Post, “he asked all his customers for their old magazines as scrap paper for the war effort.” Warren then checked the magazines for their subscription expiration dates, established a card system for tracking all his customers, and sold them renewals for commission. From these efforts, Warren was making more money per year than any of his teachers and, bored at school, taunted them by shorting the AT&T stock they had their retirement savings in. Despite his smarts, Warren’s grades were mediocre – until Howard told him he’d have to give up his profitable paper route and instantly the marks improved. Yet Warren was still entrepreneurially restless, redirecting his paper profits into operating pinball machines in local barbershops, renting out a 40 acre tenant farm back in Nebraska, and experimenting with whatever money-making scheme he could conjure. By 16, he wondered why the heck he would want to go to college when he was making so much money.
Figure 5. A deeply under-studied strategy is investing for spite. Thumb your nose / stick out your tongue / see how it goes / in the long run!
Howard insisted, so Warren went off to Wharton, where he was, again, completely bored. “His professors had fancy theories but were ignorant of the practical details of making a profit that Warren craved.” About the only notable aspect of his time there was his arrangement “with the Philadelphia Zoo to ride an elephant” down a main avenue to celebrate the expected victory of Republican Thomas Dewey in the 1948 presidential election. Dewey, of course, did not beat Harry Truman, and the carnival stunt had to be canceled. More close to home, his father Howard lost his congressional seat, probably due to his rare vote for successful legislation – Taft-Hartley – which, among other related labor reforms, forbade unions from compelling employers to only hire their members. Though Howard would briefly return to Congress, he was part of the Robert Taft wing of the Republican Party and Dwight Eisenhower’s Nebraska allies oversaw the end of his career. Howard would spend the remainder of his life back at the stock brokerage, worried about the country’s bad choices.
Figure 6. Modern zoos are really missing out on the profits involved in renting out their animals to college students.
Warren thus transferred home to the University of Nebraska and graduated at 19 to get it over with. Warren considered an alternative education far more practical than college: Dale Carnegie. Till now, Warren had always been an argumentative contrarian but
“He decided to do a statistical analysis of what happened if he did follow Dale Carnegie’s rules, and what happened if he didn’t. He tried giving attention and appreciation, and he tried doing nothing or being disagreeable. People around him did not know he was performing experiments on them in the silence of his own head, but he watched how they responded. He kept track of his results. Filled with a rising joy, he saw what the numbers proved: The rules worked. Now he had a system. He had a set of rules [for winning people over]”
More significant to his future, Warren would soon get the practical financial education he craved. Still running his various side rackets, Buffett confidently applied to Harvard Business School – and got rejected. Reconsidering his options, Buffett successfully applied to Columbia Business School, where he could study with the Wall Street legend of that era now known as the father of value investing: Ben Graham. Graham would become his personal mentor and give Buffett the intellectual foundation for his future success.
Born in 1894 to a comfortable life, Ben Graham’s introduction to the stock market had been unpleasant: his widowed mother had over-borrowed to play the market and been wiped out in the Panic of 1907. His family was saved, in his own words, “from misery, though not from humiliation” by the generosity of relatives. Undeterred by his childhood experience, Graham went to Wall Street and started making a name for himself – then lost 70% when he assumed Black Tuesday 1929 was the bottom and borrowed to buy in. Still undaunted, with everyone else scared of stocks, Graham saw bargains. Over the rest of his career, he assembled one of the best long-term Wall Street records ever, beating the market average by about 2.5%. Buffett biographer Alice Schroeder advises “That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market’s average result.” Incredibly, Lowenstein reports that “the figure, though, does not include what was easily its best investment, its GEICO shares, which were distributed to Graham-Newman’s stockholders. Investors who kept their GEICO through 1956 did twice as well as the S&P 500.”
Graham made no secret of his approach and in fact considered investing just another intellectual exercise along with the study of classics, the suggestion of novel inventions, and the seduction of women. He claimed that he wanted to do something foolish, something creative, and something generous every single day. Graham endlessly annoyed his business partner by sharing in real time his insights about stocks with his Columbia business school class. His still-popular book, the Intelligent Investor, inspired Buffett to apply to the school in the first place
At the core of Graham’s philosophy is the attempt to buy a dollar for fifty cents. Graham advised that all companies have an intrinsic value derived from their actual business operations but detached from the price that people are willing to pay for them at any given time. Graham intoned that “you are neither right nor wrong because the crowd disagrees with you” and that “in the short run, the market is a voting machine. In the long run, it’s a weighing machine.” At the most basic level, a value investor would look for companies trading at a small multiple (say, 1.5x) of or even less than their book value – that is, the value of the company if all of its assets were liquidated. Graham initially got famous in the 1920s by buying lots of shares in an oil pipeline company who he realized owned bonds of 50% greater value than the company was selling for on the stock market – and then putting himself on the board and distributing an enormously profitable dividend. Buffett quips: “Price is what you pay, value is what you get.”
Graham conjured the analogy of an obliging but manic Mr. Market who is always prepared to buy or sell stocks, often at nonsensical prices. Jason Zweig summarizes: “The intelligent investor is a realist who sells to optimists and buys from pessimists.” “The secret of getting rich on Wall Street,” Buffett told a class of his own, is “try to be greedy when others are fearful and… very fearful when others are greedy.”
Figure 7. Unfortunately, while we can often profit from Mr. Market, we can often suffer from Dr. Democracy, who is subject to similar nonsensical swings unless slowed down.
Because you can’t anticipate when Mr. Market will be manic or depressive, Graham says “selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook.” The market can remain irrational for longer than you have capital. The opposite side of the equation is preferable, but “buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.” Graham’s advice to derisk was to buy so cheaply so as to create a “margin of safety.” As Buffett would later say in one of his famous shareholder letters, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” For Graham, to do otherwise would be a game of chance – or speculation that some greater fool would pay more than you. “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” And, if the stock market is too expensive, trading at large multiples of an average of the past few years’ earnings, Graham advised to buy bonds instead (indeed, Graham instructed never to own less than 25% bonds nor less than 25% stocks, adjusting the exact split in contrarian spirit to buy low and sell high)
Figure 8. Buffett would also say that the first rule of investing is don’t lose money. The second rule is to remember the first rule. But the truth is that the first rule of value investing is that you don’t talk about value investing. Don’t let other people in on your bargains. The second rule is the same. The third rule is that someone yells “STOP!” when the market is too high and buying is over. The fourth and fifth rule have to do with concentrating your investments. The sixth rule: No shirts, no shoes. The seventh rule is that investments will go on as long as they have to – be patient for that return. And the eighth and final rule: if this is your first time value investing, you have to buy something cheap.
When Buffett met Graham, Schroeder records that “the rest of the class became the audience to a duet.” Lowenstein relates what happened after graduation: “Having racked up the only A+ that Graham had awarded in twenty-two years at Columbia, Buffett made what seemed an irresistible offer: to work for Graham-Newman for free.” But Graham turned him down – the Wall Street firms did not hire Jews, so he only hired Jews. Deflated, Buffett returned to his father’s company to be a stockbroker, unhappily a salesman rather than an investor. But Buffett kept in contact with Graham and, after a couple of years, Graham relented and invited Buffett back to New York.
In that era, market information was relatively scarce – there were no quick Google searches to discover endless reams of data about stocks. So instead Buffett was put to work endlessly reading annual reports and financial information to discover bargains in the depths of the market. Graham’s methods were remarkably mechanical. He was almost myopically focused on a company’s balance sheet and almost indifferent to what a company actually did for its money – if anything, knowing more might constitute a distraction from the opportunity. When Buffett or another would present a stock, “Graham would decide on the spot whether to buy it. It wasn’t a matter of persuading Graham. A stock either met his criteria or it didn’t. He did it by the numbers… when anyone tried to talk to Graham about a company’s products, ‘Ben would look out the window and get bored.’” Buffett soaked up everything he could but, within a couple of years, Graham decided to quit while he was ahead and returned capital to investors.
Buffett was not going to return to stock salesmanship so, despite cautions from his father and Graham that the stock market was overpriced, he opened up his own investment partnership. It had two unusual aspects. First, he based himself in Omaha at a time when “no serious American money man worked anywhere but New York City.” Second, Buffett offered not the friendliest terms: he would give investors an annual summary of results but not tell them anything they were actually invested in and he’d only allow them to take out money once a year on December 31. Otherwise, investors would receive 100% of profits up to 4% and 75% of any profits that Buffett generated thereafter. Around Omaha, the initial whisper was that he was a sophisticated conman. And, to be fair, this is the kind of thing that lured investors to crooks like Bernie Madoff.
But Buffett wanted to spend more time analyzing stocks than having to explain and defend to his average investor why he had money in unwanted, problematic, or broken companies that were therefore cheap to buy shares in. As incredible as it may seem, by then, “Buffett was familiar with virtually every stock and bond in existence. Line for line, he had soaked up the financial pages and the Moody’s books; day after day, he had built up a mental portrait of Wall Street.” He later advised that the secret to success was to read “Read 500 pages every day. That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” It wasn’t easy but “intensity is the price of excellence.” That intensity, Schroeder says,
made him burrow into libraries and basements for records nobody else troubled to get. He sat up nights studying hundreds of thousands of numbers that would glaze anyone else’s eyes. He read every word of several newspapers each morning and sucked down the Wall Street Journal like his morning Pepsi, then Coke. He dropped in on companies, spending hours talking about barrels… or auto insurance… He read magazines like the Progressive Grocer to learn how to stock a meat department. He stuffed the backseat of his car with Moody’s Manuals and ledgers on his honeymoon. He spent months reading old newspapers dating back a century to learn the cycles of business, the history of Wall Street, the history of capitalism, the history of the modern corporation. He followed the world of politics intensely and recognized how it affected business. He analyzed economic statistics until he had a deep understanding of what they signified. Since childhood, he had read every biography he could find of people he admired, looking for the lessons he could learn from their lives… He ruled out paying attention to almost anything but business—art, literature, science, travel, architecture—so that he could focus on his passion. He defined a circle of competence to avoid making mistakes… He never stopped thinking about business: what made a good business, what made a bad business, how they competed, what made customers loyal to one versus another. He had an unusual way of turning problems around in his head, which gave him insights nobody else had… In hard times or easy, he never stopped thinking about ways to make money. And all of this energy and intensity became the motor that powered his innate intelligence, temperament, and skills.
Some friends, family, and acquaintances – around Nebraska or associated with Graham – saw something in that intensity and invested. If you had been crazy and lucky enough to invest $10,000 at the beginning and had stubbornly stuck with him, you’d have over $500 million today (versus over $5 million if you had gotten the market return). But even by the sixties, Omaha now whispered that Warren Buffett could make you rich. Per Buffett’s childhood vow, by 35, he was a millionaire – worth over $50 million in today’s money.
Buffett was doing it by applying Graham’s principles about intrinsic value – but also learning new things along the way. As a new generation started trading on the stock market, fears of another crash disappeared and the market began to get frothy – especially about new technology. With tech trading at crazy multiples, Buffett pledged to his partners that “We will not go into businesses where technology which is way over my head is crucial to the investment decision.” (And while you hopefully can see that this was prudent, you also should know that he declined the opportunity to invest in Intel when given a special opportunity to do so at the beginning). At the same time, with an ever-increasing amount of capital to put to work, it was harder to find bargains that Buffett could take advantage of without moving the entire price – so he contemplated buying entire companies. But as Buffett got more involved in the operations of the companies he bought into, he understood better why they were so cheap: they really did have significant problems. And yet he’d be hesitant to get rid of a company that still generated a return – even if it was measly – because he resisted confrontation and enjoyed the collection.
Figure 9. Turns out the incredible savings of eating every meal at McDonald’s are overwhelmed by later medical expenses.
But Buffett thought that if he could get management right that the value would pay off. Knowing relatively little about the underlying businesses, even after much research, he tried to find the right kind of obsessive. He loved to tell the story of when he bought a grocery store chain and convinced the owner, Ben Rosner, to stay on to manage the asset. Rosner was so consumed with his business that, when he went to a black tie event at the Waldorf Astoria and ran into a rival, he started asking him all about what prices he paid for different goods and discovered that he was paying a lot cheaper price for toilet paper. Rather than gloat, Rosner thought something was wrong and immediately left in his tuxedo, drove out to one of his warehouses, tore open a box and individually counted the sheets of toilet paper, discovering that his vendor had screwed him over, providing less sheets than promised.
Following the Graham playbook, Buffett would eventually acquire a controlling stake in a Massachusetts textile manufacturer called Berkshire Hathaway, whose stock was selling at a 2.5x discount to its liquidation value – presumably plenty of margin of safety. But Berkshire was in an extremely tough industry that would eventually leave the United States but by then had already basically left the northeast and fled south. Partially because of uncooperative management who was idealistic about making textiles and not money, Buffett got mad enough to buy them out. Putting in his own team, he explained “the basic theory of return on investment. He didn’t particularly care how much yarn [Berkshire] produced, or even how much [it] sold. Nor was Buffett interested in the total profit as an isolated number. What counted was the profit as a percentage of the capital invested.” This was wise direction, but there was too much headwind in the industry. He would ultimately reflect: “I would have been better off if I’d never heard of Berkshire Hathaway.”
And yet Berkshire would be his destiny: in 1970, after years of warning investors that he could not sustain his track record amidst the Go-Go years of an overheated market, he closed his partnership and offered to return all capital. With the market so crazy, Buffett said he would invest his own money in municipal bonds – and Berkshire Hathaway. For some lucky investors, knowing that Buffett would be in control was enough to roll over their investment into Berkshire. When the market came down again, Buffett told people now was the time to get rich and he would use Berkshire to propel his further investments. But he also partnered with the man who would redefine his investment style, building on and adjusting from Graham: Charlie Munger.
More on that partnership and the rest of Buffett’s career in our next correspondence.
Figure 10. Click here to acquire Alice Schroeder’s the Snowball (9/10), titled to evoke the wintry sphere growing in size as it rolls down a mountain – just like what compound interest does to your money. A former insurance analyst, she spent over 5 years working on this book, interviewing hundreds of people who knew Buffett. More or less authorized, Buffett told her “Whenever my version is different from somebody else’s, Alice, use the less flattering version.” Unfortunately for their relationship, she apparently used a few too many versions different from Warren’s memory – but it still comes across as a tribute to the man. Published in 2008.
Figure 11. Click here to acquire Roger Lowenstein’s Warren Buffett: the Making of an American Capitalist (8/10). A Wall Street Journal reporter and Berkshire investor, he spent three years working on this biography, published in 1995. Some of his descriptions of politics seemed off and he is very dismissive of academic commentary on Buffett’s investing history, but it’s a good book!
Figure 12. Click here to acquire Ben Graham’s The Intelligent Investor (8/10) – appropriately, Buffett’s purchase of the book had an outstanding rate of return. This version has commentary from Wall Street Journal columnist Jason Zweig after every chapter offering additional context through the early 21st century. Graham distinguished between an entrepreneurial investor – like Buffett – who would have to put in a ton of work to find bargains and a defensive investor who was just trying to get the market return. While there is timeless wisdom here, Graham found it harder and harder to apply his mechanical rules even in his day and it’s only become harder. Toward the end of his life, he recommended the average investor defensively invest in index funds, then a new-fangled instrument of John Bogle’s, now a standard offering.
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