Notes – Best Practices in Deal Flow Origination

These notes are from an article entitled “Where Are The Deals?” by David Teten. He also has resources on adding value to portfolio companies which are worth browsing. For notes on a related topic, check out the “Notes – Stanford Graduate School of Business Search Fund Primer” post.

  • the median investor in private companies had to review 80 companies in order to close one transaction
  • investments sourced through personal and professional networks have been shown to yield better results
  • in order to train your relationships, it is important that you provide them with simple, clear investing criteria, not lengthy checklists; provide them a narrowly defined niche of interest (“Retail brands with $50M in annual revenues”)
  • on average it can take 1-2 years between the first meeting with a target CEO sourced through a network and the close of the deal
  • market mapping, identifying key macro and micro drivers of an industry and creating a database of all key companies; identify those with greatest growth potential or competitive white space
  • specialization enhances deal origination through deeper knowledge base, ability to add value through enhanced network and likelihood of being top of mind to key deal sources
  •  monitor target sector for cyclical opportunities and structure shifts; M&A creates orphan divisions and downturns cause strategy refocuses; 30-46% of PE returns over last 30 years driven by EBIT arbitrage (market timing)
  • other valuable sources of deal flow:
    • regional surveys
    • “fastest growing company” lists
    • trade association membership lists
    • commercial vendors
      • Amadeus
      • Capital IQ
      • Dun & Bradstreet
      • Hoover’s
      • InfoUSA
      • Lexis-Nexis
      • Thomson-Reuters
      • OneSource
  • set up alerts in a blog reader based on key words important to your target or industry focus
  • “A large portion of my deal flow comes from people I have rejected in the past.” be kind to everyone, even those you don’t do a deal with
  • consider having a dedicated, SEO-optimized website and blog for your acquisition fund/team that explains what you’re looking for, why, what you bring to the table, etc.; many VCs and most PE investors are not using basic internet marketing techniques (competitive advantage opportunity)
  • Accel Partners and Khosla Ventures post detailed analyses of their target investment sectors; blogging and posting of internal analyses is the “VC freemium model”
  • PE investing is a relationship business and the most important relationships are with LPs, entrepreneurs, executives and intermediaries which are relatively few in number
  • blogging is the best tool for VC investing according to one experienced observer; helps investor gain information, credibility and relationships through improved visibility
  • look for access to secondary interests through directly approaching funds (particularly distressed), markets for secondary interests (SecondMarket, NYPPEX, PORTAL Alliance) and approaching ibanks specializing in secondary interests (Cogent Partners, Probitas, Triago, UBS)
  • service providers such as accountants, lawyers, etc., are typically not good sources of deal flow because they require too much education and often have a fiduciary responsibility to their client; on the other hand, connecting with service providers in a specialized domain that is being targeted can be a good source of insight
  • trawl the Q&A portion of sites such as LinkedIn to identify domain experts for further outreach
  • measure your deal origination efforts with activity measures, deal flow by source, pipeline analytics and industry benchmarking measures
  • many professional services firms do not use a global CRM system such as Salesforce.com, Act, Saleslogix, Microsoft Access or Angelsoft (angel/VC network)
  • Key data sources for CRM systems include employee networks (ContactNet Enterprise Relationship Management), business cards (Cardscan, IRIS, Neat, Presto), data from email and files (eGrabber, Gwabbit, Grab-Text, Broadlook), the “cloud” (LinkedIn, Spoke, Plaxo) and direct from target companies’ websites, media, etc.

Key attributes of top originators in order of importance

  1. persistence (every no gets you closer to a yes)
  2. personality (people do business with those they like)
  3. business and financial judgment
  4. adequate financial sophistication
  5. seniority and appropriate title (decision-maker)
  6. internal authority to get transaction executed
  7. creativity

Important deal signals when identifying targets (utilize commercial databases, social media, data mining and targeted phone research to uncover)

  • Status of the major equity owner
    • PE funds motivated to sell due to fully invested, raising next fund or current fund has aged beyond 5-7 years
    • Large corp raising cash by selling subsidiaries
    • Time limited tax incentives
    • Family in midst of succession battle
    • Death, disease and divorce (“three Ds”)
  • Status of CEO
    • retirement
    • age
    • acknowledgement of limited competence
  • Corporate performance
    • growth too rapid for self-funding
    • underperforming/distressed
  • Industry/economic trends
    • industry consolidation
      • competitive pressure
      • seeing competitors liquidating equity for large gains
    • competitors raising capital; pressure to maintain parity
    • growth sector

Top considerations for deal intermediaries in directing deal flow

  1. Possibility of future revenue
  2. Integrity
  3. Timely responses
  4. “Fair” treatment of sellers
  5. Experience with the industry or owner type
  6. High certainty to close
  7. Friendship
  8. Feedback and referrals
  9. Maintaining a single point of contact

Most valued aspects of acquiring companies by the acquired

  1. Added operational value
  2. No extra costs
  3. Fair treatment of employees post-transaction
  4. Brand
  5. Long holding periods (no buy-to-flip)

Leading databases of institutional investors (use principles of SEO to optimize your profile here)

  • Galante’s
  • Grey House
  • VentureXpert
  • PE funds
    • Eurekahedge
    • Pitchbook
  • VC funds
    • Angelsoft
    • CrunchBase
    • PWC MoneyTree
    • TheFunded
    • VentureDeal

Market Mapping steps

  1. choose industries and geographies of initial interest
  2. define your proprietary point of view
  3. translate into investment theme (industries/geographies of interest)
  4. list major players in target industry/geography
  5. improve market map with feedback from industry contacts and investment targets
  6. determine which activities offer the highest return and outsource the rest
  7. identify areas of future growth
  8. asses fit with your overall strategy
  9. regularly update the market map with additional feedback and lessons

10 Simple Steps to Improve Your Origination

  1. Analyze your network
  2. Use market mapping to develop deep, proprietary insights about your target
  3. Monitor target ecosystem for cyclical/structural opportunities
  4. Align internal interests
  5. Divide and conquer
  6. Centralize data and become an information sponge
  7. Develop a network with limited overlap
  8. Take control of your virtual presence (marketing)
  9. Join the in-person and virtual communities of your target market
  10. Take a leadership role; find a way to stand out and attract others to you
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Notes – The Snowball, By Alice Schroeder: Part V, Chap. 43-52

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder (buy on Amazon.com). This post covers Part V: The King of Wall Street, Chap. 43-52

The modern Buffett

In Part V of the Snowball, we see Buffett’s transformation from the early, cigar butt-picking, Grahamian value-minded Buffett, through the filter of his Fisherite partner, Charlie Munger, into the mega cap conglomerator and franchise-buyer Buffett who is popularly known to investors and the public the world round.

It is in this part that we also see Buffett make one of his biggest missteps, a stumble which almost turns into a fall and which either way appears to shock and humble the maturing Buffett. It is in this era of his investing life that we see Buffett make some of his biggest rationalizations, become entangled in numerous scandals he never would’ve tolerated in his past and dive ever deeper into the world of “elephant bumping” and gross philanthropy, partly under the tutelage of his new best friend and Microsoft-founder, Bill Gates.

The lesson

Buffett made a series of poor investments but ultimately survived them all because of MoS. There will be challenges, struggles, and stress. But after the storm, comes the calm.

The keys to the fortress

From the late seventies until the late nineties, despite numerous economic and financial cycles Buffett’s fortune grew relentlessly under a seemingly unstoppable torrent of new capital:

Much of the money used for Buffett’s late seventies spending spree came from a bonanza of float from insurance and trading stamps

This “float” (negative working capital which was paid to Buffett’s companies in advance of services rendered, which he was able to invest at a profit in the meantime) was market agnostic, meaning that its volume was not much affected by the financial market booming or crashing. For example, if you owe premiums on your homeowner’s insurance, you don’t get to suspend payment on your coverage just because the Dow Jones has sold off or the economy is officially in a recession.

The growth in Buffett’s fortune, the wilting of his family

Between 1978 and the end of 1983, the Buffetts’ net worth had increased by a stunning amount, from $89 million to $680 million

Meanwhile Buffett proves he’s ever the worthless parent:

he handed the kids their Berkshire stock without stressing how important it might be to them someday, explaining compounding, or mentioning that they could borrow against the stock without selling it

Buffett had once written to a friend when his children were toddlers that he wanted to see “what the tree has produced” before deciding what to do about giving them money

(he didn’t actively parent though)

Buffett’s private equity shop

Another tool in Buffett’s investment arsenal was to purchase small private companies with dominant franchises and little need for capital reinvestment whose excess earnings could be siphoned off and used to make other investments in the public financial markets.

Continuing on with his success in acquiring the See’s Candy company, Buffett’s next private equity-style buyout involved the Nebraska Furniture Mart, run by a devoted Russian immigrant named Rose Blumkin and her family. And, much like the department store chain he once bought for a song from an emotionally-motivated seller, Buffett beat out a German group offering Rose Blumkin over $90M for her company, instead settling with Buffett on $55M for 90% of the company, quite a discount for a “fair valuation” of practically an entire business in the private market, especially considering the competing bid.

An audit of the company after purchase showed that the store was worth $85M. According to Rose Blumkin, the store earned $15M a year, meaning Buffett got it for 4x earnings. But Rose had buyers remorse and she eventually opened up a competing shop across the street from the one she had sold, waging war on the NFM until Buffett offered to buy her out for $5M, including the use of her name and her lease.

One secret to Buffett’s success in the private equity field? Personality:

“She really liked and trusted me. She would make up her mind about people and that was that.”

Buffett’s special privileges

On hiding Rose Blumkin’s financial privacy: Buffet had no worries about getting a waiver from the SEC

Buffett got special dispensation from the SEC to not disclose his trades until the end of the year “to avoid moving markets”

The gorilla escapes its cage

Another theme of Buffett’s investing in the late 1980s and 1990s was his continual role as a “gorilla” investor who could protect potential LBO-targets from hostile takeover bids. The first of these was his $517M investment for 15% of Tom Murphy-controlled Cap Cities/ABC, a media conglomerate. Buffett left the board of the Washington Post to join the board of his latest investment.

Another white knight scenario involved Buffett’s investment in Ohio conglomerate Scott Fetzer, which Berkshire purchased for $410M.

Then Buffett got into Salomon Brothers, a Wall Street arbitrage shop that was being hunted by private equity boss Ron Perelman. Buffett bought $700M of preferred stock w/ a 9% coupon that was convertible into common stock at $38/share, for a total return potential of about 15%. It even came with a put option to return it to Salomon and get his money back.

But Buffett had stepped outside of his circle of competence:

He seemed to understand little of the details of how the business was run, and adjusting to a business that wasn’t literally made of bricks-and-mortar or run like an assembly line was not easy for him… he had made the investment in Salomon purely because of Gutfreund

Buffett’s disgusting ignorance and hypocrisy

Buffett:

I would force you to give back a huge chunk to society, so that hospitals get built and kids get educated too

Buffett decides to sell the assets of Berkshire’s textile mills– on the books for $50M, he gets $163,122 at the auction. He refused to face his workers and then had the gall to say

“The market isn’t perfect. You can’t rely on the market to give every single person a decent living.”

Buffett on John Gutfreund:

an outstanding, honorable man of integrity

Assorted quotes

Peter Kiewit, a wealthy businessman from Omaha, on reputation:

A reputation is like fine china: expensive to acquire, and easily broken… If you’re not sure if something is right or wrong, consider whether you’d want it reported in the morning paper

Buffett on Wall St:

Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway

Notes – The Snowball, By Alice Schroeder: Part IV, Chap. 34-42

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part IV: Susie Sings, Chap. 34-42

Buffett unwinds, but does not relax

In 1970, Buffett decided to unwind his partnerships, partly because he seemed to have plenty of his own capital to manage at this point and no longer needed the headaches that came with fiduciary leverage, partly because the labyrinthine holdings of the partnership were becoming a regulatory compliance headache and partly, no doubt, because of Buffett’s ill mood toward future return potential offered by the market at that point in time.

In his 1969 letter Buffett made another of his unusual market forecasts which, as infrequently as they’ve appeared over the course of his career, nonetheless seem to mark intermediate tops and frothy market conditions. In it, Buffett said,

I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds

As his partners were left with the choice of holding onto their stock or selling, Buffett, the most sophisticated of the partners, left them with one clue as to what he recommended, announcing that he intended to continue buying the stock of Berkshire Hathaway and others which had become his investment holding vehicles.

The “implacable acquirer”

Buffett’s four main holdings at this time were Berkshire Hathaway, Blue Chip Stamps, National Indemnity (an insurance company) and Diversified Retail Holdings. But it was through these companies that Buffett would eventually come to own and control many others, using the earnings of each to buy even more of the next. The key in each situation was that the holdings were either capable of generating investable float, or else they were generating excellent free cash flows that could be redirected away from the core business into ownership of others.

Buffett learned this “Russian doll” strategy in part from a little-known investor named Gurdon W. Wattles, whose control company, American Manufacturing, was used to take controlling stakes in numerous other companies such as Mergenthaler Linotype, Crane Co., and Electric Auto-Lite, many of which Buffett gladly road the coattails on. Buffett claimed he followed the man for ten or fifteen years and that he saw himself as simply standing on the shoulders of a giant in emulating his acquisition approach.

The beauty of this investment technique is that the cash flows are largely market-agnostic– aside from the impact of a general business recession, they would keep generating new cash to be invested to matter what the larger market was doing, which was excellent because when the market was swooning under the weight of panicky investors, Buffett had ample resources to take deep dives on any number of absurdly cheap, high quality companies he might want.

Combined with the power of compounding, his reinvestable cash flows and float would continually increase over time.

Buffett and Mungers’ sweet teeth

One of Buffett and Mungers’ most famous coups of this era was their purchase of See’s Candies. Demanding $30M for assets worth $5M, the true value of See’s was captured in its goodwill with customers, built on its uncompromising quality standards. Buffett believed this goodwill meant the company had “uncapped pricing power”– with current earnings to acquisition price generating a 9% “yield” on investment, the deal was good, but on top of that earnings were growing 12% per year organically and Buffett was convinced that prices could be steadily raised each year to increase the rate of earnings growth beyond the rate of growth in unit volumes.

If the price increases could be met and earnings growth would continue, Buffett and Munger were looking at something that would earn not $4M on a $25M acquisition price, but $6-7M plus additional growth over time. Because the business required very little ongoing maintenance or growth capex, almost all of the earnings were investable free cash flow that Buffett and Munger could use to make additional investments and acquisitions.

Extra! Extra! Buffett buys the Washington Post and becomes board member for Kay Graham

Whether it was because of his early childhood experiences as a newspaper delivery boy or because of his belief in the pseudo-monopolistic economics of newspapers, Buffett found himself drawn to the Washington Post and other media enterprises as an investment. According to the author, newspapers were the perfect investment for Buffett because they allowed him to play all the roles he so enjoyed at once: relentless collector, preacher and cop.

Prior to his engagement, the WaPo was earning $4M per year on $85M in revenues. Run by a talented but psychologically troubled Kay Graham, Buffett was the beneficiary of temporary troubles at the paper which pushed its stock price from a high of $38/share to a low of $16. Buffett bought in big blocks whenever they were available and aimed all along at taking a seat on the board.

In the meantime, he was investing in other newspaper and media companies, breaking his no-IPO rule and buying stock in Affiliated Publications (publisher of the Boston Globe) at a negotiated discount, as well as Booth Newspapers, Scripps Howard and Harte-Hanks Communications.

By 1973 he had accumulated 5% of the shares of WaPo and he wrote a letter to Kay Graham announcing his ownership and advising her that he planned to increase it substantially, telling her that

Writing a check separates conviction from conversation

But Buffett faced challenges from other board members who were protective of Graham, untrustworthy of Buffett and bent on protecting their own turf, such as the great Lazard banker Andre Meyer. Despite controlling the voting stock A shares, even Graham herself became paranoid and defensive at one point and Buffett, to calm her nerves, agreed not to purchase anymore stock without her permission even though he’d already spent almost $10.7M to acquire 12% of the company.

He also made a play for the Buffalo Evening News, one of two newspapers in the Buffalo market. But this investment quickly became complicated as the BEN suffered not only numerous anti-competitive lawsuits from the other local paper, but massive labor disruptions as well. Buffett’s investment quickly turned into a loser whose cash-consumption multiplied rapidly with each passing year, creating a real moment of truth for Buffett and Munger who had, until this time, constructed a nearly flawless investment record.

In Buffett’s mind, the critical element in the equation was customer habit,

You’re gauging the likelihood of people changing their habits… the question is, at what point does it become more of a habit for them to buy the other paper?

Ultimately, their insight on customer habit was correct and their saving grace. Despite losing tens of millions initially on their investment of $35.5M, after surviving the labor disputes and the eventual bankruptcy of the local rival, Buffett’s Buffalo Evening News earned $19M pretax in 1983, more than all the previous losses combined.

Things get sticky with the SEC

In the mid-1970s, Buffett and Munger found themselves in a compromising position with the SEC. Supposedly tipped off by angry competitors and customers of Blue Chip Stamps, the SEC began a cursory investigation of claims about insider dealings between Buffett, Munger and Wesco Financial which eventually turned into a full-blown investigation of every single part of their combined business operations.

The details are complicated and irrelevant at this point, but at the time it was Buffett and Munger’s first real hair-raising legal experience and despite their good intentions and attempts at sweet-talking and playing innocent, they found the SEC investigators to be fairly ruthless in their inquiries and accusations.

The net result was Buffett and Munger’s decision to clean up their ownership structure and simplify it by merge more of their companies into the umbrella holding company of Berkshire Hathaway.

But one can’t help but wonder about the timing– just as Buffett was making his move on the Washington Post and beginning to enter the world of the Washington power elite, had someone decided to give Buffett a scare, to show him just how delicate his “conservative” investment empire really was, and to compel his obedience to the power elite agenda going forward?

More Buffett investments

Here is a running list of Buffett investments over the period of 1970-1983:

  • Berkshire Hathaway
  • Blue Chip Stamps
  • Diversified Retail Holdings
  • National Indemnity
  • Cornhusker Casualty
  • National Fire & Marine
  • The Washington Post
  • See’s Candies
  • Scripps Howard
  • Harte-Hanks Communications
  • Affiliated Publications
  • Booth Newspapers
  • San Jose Water Works
  • Source Capital
  • Wesco Financial
  • National Presto
  • Vornado Realty Trust
  • Interpublic
  • J. Walter Thompson
  • Oglivy & Mather
  • Studebaker-Worthington
  • Handy & Harman
  • Multimedia, Inc.
  • Coldwell Banker
  • Pinkerton’s, Inc.
  • Detroit International Bridge
  • Buffalo Evening News
  • The Illinois National Bank and Trust Company of Rockford
  • GEICO
  • Munsingwear
  • Data Documents (a private investment)

A collapsing personal life

With regards to Buffett’s personal life, Part IV is so far the saddest of all. It is in this stage of Buffett’s life and investment career that he really begins to lose touch with his children and his spouse, Susie. Though married in name, the couple are de facto separated and living their own independent lives, with Buffett traveling constantly and spending a lot of time “elephant bumping” with Kay Graham in Washington and Susie leaving her now empty nest in Omaha to take up her own apartment in racy San Francisco.

Buffett’s children are distant from him, physically and emotionally and the life choices and dysfunction of each seem to demonstrate quite clearly what an absentee father he was. Sadly, Susie turns to an affair (or two) in her search for companionship and even Buffett eventually caves and shacks up with his caretaker, Astrid Menks, a friend of Susie’s in Omaha.

Buffett expresses deep regret about this part of his life, realizing too late to salvage the situation what damage his indifference had caused.

If there’s a lesson here, it is that life always requires balance for it to be happy and worthwhile. What good is knowing you’re the world’s greatest (and soon to be wealthiest) investor, if it comes at the cost of agonizing sadness when your marriage falls apart and your children no longer seem to know much of you?

Other important investment ideas

In no particular order, below are a few more quotes on important investment ideas, as shared by Buffett and other investors, in Part IV.

Buffett on uncertainty:

The future is never clear, you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values

Buffett on reputation:

Over a lifetime, you’ll get a reputation for either bluffing or not bluffing. And therefore, I want it to be understood that I don’t do it [bluff]

Tom Murphy on the value of stock as a currency:

Warren never gave his stock away; neither did I if I could possibly avoid it. You don’t get rich that way. [Commentary by Alice Schroeder] Giving stock in exchange for TV Guide was saying, in a literal sense, that they thought it would earn more in the future than whatever share of Berkshire Buffett swapped for it. Paying with stock showed a sort of contempt for your own business versus whatever it was that you were buying– that is, unless you were paying with stock that had gotten wildly overpriced

Buffett’s advice to Graham on acquisitions, channeled through Alice Schroeder:

It was always a mistake to pay too much for something you wanted. Impatience was the enemy… [there was] immense value in buying their company’s own stock when it was cheap to reduce the shares outstanding

Bill Ruane on the investment business:

In this business you have the innovators, the imitators, and the swarming incompetents

Buffett on Wattles and coattailing:

There’s nothing wrong with standing on other people’s shoulders

Notes – The Snowball, By Alice Schroeder: Part III, Chap. 20-33

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part III: The Racetrack, Chap. 20-33

Racing On

The third part of The Snowball opens with Warren Buffett on the verge of starting his infamous partnerships, the precursor to his Berkshire Hathaway holding company conglomerate. On the way, he took a few short detours and learned lessons all over the place, some of them completely unrelated to the art of investing. For example, witnessing the implosion of his father’s political career and campaign, Warren realized:

  • allies are essential
  • commitments are so sacred that by nature they should be rare
  • grandstanding rarely gets anything done

And from his father-in-law, Doc Thompson, the young Buffett learned

always surround yourself with women. They’re more loyal and they work harder

Meanwhile, Buffett’s young wife and mother-to-be, Susie Thompson, was learning just how deep the rabbit hole went when it came to Warren’s insecurities:

Leila [Buffett’s emotionally unbalanced mother] convinced both Warren and Doris that deep down they were worthless… [Buffett] was riddled with self-doubt. He had never felt loved, and she saw that he did not feel lovable

The depth of Buffett’s personal insecurities not only explain a lot about his later behavior and public persona, but they also provide a couple of startling questions to ponder, namely:

  • how did a person with such fundamental self-confidence issues nevertheless summon the self-confidence necessary to trust his own investment thinking?
  • being as insecure as he appeared to be, how much better of an investor might Warren Buffett have been had he not been carrying around such a handicap?

Who is Charlie Munger?

In Part III, we begin to get a more detailed picture of Buffett’s soon-to-be-infamous partner, Charlie Munger, as well as the subtle but fundamental ways in which his own thinking about investing and business analysis came to influence and then dominate Buffett’s own style. A mathematics major at the University of Michigan at age 17, following the incident at Pearl Harbor, the young Munger enlisted in the military and found himself as an Army meteorologist in Nome, Alaska. He took up poker where he learned to bet big when he had the odds and fold fast when he did not. He later attended Harvard Law School where he claims he graduated “without learning anything.”

After law school, he was obsessed with the idea of achieving social prominence, choosing Los Angeles as a place that was growing and full of opportunity but not so big and developed that he’d never be noticed. Munger’s life, like Buffett’s, was not without personal tragedy. His first marriage fell apart right around the time his 8-year-old son came down with a terminal illness. Munger had to watch these two pillars of his life dissolve simultaneously.

He later became obsessed with children and raised eight of them with his second wife. Munger was a compulsive reader and thinker, known to his family as a “book with legs” and was constantly found reading books on science and the achievements of great figures. Munger was interested in making money early on. When he was a young lawyer and earning about $20/hr he realized his most valuable client was himself so, in the style of [amazon text=The Richest Man In Babylon&asin=0451205367], Munger decided to “sell himself an hour each day”, which he used to pursue real estate and construction projects as well as other investment opportunities. Munger had

a considerable passion to get rich, not because I wanted Ferraris– I wanted the independence

Buffett was patient with Munger. Even though Munger was his senior by several years, Munger pleadingly inquired about whether he could do what Buffett was doing in Los Angeles. Not only did Buffett tell him he could and should, he proceeded to build a relationship with him that involved hours of phone conversations everyday as the two came up with different business ideas together. As Munger described Buffett, and his fascination with him,

That is no ordinary human being

In other words, they seemed to be soulmates, a truly odd couple.

The Munger Effect

Charlie Munger entered Buffett’s life and investment world at a critical juncture in Buffett’s development as a capital allocator.

Until 1958, his straightforward route was to buy a stock and wait for the cigar butt to light. Then he usually sold the stock, sometimes with regret, to buy another he wanted more, his ambitions limited by his partnerships’ capital

But as his total AUM approached $1M with his partnerships and personal money, Buffett had a new scale that let him branch out into new styles of investing. His investments began to become concentrated, elaborate and time-consuming, such as the Sanborn Maps episode. Munger himself started his own partnership in 1962 with his poker buddy Jack Wheeler  who was a trader on the floor of the Pacific Stock Exchange and $300,000 in capital he had accumulated through real estate investments. He eventually gave up his law practice at age 41 and decided to pursue investing full-time. He also used Wheeler’s membership on the exchange to lever up (at a ratio of 95/100) when he felt sure about his investments, something Buffett was not willing to do early on.

Munger’s early investment style involved net-nets, arbitrage and even the acquisition of small businesses. But his real interest lay in buying “great businesses”, which he identified by:

  • strength of management
  • durability of brand
  • cost to compete/replicate the firm
  • did not require continual investment
  • created more cash than it consumed

To find these businesses, Munger asked everyone he met, “What is the greatest business you’ve ever heard of?”

As the market for net-nets dried up in the mid-60s and Buffett’s capital swelled, he found more and more he had to look at the kinds of great businesses that Charlie Munger favored, changing his focus from statistical cheapness (quantitative investing) to competitive advantage (qualitative investing).

With his capital ballooning, Buffett began looking at the acquisition of entire businesses as a more attractive option. In 1966, this twinkle in Buffett’s eye became Diversified Retailing Company, Inc., an 80/10/10-ownership holding company owned by Buffett, Munger and Sandy Gottesman, whose first acquistion was a $12M Baltimore department store called Hochschild-Kohn, financed 50% with bank borrowings, a “second-class department store” at a “third-class price”. However, the store had no competitive advantage, as the partners soon learned, and was continually caught up in a game of “standing tiptoe at a parade” as every innovation by a competitor had to be quickly imitated (at additional capital expense) lest customers shop elsewhere. It was here that Buffett and Munger learned that the essential skill of retailing was merchandising, not finance, and that retailing, like restaurants, is

a wearing marathon in which, every mile, fresh, aggressive competition could leap in and race ahead of you

Having learned their lesson, their next foray into Associated Cotton Shops, “a set of third-class stores for a fourth-class price” 80 in number led by Benjamin Rosner, a “true merchandiser” found them with a retail operation generating $44M in sales and approximately $2M/yr in earnings. Buffett made a deal to buy the stores for $6M, a sale which was ultimately made by Rosner in part to screw over his female business partner who drove him nuts, causing him to purposefully sell the business for less than it was worth just to get back at her. Buffett and Munger also insisted that Rosner stay on the manage the company for them.

In 1967, Buffett increased his control of the Buffett Partnerships while simultaneously weeding out 32,000 shares worth of investors who preferred a 7.5% debenture to Berkshire stock, ensuring that those who remained were in for growth and the risks that came with it.

Miscellany of the markets

As Buffett’s investment strategy changed over the 1950s and 1960s and his level of sophistication rose, he picked up a number of useful techniques for gaining informational edges in the market and making successful investments:

  • coat-tail riding – Buffett became a notorious borrower of good ideas and was not too proud to keep an eye on people who demonstrated deal-making intelligence in the past, such as Ben Graham and Jay Pritzker, assuming they’d continue to make good judgments in the future
  • detective-work/sleuthing – Buffett was the only person digging through the Moody’s Manuals at their company headquarters, or going to the shareholder meetings of small companies, or even meeting with executives of small companies to get an idea of who was running these companies
  • no self-imposed market cap restrictions – Buffett looked at EVERY company he came across, no matter how small, looking for opportunities others weren’t focused on; he was particularly fond of the “Pink Sheets” publications
  • consulting lists of registered shareholders – Buffett would buy blocks of companies he was interested in by hunting down individual shareholders and convincing them to unload the shares to him
  • collecting scarce things – Buffett’s National American Fire Insurance investment taught him “the value of gathering as much as possible of something scarce”, both undervalued stocks and information related to said stocks
  • proxy-investing – Buffett would often have his friends buy stocks he was interested in to hide his identity as the main buyer accumulating a position
  • benefit from sentiment – when the market hit a fever pitch in the 1960s, Buffett went into fundraising overdrive and raised as much capital as he could while people were eager to invest
  • use psychology to your advantage – as Buffett’s success unfolded, he forced would-be partners to ask him to allow them to invest with him, which put him psychologically in control
  • preservation of capital – Buffett would willingly forgo the chance of profit to avoid too much risk, viewing it as a “holy imperative”; his partner Munger believed unless you were already wealthy you could afford to take risk if the odds were right
  • haystack of gold – a concept imparted to him by friend Herb Wolf, the idea was if you’re looking for a gold needle in a haystack of gold it is not better to find the gold needle; obscurity was not virtue
  • expense control – Buffett only took on overhead as needed, and in ways that could be easily turned back off or were free to begin with; he made extensive use of “soft-dollars” in his brokerage commissions to buy research from his favorite sleuth brokers
  • profile visibility – when he was buying small companies early in his career, Buffett valued secrecy and anonymity, but as he began to target bigger companies he saw the value of a public profile and cultivated a relationship with Carol Loomis, a financial markets journalist

Buffett’s partnerships

Buffett had a total of 9 official partnerships that later became the infamous Berkshire Hathaway. However, he also set up an early partnership with his father, Howard, called Buffett & Buffett, which

formalized the way they had occasionally bought stocks together. Howard contributed some capital, and Warren’s contribution was a token amount of money, but mostly ideas and labor

Why was Buffett interested in managing money? Two reasons. One, Buffett had a strong aversion to working for others and he understood that

The overseer of capital was not an employee

Two, Buffett was obsessed with becoming a millionaire. Managing money for others and collecting a fee on profits generated would allow him to grow his own capital faster than if he were earning a return on just the money that was actually his. In other words, agreeing to manage money for others was a way to leverage his own investment returns.

Buffett started with 7 official partnerships, which were essentially all mini-hedge funds under his exclusive control, and which he viewed as “compounding machines”, meaning once the money went in it should not come out, which is why he managed most of his own wealth separately (as he would be living off his trading gains). And Buffett was so obsessed with compounding he decided to rent rather than own his own home, to free more capital for compounding.

The seven initial partnerships and several follow-on partnerships were as follows:

  1. May 1, 1956, Buffett Associates Ltd., starting capital of $105,100, seven partners: Doc Thompson, Doris Buffett, Truman Wood, Chuck Peterson, Elizabeth Peterson, Dan Monen and Warren Buffett; Buffett charged 50% performance fee on returns over 4% (4% returns being guaranteed as a minimum by Buffett); added $8,000 in capital in 1960 from Buffett’s aunt and uncle
  2. September 1, 1956, Buffett Fund, Ltd., starting capital of $120,000, partnered with Homer Dodge, a former Graham-Newman investor
  3. Late 1956, B-C, Ltd., starting capital of $55,000, partnered with John Cleary, Howard Buffett’s secretary in Congress
  4. June 1957, Underwood, starting capital of $85,000, partnered with Elizabeth Peterson; 1960, another $51,000 from connections of Chuck Peterson’s
  5. August 5, 1957, Dacee, starting capital of $100,000, partnered with the Davis Family
  6. May 5, 1958, Mo-Buff, starting capital of $70,000, partnered with Dan Monen (who had withdrawn his capital from partnership #1 to do a special investment with Buffett on National American), later joined by the Sarnats and Estey Graham with another $25,000 in capital
  7. February 1959, Glenoff, starting capital of $50,000, partnered with Casper Offutt, Jr., John Offutt and William Glenn
  8. August 15, 1960, Emdee, starting capital of $110,000, partnered with  11 local doctors
  9. 1960, Ann Investments, starting capital of ??, partnered with a prominent member of a local Omaha family
  10. 1960, Buffett-TD, starting capital of $250,000, partnered with Mattie Topp and two daughters plus son-in-law (MT owned the fanciest dress shop in town)
  11. May 16, 1961, Buffett-Holland, starting capital of ??, partnered with Dick and Mary Holland, friends he had met through his lawyer Dan Monen
  12. May 1, 1962, Buffett dissolves all partnerships into Buffett Partnership, Ltd. (BPL), beginning the year with $7.2M in net assets

His total starting capital across all of his partnerships was $580,000 and he

never deviated from the principles of Ben Graham. Everything he bought was extraordinarily cheap, cigar butts all, soggy stogies containing one free puff

Truly, one man’s junk is another man’s treasure.

Buffett’s investments

The “racetrack” period of Buffett’s life marked Buffett’s gradual transformation from a Grahamian “cigar butt” (Net-Net) investor to the well-known “growing franchise” investor of today. As Buffett’s assets under management (AUM) grew and the general market conditions of the era changed, so, too, did Buffett’s idea of a good investment. Below is a list of some of Buffett’s investments for his partnerships, as well as his personal and peripheral portfolios:

  • Greif Bros. Cooperage; originally purchased for the B&B partnership in the early 1950s
  • Western Insurance; purchased for Buffett’s personal portfolio in the early 1950s, Buffett actually sold his GEICO position to raise money to invest in this company earning $29/share and selling for $3/share, “He bought as much as he could”
  • Philadelphia and Reading Coal & Iron Company; controlled by Graham-Newman, Buffett has discovered it on his own and had invested $35,000 by the end of 1954; it was not worth much as a business but was throwing off a lot of excess cash; Buffett learned about the value of capital allocation with this company
  • Rockwood & Co.; controlled by Jay Pritzker, the company was offering to exchange $36 of chocolate beans for shares trading at $34, a classic arbitrage opportunity; unlike Graham, Buffett didn’t arbitrage but instead bought 222 shares and held them, figuring Pritzker had a reason he was buying the stock, “inverting” the scenario; the stock ended up being worth $85/share, earning Buffett $13,000 vs. the $444 he would’ve received from the arbitrage
  • Union Street Railway; a net-net he discovered through Ben Graham, had about $60/share in net current assets against a selling price of $30-35/share, Buffett ultimately made $20,000 on this investment through sleuthing and speaking to the CEO in person
  • Jeddo-Highland Coal Company (mentioned as an idea Buffett investigated on a road trip)
  • Kalamazoo Stove and Furnace Company (mentioned as an idea Buffett investigated on a road trip)
  • National American Fire Insurance, earning $29/share, selling for around $30/share, Buffett first bought five shares for $35/share, and later realized that paying $100/share would bring out the sellers because it would make them whole (financially and psychologically) after being sold the stock years earlier
  • Blue Eagle Stamps, a failed investment scheme between Buffett and Tom Knapp, they eventually spent $25,000 accumulating these “rare” stamps that weren’t worth more than their face value ultimately
  • Hidden Splendor, Stanrock, Northspan, uranium plays that Buffett described as “shooting fish in a barrel”
  • United States & International Securities and Selected Industries, two “cigar butt” mutual funds recommended to him by Arthur Wisenberger, a well known money manager of the era; in 1950, represented 2/3 of Buffett’s assets
  • Davenport Hosiery, Meadow River Coal & Land, Westpan Hydrocarbon, Maracaibo Oil Exploration, all stocks Buffett found through the Moody’s Manuals
  • Sanborn Maps, in 1958 represented 1/3 of his partnerships’ capital; the stock was trading at $45/share but had an investment portfolio worth $65/share; Buffett acquired control of the board in part through proxy leverage; ultimately he prevailed over management and had part of the investment portfolio exchanged for the 24,000 shares he controlled
  • Dempster Mill Manufacturing, sold for $18/share with growing BV of $72/share, Buffett’s strategy as with many net-nets was to buy the stock as long as it was below BV and sell anytime it rose above it and if it remained cheap, keep buying it until you owned enough to control it and then liquidate at a profit; he and his proxies gained control of 11% of the stock and got Warren on the board, then bought out the controlling Dempster family, creating a position worth 21% of the partnership’s assets; the business was sliding and at one point he was months away from losing $1M on the investment, but was ultimately rescued by Harry Bottle, a new manager brought in on Charlie Munger’s recommendation; the business eventually recovered through strict working capital controls and began producing cash, which Buffett augmented by borrowing about $20/share worth of additional money and used it to purchase an investment portfolio for the company; he later sold the company for a $2M profit
  • Merchants National Property, Vermont Marble, Genesee & Wyoming Railroad, all net-nets he later sold to Walter Schloss to free up capital
  • British Columbia Power, selling for $19/share and being taken over by the Canadian government at $22/share, this merger arb was recommended by Munger and Munger borrowed $3M to lever up his returns on this “sure thing”
  • American Express, one of Buffett’s first “great company at a good price” investments, the firm’s reputation was temporarily tarnished in the aftermath of the soybean oil scandal; Buffett did scuttlebutt research and realized the public still believed in American Express, and as trust was the value of its brand, the company still had value; Buffett eventually invested $3M in the company and it represented the largest investment in the partnership in 1964, 1/3 of the partnership by 1965 and a $13M position in 1966
  • Texas Gulf Producing, a net-net Buffett put $4.6M into in 1964
  • Pure Oil, a net-net Buffett put $3.5M into in 1964
  • Berkshire Hathaway, the company was selling at a discount to the value of its assets ($22M BV or $19.46/share) and Buffett’s original intent was to buy it and liquidate it, which he started accumulating 2000 shares for $7.50/share; the owner, Seabury Stanton had been tendering shares with the company’s cash flow, so Buffett tried to time his transactions, buying when it was cheap and tendering when it was dear; he continued purchasing stock assuming Seabury would buy him out via tender offers, the two eventually agreed to a $11.50 tender but Seabury reneged at the last moment, changing the bid to $11 and 3/8, sending Buffett into a rage and causing him to abandon his original strategy in favor of acquiring the entire company; he eventually bought out Otis Stanton’s two thousand shares and had acquired enough to gain control with 49% of Berkshire
  • Employers Reinsurance, F.W. Woolworth, First Lincoln Financial, undervalued stocks he found in Standard & Poor’s weekly reports
  • Disney, which he bought after meeting Walt Disney and being impressed by his singular focus, love of work and the priceless entertainment catalog
  • A portfolio of shorts to hedge against a potential market collapse in the mid 60s, totally $7M and consisting of Alcoa, Montgomery Ward, Travelers Insurance and Caterpillar Tractor
  • Near the end of 1968, as the market became more and more overvalued, Buffett relented and bought some of the “blandest, most popular stocks that remained reasonably priced” such as AT&T ($18M), BF Goodrich ($9.6M), United Brands ($8.4M) and Jones & Laughlin Steel ($8.7M)
  • Blue Chip Stamps, a “classic monopoly” Buffett and Munger discovered in 1968, the company was involved in a lawsuit that the pair thought would be resolved in the company’s favor, and it also possessed “float” which could be invested in more securities, Munger and his friend Guerin each purchased 20,000 shares while Buffett acquired 70,000 for the partnership, in part through share swaps with other companies that owned Blue Chip stock for their own stock; the lawsuit was eventually resolved and the $2M investment produced a $7M profit
  • Illinois National Bank & Trust, a highly profitable bank that still issued its own bank notes, it was managed by Eugene Abegg, an able steward of the company whose retainer was one condition for Buffett’s investment in the company
  • The Omaha Sun and other local newspapers, which Buffett figured he’d make an 8% yield on, his motivation for buying seemed to be primarily connected to his desire to be a newspaper publisher
  • The Washington Monthly, a startup newsmagazine that Buffett lost at least $50,000 on, again, as a vanity project

Buffett’s AUM

Below is a record of the growth of Buffett’s personal wealth, partnership AUM and performance fees accrued:

  • 1954, Buffett’s total personal capital stood at approximately $100,000
  • 1956, Buffett was 26 years old and had $174,000 of personal capital, growing his money by more than 61% per year for six years since he entered Columbia with $9,800 in capital
  • 1959, partnership returns beat the market by 6%
  • 1960, partnership assets stood at $1.9M and returns beat the market by 29%, and Buffett’s reinvested partnership fees had earned him $243,494 (13% of partnership assets belonged to him)
  • 1962, Buffett was a millionaire and his outside investments totalled over $500,000, which he added with the rest of his money into the BPL partnership; he had acquired more than a million dollars in six years and owned 14% of the partnership
  • 1964, $5M in new capital for the partnerships, and $3M in investment earnings, Buffett’s personal net worth was $1.8M and BPL had $17.5M in capital
  • 1965, ended the year with assets of $37M, including $3.5M in profit on American Express, Buffett had earned more than $2.5M in fees, bringing his total stake to $6.8M
  • 1966, $6.8M in additional capital investments in the partnerships, with total capital amounting to $44M, some of which was set aside as cash for the first time in Buffett’s career
  • 1967, Buffett’s personal net worth was $9M and he had generated $1.5M in fees in 1966
  • 1968, the partnership was worth $105M thanks to additional capital infusions and investment returns
  • 1969, Buffett’s net worth was $26M

The Desert Island Challenge

Buffett and his investor friends came up with the following challenge that is a helpful mental tool for thinking about the investment problem:

If you were stranded on a desert island for ten years, he asked, in what stock would you invest? The trick was to find a company with the strongest franchise, one least subject to the corroding forces of competition and time: Munger’s idea of a great business.

Notes – The Snowball, By Alice Schroeder: Part II, Chap. 5-19

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part II: The Inner Scorecard, Chap. 5-19

The beginning of Buffett

In a letter to a family member from one of Warren Buffett’s ancestors, Zebulon, the elder Buffett counsels his grandson to

be content with moderate gains

almost as if some strain of value investing ethic permeated his lineage from before Buffett himself had even heard of The Intelligent Investor. Buffett’s family represents a long line of business minded people. Yet, despite this heritage,

Buffett always credited most of his success to luck

It’s an odd, likely guilt-laden existential belief to carry around with oneself! But it is maybe no surprise. Love doesn’t sound like it was given much attention in Buffett’s childhood home, and self-love is probably included, as we learn that:

Politics, money and philosophy were acceptable topics for dinner-table discussion at the Buffett house, but feelings were not. Nobody in the Buffett household said “I love you,” and nobody tucked the children into bed with a kiss.

Any guess as to where some of Buffett’s later self-hating charitable giving ideas might have come from?

[Buffett’s mother, Leila’s] favorite stories told of her and Howard’s sacrifices… anything for Howard. “She crucified herself”… But Leila’s attitude of duty and sacrifice had another, darker side: blame and shame.

If you guessed his psychotic, clinically depressed mother, you answered correctly!

It is Buffett’s relationship to his mother and his vulnerability to her rage as a child that we actually see Buffett in the most sympathetic light. We see as Warren recounts his relationship with his mother this grown, aged man “weeping helplessly”, and we also learn that despite the savage treatment from his mother, which his idolized father was aware of, Howard “didn’t intervene.”

The most vulnerable people in any society are children– they’re physically, intellectually AND emotionally unequipped to make sense of and thoughtfully respond to the irrationalities and volatilities of unstable and violent adults. It is actually quite touching imagining this young, budding genius, Warren Buffett, suffering at the hands of his psychologically diseased mother and developing a precarious existential belief system that leaves him feeling so guilty for the remainder of his life that after all he has (legitimately) achieved, he is still convinced it was mostly due to luck! What an absolute tragedy of human imagination! It would be nice to imagine the poor, hurting and timid child inside of Warren Buffett eventually being freed to go on his way and let Warren wrestle with these childhood demons no more.

What a different world it would be if Warren was a hero entrepreneur rather than a man so tormented by his past that he carries his fears and anxieties into his public persona and recommendations for society at large!

We also see in this information the source of Warren’s fascination with other people’s mothers (who he often developed crushes on), with motherly women in general and with his tendency to have a cadre of close female friends in both his personal and professional life, all while simultaneously having a troubled and distant relationship with his own wife and children later on. What a sad development for an otherwise triumphant individual.

The search for a system – Buffett the handicapper

One of the central themes of Part II is the young Warren Buffett’s search for a “system”: a predictable, confined process for predicting and handicapping the odds of various events in his life. Starting with his bathtub marble race, extending to the racing track (horses) and eventually culminating in his quest for an investment system (part of his initial attraction to Graham, who was especially formulaic, scientific and systematic in his approach to the investment question in general).

And a system, once found, is only valuable if it has a lot of information to process:

There were opportunities to calculate odds everywhere. The key was to collect information, as much information as you could find.

We also begin to see hints of the later, “original” Buffett, with his love of monopoly as a competitive advantage. The anecdotes of Buffett and his friend Russ collecting license plate information in the hopes of eventually providing it to the police to catch a bank robber are examples of Buffett’s early obsession with  the value of a monopoly. Similarly, while the young Warren was holed up in a hospital with an illness, he took to collecting the fingerprints of the nurses so that if one of them committed a crime,

he, Warren Buffett, would own the clues to the culprit’s identity

This is a pretty astounding conclusion for a young child to reach, even if it is innocently done. It appears Warren had something of an intuitive understanding of the value of a restricted supply granted by a monopoly on a particular resource.

He also was perplexed by the way so much valuable information (valuable to someone with a system in place for interpreting and analyzing it) went uncollected and unused. An early example is Buffett’s collecting of bottle caps nearby soda dispensers:

The numbers told him which soft drinks were most popular

Do you see the future investor in Coca-Cola beginning to formulate his understanding of the value of consumer habits and patterns?

In the 1940s, Buffett started visiting horse racing tracks where he learned

The art of handicapping is based on information. The key was having more information than the other guy

Buffett ended up reading HUNDREDS of books on horse handicapping before he eventually learned the Rules of the Racetrack:

  • Nobody ever goes home after the first race
  • You don’t have to make it back the way you lost it

Buffett later connected these experiences to his investing and understood

The market is a racetrack too. The less sophisticated the track, the better… the trick, of course, is to be in a group where practically no one is analytical and you have a lot of data

In this way, a handicapper or investor can develop informational asymmetries which grant him the all-important edge. Interestingly, Buffett earned a college scholarship in just this way, as he was the only person to show up to a scholarship committee session and thus earned the scholarship by default because he had no competition.

This is where the quote about Buffett sifting through the Moody’s Manuals company by company, page by page (all ten thousand) comes from, and the famous quote,

I actually looked at every business– although I didn’t look very hard at some

In a similar vein, Warren’s classmates at the Columbia Business School completely ignored the opportunity they had, right in front of them, to learn investing from the premier guru of their era, Benjamin Graham. Instead,

They were a remarkably homogeneous group of men, mostly headed to General Motors, IBM or U.S. Steel after they got their degrees

These young men were being trained to become managers. Meanwhile, Buffett was training to become an owner (and he would later own IBM, while the other two American stalwarts died slow, painful deaths). Or, as Buffett later put it,

U.S. Steel was a good business… it was a big business, but they weren’t thinking about what kind of train they were getting on

Buffett also learned the importance of “swinging at the right pitches”:

You’re not supposed to bet every race. I’d committed the worst sin, which is that you get behind and you think you’ve got to break even that day

Simultaneously, Buffett was realizing the importance of thinking for oneself and not being a mindless trend follower. Granted an opportunity to play “the echo” to another trumpeter in the school band, Buffett found himself in a confusing and embarrassing situation in which the lead player played the wrong note and Warren didn’t know what to do as his “echo”. The lesson?

It might seem easier to go through life as the echo– but only until the other guy plays a wrong note

He also became enamored with Dale Carnegie and his social system, one of the most important lessons of which he felt was “Don’t criticize, condemn or complain.”

In addition, Buffett studied the biographies of great businessmen such as:

  • Jay Cooke
  • Daniel Drew
  • Jim Fisk
  • Cornelius Vanderbilt
  • Jay Gould
  • John D. Rockefeller
  • Andrew Carnegie

looking for the keys to their “system”.

History repeats itself, or at least rhymes

In Part II we also get a glimpse into the way that early themes and experiences in Buffett’s life replayed themselves as important investments in his later life as the world’s best known and must successful investor. For example:

  • as a child, Buffett sold chewing gum door-to-door; he later successfully invested in Wrigley’s chewing gum
  • as a child, Buffett collected soda bottle caps; he later successfully invested in Coca-Cola
  • as a child, Buffett was obsessed with model trains and always dreamed of owning a train set; he later successfully invested in Burlington Northern railroads
  • as a child, Buffett met Sidney Weinberg, an important figure at Goldman Sachs, during a field trip to Wall St with his father; he later successfully invested in Goldman Sachs
  • as a child, Buffett had a paper route in which he distributed, amongst many other papers, the Washington Post; he later successfully invested in the Washington Post and other dailies

Warren catches the wealth-bug

It was on his trip to the Stock Exchange in New York City in 1940 with his father that Warren first understood the money-making potential of stock investing. Witnessing exchange members who had servants roll custom cigars, Warren realized

the Stock Exchange must pour forth streams of money… he worked with a passion for the future he saw ahead of him, right there in sight. He wanted money

Later, Warren came across a book entitled “One Thousand Ways to Make $1,000” or, in Warren’s mind, how to make a million dollars. This was it. He was going to be a millionaire. The book had hopeful, helpful and optimistic advice that we would all well consider and pay attention to in the event that we become similarly motivated:

the opportunities of yesterday are as nothing compared with the opportunities that await the courageous, resourceful man of today! You cannot possibly succeed until you start. The way to begin making money is to begin… Hundreds of thousands of people in this country who would like to make a lot of money are not making it because they are waiting for this, that or the other to happen

Buffett also learned around this time the power of compounding and decided

If a dollar today was going to be worth ten some years from now, then in his mind the two were the same

Early Buffett investments, and why he made them

Before he had even graduated from college, the young Warren Buffett had made a number of stock and private investments:

  • Cities Service Preferred; bought three shares at $114.75 for himself and his sister, the shares fell and then recovered; Buffett sold at $40/share for a $5 profit, only to watch the shares rise to $202, lessons learned:
    • Do not overly fixate on the price paid for a stock
    • Don’t rush unthinkingly to grab a small profit; it can take years to earn back the profit “lost” through opportunity cost
    • Buffett didn’t want to have responsibility for other people’s money unless he was sure he could succeed
  • Around age 15, Warren had invested in “Builders Supply Co.”, a hardware store owned and operated by his father and his father’s business partner, Carl Falk, in Omaha
  • Around age 15, Warren bought a 40-acre farm for $1,200 that he split the profits of with a tenant farmer; he sold it when he was in college (5 years later) for $2,400
  • Buffett invested “sweat equity” in a paper route which earned him $175/mo in an era when a grown man felt well-paid on $3,000/yr
  • Buffett started a used golf-ball retailing business with a friend, selling golf balls for $6/dozen, through a wholesaler in Chicago named Witek
  • Buffett bought a pinball machine for $25, placed it in a barbershop and recouped $4 in the first day; he went on to purchase 7-8 pinball machines for “Mr. Wilson’s pinball machine company”, learning the principle of capital,  money that works for its owner, as if it had a job of its own
  • 1949, Buffett shorts automaker Kaiser-Frazer, which went from producing 1/20 cars to 1/100 in the market; Buffett saw a trend in the statistics
  • Preparing to enter Columbia, Buffett invested in Parkersburg Rig & Reel, purchasing 200 shares after discovering the company “according to Graham’s rules” in The Intelligent Investor
  • At Columbia, Buffett was invested in Tyer Rubber Company, Sargent & Co. and Marshell-Wells (a hardware company) of which he had jointly purchased 25 shares with his father; Marshell-Wells was the largest hardware wholesaler in the US and traded for $200 but earned $62/share, making it similar to a bond with a 31% yield
  • After visiting with Lou Simpson at GEICO, Buffett dumped 3/4ths of his stock portfolio to buy 350 shares of GEICO, which was trading at 8x current earnings at $42/share and was rapidly growing; Buffett felt his margin of safety was a growing, small company in a large field meaning it had a lot of opportunity ahead of it, especially because it was the lowest cost provider
  • Grief Bros. Cooperage, a barrel maker and Ben Graham stock
  • Philadelphia Reading Coal & Iron Company, selling for $19/share with $8/share worth of culm banks
  • Cleveland Worsted Mills, textile manufacturer selling for less than its current assets of $146/share; the company cut the dividend which was part of Buffett’s investment thesis and he sold the stock in disgust
  • A gas service station, which he bought with a friend for $2,000; the property never made money as they couldn’t entice customers from the nearby Texaco station; Buffett lost his investment and learned the value of customer habit

Related to the theme of early Buffett investments is the course of the young Buffett’s savings and the accumulation of his capital stock:

  • Age 14, his savings totaled around $1,000, “he was ahead of the game… getting ahead of the game, he knew, was the way to the goal”
  • Age 15, his savings totaled around $2,000, much of which was from his newspaper route
  • Age 16, his savings totaled around $5,000 ($53,000 in 2007 dollars), much of it from his pinball and golfball businesses
  • Age 20 (1950), his savings totaled $9,803.70 which was partly invested in stocks, as well as a $500 scholarship and $2,000 from his father for not smoking
  • Age 21, his savings totaled $19,738, he had boosted his capital 75% in a single year and he felt “supremely confident in his own investing abilities”, he also was willing to take on debt equal to a quarter of his net worth, or about $5,000, for total capital of around $25,000

Miscellaneous Buffett lessons

On betting and deal-making in general:

Know what the deal is in advance

What Buffett learned from Graham:

  • A stock is the right to own a little piece of a business
  • Use a margin of safety so the effects of good decisions are not wiped out by errors; the way to advance is to not retreat
  • Mr. Market is your servant, not your master
On influence:

it pays to hang around people better than you are, because you will float upward a little bit. And if you hang around with people that behave worse than you, pretty soon you’ll start sliding down the pole

Buffett’s authorship of the article “The Stock I Like Best” on GEICO attracted the attention of a later financial backer, Bill Rosenwald, son of Julius Rosenwald and longtime chairman of Sears, Roebuck & Co.

Notes – The Snowball, By Alice Schroeder: Part I, Chap. 1-4

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part I: The Bubble, Chap. 1-4

Why Warren Buffett is driven to make money

The first chapter of The Snowball opens with the author interviewing Buffett in his office at Kiewit Plaza. She asks,

Where did it come from, Warren? Caring so much about making money?

Interestingly, Buffett’s response is something of a non-sequitur:

Balzac said that behind every great fortune lies a crime. That’s not true at Berkshire.

Are we supposed to believe this means Buffett is ultimately a moralizer? That he’s driven to make money just to show it can be done in an honest fashion? If so, where does THAT come from? You see, Buffett didn’t answer the question posed to him.

We also learn that Buffett reads voraciously, and that he watches CNBC (on mute, just to get the scroll of news stories and market developments). Every good investor knows CNBC is a bunch of noise, it is not edifying and it is distracting. It’s peculiar that a long-term oriented, value investor like Buffett would make CNBC part of his daily routine.

Buffett travels to Sun Valley, Idaho, July 1999

We begin to see Buffett as a completely self-absorbed individual. As he travels with a contingent of his family (children and grandchildren) to the Allen & Co. “elephant-bumping” retreat in Sun Valley, the man never looks out the window of his G4 and

He sat reading, hidden behind his newspapers, as if he were alone in his study at home

where, apparently, he treats his significant other, Astrid Meeks, in similar fashion, as noted in a later chapter which depicts Astrid as something of a live-in hamburger-making, Coke-delivering otherwise-invisible person who tries not to disturb the Great Warren during his nightly routine of hours of online bridge and conversations with his insurance lieutenant, Ajit Jain, at 10PM at night. Everyone’s entitled to their flaws and interpersonal relationships seem to be one of Buffett’s.

Which is interesting, because he goes to great pains in Sun Valley to be liked by everyone. Buffett

liked few things more than getting a free golf shirt from a friend [Allen & Co.’s president and organizer of the outing]

and he

went out of his way not to be disliked by anyone

Somewhat peculiar juxtaposed social relationships for a man who waxes philosophical about the Inner Scorecard versus Outer Scorecard in life, one being a measure of self as seen by self, the other being a measure of self as seen by others. You’d think neglecting your family while making pains to impress social acquaintances would register on the Inner Scorecard, but no matter.

This isn’t a Beat Up Buffett blog– the man has a lot to teach and I have a lot to learn. I just find these items odd as I read.

The festivities in Idaho are noteworthy because of what an extremely above-average experience it is for the people involved when compared to daily existence for the Average American, let alone the Average Human Being. To wit, after “white water river rafting” down a stream lined with ambulances and quick response teams for safety (and, one might imagine, helicopter gunships for security),

the guests were handed warm towels as soon as they put down their paddles and stepped out of the rafts, then served plates of barbecue

In addition,

Reporters were banned [from covering the outing]… [the various money managers in attendance represented] more than a trillion dollars [in combined wealth under management]

This is unusual company, an elite group within society, wittingly or not. There is nothing wrong with this level of affluence, it’s simply worth mentioning to set Buffett’s life into context– he’s not of us, at least not at this point in his career.

The key scene at Sun Valley is Buffett’s economic-prediction-as-financial-market-lesson-speech in which he lectures the newly minted tech bubble millionaire crowd on economic cycles and sound investing. A few notes:

  • Most people treat stocks like chips in a casino; Buffett sees the chips represent ownership in businesses (entities that create more chips over time)
  • Technology is not a guaranteed win for investors; history is replete with new technologies that made huge improvements in everyone’s standard of living, yet few had made investors rich (ie, the automobile, and the 3,000 original manufacturers that had over time combined into 3 major firms in the US; airline industry, $0 made in the aggregate stock investments in the industry’s lifetime)
  • Valuing is not the same as predicting
  • What you’re doing when you invest is deferring consumption and laying money out now to get more money back at a later time. And there are really only two questions. One is how much you’re going to get back, and the other is when.
  • As interest rates vary, the value of all financial assets change
  • Three ways the stock market can grow faster than the economy:
    • interest rates fall and remain below historic levels
    • share of the economy going to investors as opposed to employees, government, etc., remains above historic levels
    • the economy grows faster than normal
  • Book value: the amount of money that had been put into the business and left there
  • Ultimately, the value of the stock market can only reflect the output of the economy; on average, the return of the stock market is about 6% a year

Buffett also makes reference to “Lord Keynes”; not that it’s a big secret, but I don’t know anyone who isn’t a Keynesian who refers to Keynes that way (with prestige and respect for the State-granted honorific). If it wasn’t obvious otherwise, I’d say this is evidence enough of Buffett being a Keynesian.

Buffett also lives by the rule, “Praise by name, criticize by category.” That’s very Dale Carnegie-esque.

Enter the Munger

In Part I, we’re also introduced to Buffett’s curmudgeonly friend and business partner, Charlie Munger.

Munger is a graduate of Harvard Law School. He also

admired [Benjamin] Franklin for espousing Protestant bourgeois values while living as he damn well pleased

We also learn a curious fact about Munger’s charitable practice, which

took the form of a Darwinian quest to boost the brightest

but often took the form of “noblesse oblige” because he attached many strings to his giving which were “for the recipients own good, because he knew best” (Schroeder’s articulation). Munger and Buffett are famous for their hands-off, passive management approach to their acquired businesses; yet when it comes to charity, Munger is a world-saver who tries to micro-manage things to an almost tyrannical degree. It seems like a mismatch, but, when combined with his love of Franklin’s philosophical pragmatism and his background at Harvard, it fits the egotistical elitist mold quite well.

Munger, like Buffett, reads a great deal, tearing through newspapers and periodicals everywhere he goes. And Munger, like Buffett, seems quite impressed with his father– Munger carries his father’s old briefcase and vacations at his father’s old Minnesota cabin, while Buffett has a shrine-like portrait of his father in his office and claims he’s “never seen anybody quite like him.”

Revisiting the theme of “Why does Buffett watch CNBC?”, Buffett is subscribed to several newsletters about stocks and bonds and he reads the daily, weekly and monthly operating reports of the Berkshire subsidiary companies. For someone with a long-term orientation, it seems puzzling he would be fascinated or concerned with this kind of contemporaneous minutiae, but perhaps his is simply a mind that thrives on volumes of data to create patterns, impressions and meaning.

Finally, when we learn about Buffett’s two scorecards, we also learn that Buffett pays “close attention” to the rankings of the world’s wealthiest people. This standing would appear to reside on the Outer Scorecard which Buffett warns against measuring one’s life against.

Review – How To Win Friends & Influence People

How To Win Friends And Influence People

by Dale Carnegie, published 1936, 1981

A master’s education in properly respectful and efficacious communication

Dale Carnegie’s 1936 classic in interpersonal communication sets the standard in techniques for dealing positively and constructively with others. The book is easy to summarize (the edition I own actually has an end-chapter summary and end-of-section summary-summary of all the major points addressed), so I’ve done that below for quick reference. But Carnegie is an excellent story teller and weaver of parables. This is a book that’s easy to pick up, hard to put down and well-suited to driving the points home in a concrete way that reading the outline by itself just can’t do. Every human being should own and know the principles of this book.

Fundamental Techniques In Handling People

  1. Don’t criticize, condemn or complain.
  2. Give honest and sincere appreciation.
  3. Arouse in the other person an eager want.

Six Ways to Make People Like You

  1. Become genuinely interested in other people.
  2. Smile.
  3. Remember that a person’s name is to that person the sweetest and most important sound in any language.
  4. Be a good listener. Encourage others to talk about themselves.
  5. Talk in terms of the other person’s interests.
  6. Make the other person feel important– and do it sincerely.

How to Win People to Your Way of Thinking

  1. The only way to get the best of an argument is to avoid it.
  2. Show respect for the other person’s opinions. Never say, “You’re wrong.”
  3. If you are wrong, admit it quickly and emphatically.
  4. Begin in a friendly way.
  5. Get the other person saying “Yes, yes” immediately.
  6. Let the other person do a great deal of the talking.
  7. Let the other person feel that the idea is his or hers.
  8. Try honestly to see from the other person’s point of view.
  9. Be sympathetic with the other person’s ideas and desires.
  10. Appeal to the nobler motives.
  11. Dramatize your ideas.
  12. Throw down a challenge.

Be a Leader: How to Change People Without Giving Offense Arousing Resentment

  1. Begin with praise and honest appreciation.
  2. Call attention to people’s mistakes indirectly.
  3. Talk about your own mistakes before criticizing the other person.
  4. Ask questions instead of giving direct orders.
  5. Let the other person save face.
  6. Praise the slightest improvement and praise every improvement. Be “hearty in your approbation and lavish in your praise.”
  7. Give the other person a fine reputation to live up to.
  8. Use encouragement. Make the fault seem easy to correct.
  9. Make the other person happy about doing the thing you suggest.