Investing for Beginners
with Joshua Kennon
Warren Edward Buffett was born on August 30, 1930 to his father Howard, a stockbroker-turned-Congressman. The only boy, he was the second of three children, and displayed an amazing aptitude for both money and business at a very early age. Acquaintances recount his uncanny ability to calculate columns of numbers off the top of his head - a feat Warren still amazes business colleagues with today.
At only six years old, Buffett purchased 6-packs of Coca Cola from his grandfather's grocery store for 25 cents and resold each of the bottles for a nickel - making a nice 5 cent profit. While other children his age were playing hopscotch and jacks, Warren was making money. Five years later, Buffett took his step into the world of high finance. At eleven years old, he purchased three shares of Cities Service Preferred at $38 per share for both himself and his older sister, Doris. Shortly after buying the stock, it fell to just over $27 per share. A frightened but resilient Warren held his shares until they rebounded to $40. He promptly sold them - a mistake he would soon come to regret. Cities Service shot up to $200. The experience taught him one of the basic lessons of investing; patience is a virtue.
In 1947, a seventeen year old Warren graduated from High School. It was never his intention to go to college - he had already made $5,000 delivering newspapers [this is equal to $42,610.81 in 2000]. His father had other plans, and urged his son to attend the Wharton Business School at the University of Pennsylvania. Buffett stayed two years, complaining that he knew more than his professors. When Howard was defeated in the 1948 Congressional race, Warren returned home to Omaha and transferred to the University of Nebraska-Lincoln. Working full-time, he managed to graduate in only three years.
The Oracle of Omaha approached graduate studies with the same resistance he displayed a few years earlier. He was finally persuaded to apply to Harvard Business School, which, in the worst admission decision in history, rejected him as "too young". Slighted, and completely surprised, Warren applied to Columbia where famed investors Benjamin Graham and David Dodd taught - an experience that would forever change his life.
Graham had become well known during the 1920's. At a time when the rest of the world was approaching the investment arena as a giant game of roulette, he searched for stocks that were so inexpensive they were almost completely devoid of risk. One of his best known calls was the Northern Pipe Line, an oil transportation company managed by the Rockefellers. The stock was trading at $65 a share, but after studying the balance sheet, Graham realized that the company had bond holdings worth $95 for every share. The value investor tried to convince management to sell the portfolio off, but they refused. Shortly thereafter, he waged a proxy war and secured a spot on the Board of Directors. The company sold its bonds off and paid a dividend in the amount of $70 per share.
When he was 40 years old, Graham published "Security Analysis", one of the greatest works ever penned on the stock market. At the time, it was risky; investing in equities had become a joke [the Dow Jones had fallen from 381.17 to 41.22 over the course of three to four short years following the crash of 1929]. It was around this time that Graham came up with the principle of "intrinsic" business value - a measure of a businesses' true worth that was completely and totally independent of the stock price. Using this 'intrinsic value', investors could decide what a company was worth paying for - and make investment decisions accordingly. His subsequent book, "The Intelligent Investor" [which Warren celebrates as "the greatest book on investing ever written"] introduced the world to Mr. Market - the greatest investment analogy in history [see Investing Lessons for more information on Mr. Market].
Through his simple yet profound investment principles, Graham became an idyllic figure to the twenty-one year old Buffett. Reading an old edition of Who's Who, Warren found out his mentor was the chairman of a small, relatively unknown insurance company named GEICO. Convinced that anything Ben was involved in must be worth knowing about, he hopped a train to Washington D.C. one Saturday morning to find the headquarters. When he got there, the doors were locked. Not to be stopped, Buffett relentlessly pounded on the door until a janitor came to open it for him. He asked if there was anyone in the building. As luck [or fate] would have it, there was. It turns out that there was a man still working on the sixth floor; Warren was escorted up to meet him and immediately began asking him questions about the company and its business practices [a conversation that stretched on for four hours]. The man was none other than Lorimer Davidson, the Financial Vice President. The experience would be something that stayed with Buffett for the rest of his life - he eventually acquired the entire GEICO company through his corporation, Berkshire Hathaway.
Flying through his graduate studies at Columbia, WB was the only student ever to earn an A+ in one of Graham's classes. Disappointingly [and strangely] enough, both Ben Graham and Warren's father advised him not to work on Wall Street after he graduated. Absolutely determined, Buffett offered to work for the Graham partnership for free. Ben turned him down - he preferred to hold his spots for Jews [who were not hired at Gentile firms at the time]. Warren was crushed.
Returning home, he took a job at his father's brokerage house and began seeing a girl by the name of Susie Thompson. The relationship eventually turned serious and in April of 1952 the two were married. They rented out a three-room apartment for $65 a month [it was run-down and served as home to several mice]. It was here their daughter [also named Susie] was born. In order to save money, they made a bed for her in a dresser drawer.
During these initial years, Warren's investments were predominately limited to a Texaco station and some real estate, but neither were successful. It was also during this time he began teaching night classes at the University of Omaha [something that wouldn't have been possible several months before; in an effort to conquer his intense fear of public speaking, Warren took a course on public speaking by Dale Carnegie]. Thankfully, things changed. Ben Graham called one day, invitation the young stockbroker to come to work for him - Warren was finally given the opportunity he had been dreaming of.
Moving to New York, the couple took a house in the suburbs. The Oracle spent his days analyzing S&P reports, searching for investment opportunities. It was during this time that the difference between the Graham and Buffett philosophies began to emerge. Warren became interested in how a company worked - what made it superior to every other in its field. Ben simply wanted numbers [whereas Warren was/is predominately interested in a company's management as a major factor when deciding to invest, Graham looked at the balance sheet only and could care less about corporate leadership]. Between 1950 and 1956, Warren built his personal capital up to $140,000 from a mere $9,800. With this war chest, he set his sights back on Omaha - and began planning his next move.
On May 1, 1956, Warren Buffett rounded up seven limited partners [including his Sister Doris and Aunt Alice], raising $105,000 in the process. He put in $100 himself, officially creating the Buffett Associates, Ltd. Before the end of the year, he was managing around $300,000 in capital. Small, to say the least, but he had much bigger plans for that pool of money. He purchased a house for $31,500 [affectionately nicknamed "Buffett's Folly"] and managed his partnerships originally from the bedroom, and later, a small office. By this time, his life had begun to take shape; he had three children, a beautiful wife, and a very successful business.
Over the course of the next five years, the Buffett partnerships racked up an impressive 251.0% profit, while the Dow was up only 74.3%. A somewhat-celebrity in his hometown, Warren never gave stock tips, despite constant requests from friends and strangers alike. By 1962, the partnership had capital in excess of $7.2 million, of which a cool $1 million was Buffett's personal stake [he didn't charge a fee for the partnership - rather Warren was entitled to 1/4 of the profits above 4%]. He also had more than 90 limited partners across the United States. In one decisive move, he melded the partnerships into a single entity called "Buffett Partnerships Ltd.", upped the minimum investment to $100,000, and opened an office in Kiewit Plaza on Farnam [the same street his house was located on].
Another important event happened in 1962 that changed the direction of everything - a man by the name of Charlie Munger moved back to his childhood home of Omaha from California. Though somewhat snobbish, Munger was brilliant in every sense of the word; he attended Harvard Law School without a Bachelor's Degree. Introduced by mutual friends, Buffett and Charlie were immediately drawn together, providing the roots for a friendship and business collaboration that would last for the next forty years.
Ten years after its founding, the Buffett Partnership assets were up more than 1,156% [compared to the Dow's 122.9%]. Acting as lord over assets that had ballooned to $44 million dollars, Warren and Susie's personal stake was $6,849,936. Mr. Buffett, as they say, had arrived.
Wisely enough, just as his persona of success was beginning to be firmly established, Warren closed the partnership to new accounts. The Vietnam war raged full force on the other side of the world and the stock market was being driven up by those who hadn't been around during the depression. All while voicing his concern for rising stock prices, the partnership pulled its biggest coup in 1968, recording a 59.0% gain in value, catapulting to over $104 million in assets. The next year, Warren went much further than closing the fund to new accounts... he liquidated the whole thing. In May 1969, he informed his partners that he was "unable to find any bargains in the current market". Buffett spent the remainder of the year liquidating the portfolio, with the exception of two companies - Berkshire Hathaway and Diversified Retailing. The shares of Berkshire were distributed among the partners with a letter from Warren informing them that he would, in some capacity, be involved in the business, but was under no obligation to them in the future. Warren was clear in his intention to hold onto his own stake in the company [he owned 29% of the Berkshire stock], but his intentions weren't revealed.
Buffett's role in Berkshire had actually been somewhat defined years earlier. On May 10, 1965, after accumulating 49% of the common stock, Warren named himself Director. Terrible management had run the company nearly into the ground, and he was certain with a bit of tweaking, it could be run better. Immediately Mr. Buffett made Ken Chace President of the company, giving him complete autonomy over the organization. Although he refused to award stock options on the basis that it was unfair to shareholders, Warren agreed to cosign a loan for $18,000 for his new President to purchase 1,000 shares of the company's stock.
Two years later, in 1967, Warren asked National Indemnity's founder and controlling shareholder Jack Ringwalt to his office. Asked what he thought the company was worth, Ringwalt told Buffett at least $50 per share [it was trading at $33 at the time]. Warren offered to buy the whole company on the spot - a move that cost him $8.6 million dollars. That same year, Berkshire paid out a dividend of 10 cents on its outstanding stock. It never happened again; Warren said he "must have been in the bathroom when the dividend was declared".
In 1970, Buffett named himself Chairman of the Board and for the first time, wrote the letter to the shareholders [Ken Chace had been responsible for the task in the past]. That same year, the Chairman's capital allocation began to display his prudence; textile profits were a pitiful $45,000, while insurance and banking each brought in $2.1 and $2.6 million dollars. The paltry cash brought in from the struggling looms in New Bedford, Massachusetts had provided the stream of capital necessary to start building Berkshire.
A year or so later, Warren Buffett was offered the chance to buy a company by the name of See's Candy. The gourmet chocolate maker sold its own brand of candies to its customers at a premium to regular confectionary treats. The balance sheet reflected what Californians already knew - they were more than willing to pay a bit "extra" for the special "See's" taste. The businessman decided Berkshire would be willing to purchase the company for $25 million in cash. See's owners were holding out for $30 million, but soon conceded. It was the biggest investment Berkshire or Buffett had ever made.
Following several investments and an SEC investigation [after causing a merger to fail, Warren and Munger offered to buy the stock of Wesco, the target company, at the inflated price - simply because they thought it was "the right thing to do". Not surprisingly, the government didn't believe them], Buffett began to see Berkshire's net worth climb. From 1965 to 1975, the company's book value rose from $20 per share to around $95. It was also during this period that Warren made his final purchases of Berkshire stock [when the partnership dolled out the shares, he owned 29%. Years later, he had invested more than $15.4 million dollars into the company at the average cost of $32.45 per share.] This brought his ownership to over 43% of the stock with Susie having another 3%. His entire fortune was placed into Berkshire - with no personal holdings, the company had become his sole investment vehicle.
In 1976, Buffett once again became involved with GEICO. The company had recently reported amazingly high losses and its stock was pummeled down to $2 per share. Warren wisely realized that the basic business was still in tact; most of the problem were caused by an inept management. Over the next few years, Berkshire built up its position in this ailing insurer and reaped millions in profits. Benjamin Graham, who still held his fortune in the company, died in in September of the same year, shortly before the turnaround. Years later, the insurance giant would become a fully owned subsidiary of Berkshire.
It was shortly thereafter one of the most profound and upsetting events in Buffett's life took place. At forty-five, Susan Buffett left her husband - in form. Although she remained married to Warren, the humanitarian / singer secured an apartment in San Francisco and, insisting she wanted to live on her own, moved there. Warren was absolutely devastated; throughout his life, Susie had been "the sunshine and rain in my [his] garden". The two remained close, speaking every day, taking their annual two-week New York trip, and meeting the kids at their California Beach house for Christmas get-togethers. The transition was hard for the businessman, but he eventually grew somewhat accustomed to the new arrangement. Susie called several women in the Omaha area and insisted they go to dinner and a movie with her husband; eventually, she set Warren up with Astrid Menks, a waitress. Within the year, she moved in with Buffett, all with Susie's blessing.
By the late '70s, the his reputation had grown to the point that the rumor Warren Buffett was buying a stock was enough to shoot its price up 10%. Berkshire's stock was worth more than $290 a share, and Buffett's personal wealth was almost $140 million. The irony was that Warren never sold a single share of his company - meaning his entire available cash was the $50,000 salary he lived on. During this time, he made a comment to a broker, "Everything I got is tied up in Berkshire. I'd like a few nickels outside."
This prompted Warren to start investing for his personal life. According to Roger Lowenstein's "Buffett", Warren was far more speculative with his own investments. At one point he bought copper futures - which was unadulterated speculation. In a short time, he had made $3 million dollars. When prompted to invest in real estate by a friend, he responded "Why should I buy real estate when the stock market is so easy?"
Later, Buffett once again showed a trait for bucking the popular trend. In 1981, the decade of greed, Berkshire announced a new charity plan which was thought up by Munger and approved by Warren. The plan called for each shareholder to designate charities which would receive $2 for each Berkshire share the stockholder owned. This was in response to a common practice on Wall Street of the CEO choosing who received the company's hand-outs [often they would go to the executive's schools, churches, and organizations]. The plan was a huge success and over the years the amount was upped for each share. Eventually, the Berkshire shareholders were giving millions of dollars away each year - all to their own causes. Another important event around this time was the stock price - it hit $750 per share in 1982, most of the gains attributed to Berkshire's stock portfolio which was now valued at over $1.3 billion dollars.
For all the fine businesses Berkshire had managed collect, one of the best was about to come under its stable. In 1983, Warren Buffett walked into Nebraska Furniture Mart, the multi-million dollar furniture retailer built from scratch by Rose Blumpkin. Speaking to Mrs. B, as local residents called her, Buffett asked if she would be interested in selling the store to Berkshire Hathaway. Blumpkin's answer was a simple "yes", to which she responded she would part for "$60 million". The deal was sealed on a handshake and one page contract was pulled up. The Russian-born immigrant merely folded the check without looking at it when she received it days later.
Scott & Fetzer was another great addition to the Berkshire family. The company itself had been the target of a hostile takeover when an LPO was launched by Ralph Schey, the chairman. The year was 1984 and Ivan Boesky soon launched a counter offer for $60 a share [the original tender offer stood at $50 a share - $5 above market value]. The maker of Kirby vacuum cleaners and World Book encyclopedia, S&F was panicking. Buffett, who had owned a quarter of a million shares, dropped a message to the company asking them to call if they were interested in a merger. The phone rang almost immediately. Berkshire offered $60 per share in cold, hard, cash. When the deal was wrapped up less than a week later, B. Hathaway had a new $315 million dollar cash-generating powerhouse to add to its collection. The small stream of cash that was taken out of the struggling textile mill had built one of the most powerful companies in the world. Far more impressive things were to be done in the next decade. Berkshire would see its share price climb from $2,600 to as high as $80,000 in the 1990's.
In 1986, Buffett bought a $850,000 used Falcon aircraft. As he had become increasingly recognizable, it was no longer comfortable for him to fly commercially. The idea of the luxury was hard for him to adjust to, but he loved the jet immensely. The passion for jets eventually, in part, led him to purchase Executive Jet in the 90's.
The 80's went on with Berkshire increasing in value as if on cue - the only bump in the road being the crash of 1987. Warren, who wasn't upset about the market correction, calmly checked the price of his company and went back to work. It was representative of how he viewed stocks and businesses in general - they were just numbers. This was one of "Mr. Market's" temporary aberrations. It was quite a strong one; fully one-fourth of Berkshire's market cap was wiped out. Unfazed, Warren plowed on. A year later, in 1988, he started buying up Coca-Cola stock like an addict. His old neighbor, now the President of Coca-Cola, noticed someone was loading up on shares and became concerned. After researching the transactions, he noticed the trades were being placed from the Midwest. He immediately thought of Buffett, whom he called. Warren confessed to being the culprit and requested they don't speak of it until he was legally required to disclose his holdings at the 5% threshold. Within a few months, Berkshire owned 7% of the company [$1.02 billion dollars worth of the stock]. Within three years, Buffett's Coca-Cola stock would be worth more than the entire value of Berkshire when he made the investment.
By 1989, Berkshire was trading at $8,000 a share. Buffett was now, personally, worth more than $3.8 billion dollars [within the next ten years, he would be worth ten times that amount.] Before that would happen, there were much darker times ahead. In the early 90's, the reputation Buffett had built was threatened by a renegade trader at Solomon Brothers, where Warren sat on the Board of Directors. The firm had been mired in losses, which seems ludicrous when one considers that there were many, many employees making over $1 million dollars a year [one trader made as much as $23 million].
The real trouble began when the head of Solomon's government bond desk, Paul Mozer, illegally used customer accounts to purchase Treasury bonds on behalf of Solomon. According to the treasury department rules, no individual dealer could be awarded more than 35% of an offering. This stemmed from an occurrence in 1962 when J.P. Morgan's company gained control of 50% of the T-Bills up for auction, giving concern to any one firm being able to "corner" the market. The short of it is, Mozer eventually bid for Treasury bills on behalf of Solomon's own account, as well as two of its major institutional clients, Mercury and Quantum Funds. The notes that were awarded to the two funds were then "sold" to Solomon, allowing Mozer to get around the thirty-five percent rule... he managed to gain 57% of the available T-Bills. Paul attempted to cover his tracks, until the Treasury department sent a "routine housekeeping letter" to an executive at Mercury. Of course, since they had placed a bid to begin with, Mercury called Mozer, who claimed it was a "mistake" and ask they not respond to the Treasury department.
Going to the top of the company, Mozer confessed and promised not to do it again. After consulting with Solomon's attorney, the executives decided not to mention it - they were not legally required to call the SEC and inform them of what happened, although the counsel advised it as the wise thing to do. This would have been fine, and more than likely, no one would have ever found out if it hadn't been for the Mozer's audacity. Shortly thereafter, he repeated his behavior and was awarded 87% of the auction. This sent out of a frenzy among other firms, who claimed Solomon was cornering the market. The SEC eventually got involved, and the executives all fired for covering up the Mozer's behavior. It turns out there had been six different instances of bidding violations. Suddenly finding itself without senior management, and having lost almost all credibility, Solomon needed a savior. The Feds had given word that Solomon's status as a primary dealer was in serious danger. The repercussions would have been massive; the firm would have gone under completely, possibly causing an economic nightmare that would have raced through Wall Street in seconds. With the entire U.S. economy potentially in danger, Warren Buffett boarded his plane and flew to New York. By the end of the day, he was named CEO [Munger, wisely, was completely and totally opposed]. Having Buffett at the helm was like a steroid shot of credibility for Solomon. The risk to his professional life was enormous; indeed, his entire reputation hung on the line. Howie warned his father that "everyone who ever wanted to take a shot at you is going to do it".
As in his operating companies, Buffett wanted the leader identified. Although he was currently the acting CEO, it was important for him to know who would eventually lead the firm after his corporate "CPR" was done. He individually pulled the upper managers into a room and asked them who they thought should run the company.
A few days later, word comes that the Treasury department has banned Solomon from trading. Panic immediately set in; almost all of the $150 billion dollars to the firm's name was financed with short-term assets. If the company couldn't participate in the federal auctions, it would have no choice but to close shop. Buffett pleaded the Federal Reserve, including Greenspan himself, informing them that the lawyers were pulling bankruptcy papers up as they spoke. The conversations ended unresolved. At the same time, Buffett distributed his home phone number to the top managers at Solomon and told them to call if they found any further evidence of dishonest behavior. The move was a brilliant stroke of talent; everything was okay, Warren was in charge.
In the end, Solomon was awarded its trading privileges and Buffett went home, effectively saving the company. [More information on the Solomon case is available in the special documents section at NorthernLights.com].
During the remainder of the 1990's, the stock catapulted as high as $80,000 per share. Even with this astronomical feat, as the dot-com frenzy began to take hold, Warren Buffett was accused of 'losing his touch'. In 1999, when Berkshire reported a net increase of 0.5% per share, several newspapers ran stories about the demise of the Oracle. Confident that the technology bubble would burst, Warren Buffett continued to do what he did best... allocate capital into great businesses that were selling below intrinsic value. His efforts did not go unrewarded. When the markets finally did come to their senses, Warren Buffett was once again a star. Berkshire's stock recovered to its previous levels [after falling as low as $30,000 per share], and the man from Omaha was once again seen as an investment icon.
Copyright © 2001 Joshua Kennon