Someone who reads my articles sent me this email:
In the last Berkshire meeting somebody asked: “I am 26. If you were me and had the chance to start over, what areas would you like to get into and do you think that my generation has the same number of opportunities as yours?” Warren: “I think you have all types of opportunities. I would very much do what I did, start earlier, and do it a little better. I would try to develop an audited record of performance as early as I could. I would try to get something a lot more interesting, buying companies to keep. I establish relationships with people, I want to be for keeps. That’s been enormously satisfying, but it takes some capital to get into that business. I built it through managing money for myself and others. I would get past that as fast as I could then buy businesses, then spend the rest of my life doing it.”
When he said: “I would get past that as fast as I could then buy businesses” (seems like he doesn’t enjoy managing money that much), I understand it as I would buy net-nets until I got enough money to buy a business that would let me snowball. Is that what you think?
No. That’s not exactly what I think. Net-nets can snowball. You just have to keep flipping them. And not everything Buffett did in his partnership years was a net-net. He owned a lot of Disney (DIS). And he bet huge on American Express (AXP).
Warren Buffett was trained by Ben Graham. Ben Graham ran a fund called Graham-Newman. And Graham-Newman didn’t just do net-nets. In fact, if you look at the portfolio of Graham-Newman the top heaviness of the portfolio would surprise you. Graham-Newman bought everything it thought was a bargain. So it had an insane number of stocks.
The median position size was tiny. But there were often about five stocks or so at the top of the portfolio that were big. Never as big as what Buffett would later do. But they were big.
Some were special situations. But others were controlled companies. Graham-Newman did a little capital redeployment. Kind of what might be called activism today. And that had an influence on Buffett. Although I think he learned from others by watching them in his partnership years.
Buffett doesn’t mean net-nets don’t snowball. He really didn’t buy many companies at all until after the partnership years. So, we’re talking about 15 years of just investing in stocks – not buying whole companies.
That’s the part Buffett would shorten. You said it sounded like he didn’t like managing other people’s money. That’s true. He quit that. And you can tell in the last letters he wrote during the partnership that he loved owning businesses. He loved the idea of Berkshire Hathaway (BRK.A)(BRK.B). He loved businesses as enduring things rather than stocks you flipped.
But there’s a lot of money in flipping stocks. And he made a lot of money flipping stocks. Both Graham-Newman (where Buffett trained) and the Buffett partnership made money by getting in and out of some stocks in a couple years at big gains. That is a good way to make money.
It’s not much fun. It is more fun to buy and hold. Buffett did things like “workouts.” These are special situations. Some were arbitrage. Two were pretty much liquidations. They were not pleasant experiences for him. One was awful. He hated the Dempster Mill experience.
So I’m sure he wanted to own businesses like Disney and American Express rather than Dempster Mill and Sanborn Map. Now, actually that’s not exactly what he ended up doing. He actually ended up getting stuck in Berkshire Hathaway. And Berkshire Hathaway was basically just another Dempster Mill. But, over time, he tried to turn it into something else.
A lot of people overestimate the extent to which Buffett switched strategies for purely rational reasons. He did it for emotional reasons. Not just rational ones. Net-nets wouldn’t last forever. He got too big for them. But he didn’t get too big for running a partnership.
And Buffett was earning 25% of the profits on his partners’ capital. He gave that up when he wound up the partnership. That doesn’t make rational sense. If all he wanted was to be as rich as possible – he wouldn’t have done that.
So, why did he do it?
Buffett’s been very honest about this. People just keep imagining other motives. He didn’t love running a partnership. He hated dealing with situations like Dempster Mill. He’s not a natural activist investor.
He wants to buy for keeps. He likes things to stay the same. He doesn’t like change. None of this is a secret. But it seems like stuff a rational investor shouldn’t let color his judgment. Well, Buffett let it color his judgment.
Buffett quit the game hedge funds play when he was in his 30s. It wasn’t a game he wanted to play anymore. Stocks were too expensive. And he was too focused on beating his benchmark every year. He put that pressure on himself.
By building Berkshire he changed the rules of the game. He made it easier to focus on the long term. He made it harder to be just another fund.
That’s what he wanted to do. And he didn’t have rational reasons for that. He had emotional reasons. Personal reasons. That’s the life he wanted. And it didn’t really exist. So he had to create it for himself.
So the whole thing about snowballing versus net-nets – I think that’s something people keep putting on Buffett when that’s not really a distinction he would draw. Yes, he grew up buying net-nets. But it’s not like that’s the only strategy he can imagine for earning very high returns.
Buffett has done arbitrage over the years. His returns were good. Unleveraged returns – when he wrote about his arbitrage record in the 1980s – had been in the 15% to 25% range. And Buffett liked to add a little leverage to arbitrage. Not to anything else. But he felt you could leverage up special situations.
So when people write about Buffett saying he could – on very small amounts of capital – earn 50% a year, they assume he means net-nets.
Maybe. Maybe not. He could mean arbitrage. Buffett’s approach wasn’t exactly Graham’s approach. He always bet bigger. This is something that isn’t talked about enough.
Buffett had a personal portfolio when he took Ben Graham’s class. And when he worked at Graham-Newman. He didn’t just hold what Graham-Newman held. Instead, he focused on just a few stocks.
At one point, he had 75% of his personal portfolio in GEICO. That’s at a time when Graham would say it wasn’t exactly a value stock anymore. It was cheap. But it was cheap in the way a good, growing business is cheap. Not in the way a cigar butt is cheap.
Buffett brought some ideas to Graham – and sometimes Graham passed. When that happened, Buffett was willing to bet big on the stocks he believed in most.
Later, in the same email you mention Union Street Railway:
My doubt comes when he states “I would do very much what I did.” But what he did in his earlier career (according to Alice Schroeder) insider trading, is illegal today. So he wouldn’t really be able to do what he did. Like talking to the management of Union Street Railway, figure out the dividend and load up.
I don’t agree. He couldn’t do exactly what he did. But management wouldn’t say exactly what they said. He could do something similar to what he did. Very similar.
I’ve done – on a very small scale – some things similar to what you’re talking about. For example, I bought shares of a company called Bancinsurance. When did I buy shares? When the SEC investigation was dropped.
Why did I buy shares then?
You might think I wanted to decrease the risk by waiting for the investigation to end. Actually, I was trying to increase the reward. The stock was cheap. And majority owned. I had no idea what would happen. But I thought I knew it wouldn’t happen during the investigation.
I had zero inside info. And I’m a lot dumber than Warren Buffett. After the going private transaction was agreed to – the company filed a report with the SEC explaining the history of the deal.
If you read that report, you might think I was clairvoyant. I wasn’t. It was just an illiquid stock. In a super liquid – super cheap stock – analysts and others would’ve made a big deal of the investigation being dropped as opening up all sorts of new possibilities. Since this stock was so illiquid I could barely get the shares even when I was always bidding for them – you can imagine the investigation being dropped didn’t move the stock price.
It did, however, change the reality of the situation. Because although it had never been made public – there had been a buyout considered in the past. It was dropped because the board decided they weren’t going to touch that issue while there was an SEC investigation. That makes sense. And anyone who’d been following the stock since the bail bond insurance debacle – a few years before – would’ve seen this as a turning point. Something that grabbed your attention. It certainly grabbed mine.
Buffett followed obscure stocks really closely in his early days. And the Internet makes it easy to do that today. Inside information is overrated. Because a lot of it can be guessed at.
In micro caps, it’s not impossible to guess there will be activism before there’s activism. Because you can – and I do – look up the names of shareholders as soon as they reach 5% of the shares outstanding.
Warren Buffett liked “coattail” riding in his early days. Well, that’s real easy in micro caps today. And you can still make money from it.
I owned a stock called Sanjo Machine Works in Japan. I didn’t buy it because of its shareholders. I just got lucky. It had a big shareholder. And that shareholder was a fund focused on working constructively with the management of public Japanese companies. Through that fund’s effort – the fund is called Symphony – Sanjo was taken private. The return was over 125%.
I don’t buy the argument that Buffett couldn’t invest as well with a couple million dollars today as he did in the 1950s. There are places – like Japan – that are cheaper than much of the market Buffett was investing in.
There are incredible information sources out there. Buffett would read the stock manuals. He knew more about really obscure stocks than anybody else. You can do that today. And you can make money doing it. That’s how he’d get started.
Would he keep doing that?
No. Because that’s not what he loves. That’s what Ben Graham taught him. And that’s how he grew his personal portfolio. And that’s how he started the partnership. But even before he wrapped up the partnership he was investing in companies like Disney and American Express.
He bet huge on GEICO – put 75% of his portfolio into the stock – based only on the confidence of talking to management for a few hours one weekend. By all accounts, the only info he got then was the business model. It wasn’t anything secret.
Even insiders tend to make their money by just betting big on a senseless drop. It’s more about emotional certainty than having specific time-sensitive information. When you line up insider buying with stock prices – they look a lot like value investors who buy big dips.
Now, Buffett did try to ride coattails. And I encourage you to do the same today. If you find a super cheap micro cap – preferably one with too much cash on the balance sheet – and see an investor who will stir things up buying shares, that’s a stock you might want to bet big on.
There’s a ton of information online. You can piece together a “non-public” interpretation from public data. Not a lot of people read every SEC report on an illiquid stock and cross reference every person’s name, etc.
That’s exactly the kind of thing a young Warren Buffett would be doing today. He’d be using the Internet. And he’d know more about unknown stocks than anybody out there.
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