Revisit the Buffett Partnership in 1957, 1960, 1962 and 1966 - Part II
In 1960, the Dow declined 6.2% whereas the Buffett Partnership advanced 18.6%. The outperformance was a whopping 24.8%. Having been skeptical of the market’s advance in 1959, the Oracle wrote the following to his investors in the 1959 letter.
“The Dow-Jones Industrial Average, undoubtedly the most widely used index of stock market behavior, presented a somewhat faulty picture in 1959. This index recorded an advance from 583 to 679, or 16.4% for the year. When the dividends which would have been received through ownership of the average are added, an overall gain of 19.9% indicated for 1959.
Despite this indication of a robust market, more stocks declined than advanced on the New York Stock Exchange during the year by a margin of 710 to 628. Both the Dow-Jones Railroad Average and Utility Average registered declines.
Most investment trusts had a difficult time in comparison with the Industrial Average. Tri-Continental Corp. the nation's largest closed-end investment company (total asset $400 million) had an overall gain of about 5.7% for the year.
Massachusetts Investors Trust, the country's largest mutual fund with assets of $1.5 billion showed an overall gain of about 9% for the year.
Most of you know I have been very apprehensive about general stock market levels for several years. To date, this caution has been unnecessary. By previous standards, the present level of ‘blue chip’ security prices contains a substantial speculative component with a corresponding risk of loss. Perhaps other standards of valuation are evolving which will permanently replace the old standard. I don't think so. I may very well be wrong; however, I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a "New Era" philosophy where trees really do grow to the sky.
To the extent possible, I continue to attempt to invest in situations at least partially insulated from the behavior of the general market.”
In this letter, Buffett shrewdly pointed out the divergence he observed: The Dow advanced 16.4% while more stocks declined than advanced on the NYSE during 1959. This divergence suggested that the advance was probably led by a small group of stocks, or in this case, very likely the “blue chip” securities. This divergence suggests another way that Buffett looks at the general market. It is widely known that one of his favorite metrics to use to value the general market is total cap as a percentage of GNP. However, by looking at the components that make up the exchange, we can also get a good sense of the market condition. In the case of 1959, the divergence observed by Buffett should serve as a cautious sign for investors.
I don’t know whether the portfolio allocation decision Buffett made leading up to 1960 was due to anticipation of a decline in the general market or not but at the end of 1959, there was a particularly large position that made up 35% of the portfolio. This is a workout that should be uncorrelated to the market movement.
“Last year, I mentioned a new commitment which involved about 25% of assets of the various partnerships. Presently this investment is about 35% of assets. This is an unusually large percentage, but has been made for strong reasons. In effect, this company is partially an investment trust owing some thirty or forty other securities of high quality. Our investment was made and is carried at a substantial discount from asset value based on market value of their securities and a conservative appraisal of the operating business.”
As some of the readers know, this investment was Sanborn Map. The readers can get the details in the 1960 letter. Essentially, Sanborn Map is a stock that was trading around $45 per share and had an investment portfolio worth about $65 per share. Sanborn Map also had a declining, yet still profitable map business that was earning less than $100,000 or less than $1 per share (Sanborn had 105,000 shares outstanding).
To unlock the value of Sanborn Map, Buffett practiced what nowadays called activism, joined by his friends Walter Schloss, Fred Stanback and Henry Brandt. In the end, he purchased enough shares to effective take control of the company and Sanborn Map exchanged a portion of the investment portfolio for company shares. As part of the deal, the Buffett partnership tendered all their shares.
It is worth noting that the Sanborn Map investment is different from National American in that Sanborn Map’s business quality and earnings power were much worse than those of National American. However, Sanborn’s asset value provides better protection as the investment portfolio could be readily liquidated.
Although in both cases, Buffett made a lot of money for his investors, often overlooked was the amount of effort he put into both Sanborn Map and National American. In the case of National American, he and his partner Dan had to go to the countryside to first find out who may own the shares and then to ask every possible shareholder to sell them their shares. In the case of Sanborn Map, he almost went on a proxy fight in order to unlock the value.
Neither investment would turn out as good as they were if not for the tremendous amount of hard work Buffett put in. Many Buffett followers know that his early career involved buying cigar-butt type of companies, but I wonder how many of us think about the fact that he went extra miles by doing whatever he needed to do in order to take control of the companies he invested in so he could unlock the value. The classic Ben Graham approach, combined with his determination and persistence, contributed to his early successes.
To be continued.