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How Buffett Crushed the Dow in 1951 - Lessons for Investing With Small Sums

February 25, 2014 | About:
Grahamites

Grahamites

114 followers

Warren Buffett (Trades, Portfolio) has famously said the following statement:

"If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."

I am sure every investor wants to find out how would he make 50% a year guaranteed. A logical starting point is his rates of return as well as portfolio details in the 1950s. Unfortunately there is extremely limited information out there with regards to his return and portfolio composition. Therefore, I was delighted to find the following information from Andrew Kilpatrick's book "Of Permanent Value." The following information was contained in a letter Warrren Buffett wrote to Andrew Kilpatrick in 2001. This table shows the details of his investment from 12/31/1950 to 12/31/1951. Let's take a look:

12/31/50

Buffett & Co. $591.20

Selected Industries (1200@3 1/8) 3,750.00

U.S & International Securities (700 @ 4 1/8) 2,887.50

Parkersburg Rig & Reel ( 200 @13) 2,600.00

Total $9,828.70

Less Loss on Interest in Marshall Wells (12 ½ @198) 25.00

Net Assets $9,803.70

12/31/51

Buffett-Falk & Co. $292.63

Dividends receivable 140.00

Government Employees Insurance (350 @ 37 ½) 13,125.00

Timely Clothes (200@13) 2,600

Baldwin Co. (100@22) 2,200.00

Greif Brothers Cooperage “A” (200@18 ¼) 3,650.00

Des Moines Railway 5’s -1955 (2000@33) 330.00

Thor Corp. (200 @12 ¾) 2,550.00

Total: $24,876.63

Less Bank Loans : $5,000.00

Loss on interest in Cleveland Worsted Mills (25@95) 150.00

Total Deductions : $5,150.00

Net Assets: 19,737.63

Net Increase in Investment Account $9,933.93

Less: Capital Additions 2,500.00

Net Gain from Investments: 7,433.93

Percentage Gain on 12/31/50 Net Assets : 75.8%

Dow-Jones Industrials 12/31/51: 269.23

Dow-Jones Dividends – 1951: 16.34

Total:285.57

Less: Dow-Jones Industrials 12/31/50: 235.41

Gain in Dow-Jones Industrials:50.16

Percentage Gain on 12/31/50 Dow-Jones Industrials 21.3%

Wow! Buffett did kill the Dow in 1951 with a return of a mind-blowing 75.8% versus the Dow's 21.3%.

Here are a few observations:

  1. Buffett put more than half of his net assets in GEICO after he found out that Ben Graham was heavily invested in it and after he spent a few hours with Lorimer Davidson.
  2. His next four largest positions such as Thor Corp and Timely Clothes made up 9% to 15% of his portfolio.
  3. Together, his five largest holdings accounted for a whopping 97% of his portoflio.
  4. Buffett's 75.8% return is leveraged as he borrowed $5,000 in 1951, probably to finance the Geico purchase.
  5. None of the year-end 1950 holdings were included in the year-end 1951 holdings, implying that Buffett flipped them within a year.
  6. This doesn't include his short position in Kaiser-Frazer, which you can find more detailes in Alice Shroeder's "Snowball."

I think the following lessons offer some foods for thought:

  • Bet big when the odds are extremely in your favor, such as Buffett's investment in GEICO. But only if you have done enough scuttlebutt work on your own and the investment is within your circle of competence. A related topic, which will require another full article, is the concept of expected return.
  • This may sound controversial, but It is okay to use some leverage when the odds are good. Both Buffett and Munger used leverage in their early investment life. Especially when you are still young and have nothing to lose. But his lesson only applies to intelligent investing, not to speculation and gambling alike.
  • You don't have to hold a stock for five to 10 years just to prove you are long-term oriented. Mohnish Pabrai (Trades, Portfolio) once said something like for most of us, the stocks that can make us 50% a year will likely not take that long to get us the results. Of course if you prefer quality and are satisfied with a 10% to 15% annual compounded return, a longer time horizon may work better.

Rating: 4.9/5 (35 votes)

Voters:

Comments

therealcytrix
Therealcytrix - 5 months ago

Is there a possibility to get annual reports of one of these companies at that time?

Grahamites
Grahamites premium member - 5 months ago

It would be very difficult, if not impossible. I can only find some information on Timely Clothes.

AlbertaSunwapta
AlbertaSunwapta - 5 months ago

A Timely Clothes discussion...

http://www.lib.rochester.edu/index.cfm?page=947

"Annual reports, 1921-1963 (several years missing)."

haoafu
Haoafu - 5 months ago

In the book "Davis Dynasty", the famous value investor Davis also borrowed money to invest in small insurance companies(very very undervalued) whe he first started.

AlbertaSunwapta
AlbertaSunwapta - 5 months ago

So, for us retail investors, are there any small publicly traded companies operating today in anyway similar to the way Buffett did when he had a small amount of capital?

Grahamites
Grahamites premium member - 5 months ago

I think the answer is yes, there are more publicly traded micro cap companies today than it was at Buffett's time and it's unlikely that many people follow them. For example, Meade Instrument, which is a micro cap company that I have followed for a while, went to as low as below $1.5 and you can clearly tell it was absurdily cheap and it even disclosed that someone is interested in buying them for a much higher price. But it was so illquid and unheard of. You can also follow Oddball's website. He's got some awesome small or micro picks.

softdude2000
Softdude2000 - 5 months ago

Is it possible to get a loan from a bank at reasonable rate(same as margin cost at brokerage firm) to invest in stocks? I dont like buying on margin because I am worried temporary/momentary crash could create crazy situations. I think using other source not directly connected to stock market could be safer than margin account. Any thoughts?

itzarjuna
Itzarjuna premium member - 5 months ago

Great Article.Grahamites, Thanks for sharing.

Softdude2000, My friend told me you could take a loan on your 401k and the interest you pay goes back to your own 401k . you just pay 5% flat fee. You can check that.

robintan
Robintan premium member - 5 months ago

Great stuff , thks

jimsinegal
Jimsinegal - 3 months ago

Were most of these companies small cap at the time? Any larger firms among them?

Evan Bleker
Evan Bleker - 3 months ago

Really great to see this article. I'm going to have to pick up the book.

Yeah, Buffett was investing far differently than he is today. A lot of people say he "woke up" to great companies and improved his investing style by moving away from Graham towards Fisher/Munger. I guess this is right so long as an improved investing style means achieving lower returns...

For people investing less than $10M, buying Ben Graham stocks is a far better way to make money.

www.netnethunter.com/have-you-been-sucked-into-the-warren-buffett-trap/

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