When re-reading Buffett’s earlier partnership letters, I came up with the idea of compiling a few examples of investments Buffett made with different styles. My goal was to study these examples in order to have a deeper understanding of the investment preaching by the Oracle such as, “It’s far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.”
It was not an easy task because limited availability of data. However, when I am finally done with this task, I felt all the efforts were absolutely worthwhile. In this article, I will share with the readers four cases studies of Buffett’s earlier investment career. My hope is that after reading this article, you will be able to appreciate Buffett’s investment wisdom on another level.
Case I - American National Fire Insurance
American National Fire Insurance is a stock Buffett invested in the very early years of the Buffett’s Partnership. According to Alice Shroeder:
“Warren Buffett (Trades, Portfolio) discovered National American while working at Buffett-Falk, flipping through the Moody’s Manual. This company’s worthless stock had been sold to farmers all over Nebraska in 1919 by unscrupulous promoters in exchange for the Liberty Bonds issued during World War I. Since then, its certificates had lain crumbling in drawers, while their owners gradually lost hope of ever seeing their money again. National American was earning $29 per share. Thus, as with the rarest and most attractive of the cheap stocks that Warren stalked, he could pay virtually the entire cost of buying a share of stock out of one year’s profits from that single share. National American was the cheapest stock Warren had ever seen—except for Western Insurance. And it was a nice little company, too, not a soggy cigar butt.
The first year Warren paid $35 each for five shares of the stock. The farmers’ ears pricked up. Now they realized that buyers were competing for the stock; they began to think maybe they weren't better off without it. The price had to keep moving up.
'Finally, toward the end, I paid a hundred. That was the magic number, because it was what they’d paid in the first place. A hundred bucks, I knew, would bring out all the stock. And sure enough, one guy came in when Dan Monen was doing this and he said, ‘We bought this like sheep, and we’re selling it like sheep.’”
In this case, Buffett bought a very illiquid but high quality insurance company whose stock has moved in 10 years. The insurance company has a great capital allocator. There are assets protections for the downside. At $35 a share,which was the price Buffett initially paid, it is trading at a little more than 1 times earning and less than 30% of the book value. Even at $100 a share, the stock is only 3.5 times earnings and 75% of book value for a high-quality insurance company. This is unbelievable. I could not find the return on this investment but based on the numbers, National American sure looked like a slam dunk.
Lesson: If you can find a small or micro-cap great company with a shrewd capital allocator, load up.
Case II- Sanborn Map
Sanborn Map was trading at around $45 per share and had an investment portfolio worth about $65 per share. It was in a declining but still profitable business. The map business had deteriorated considerably before Buffett’s purchase. So this is a company that has high margin, high return on equity, but negative growth. The main thesis is the investment portfolio, which can be easily liquidated. It was sort of like buying a real dollar bill for 60 cents.
But the problem, which some investors today still face today in the case of pure assets play, is that as long as the asset value is not unlocked through corporate actions, your money is dead money. You don’t know how long your capital will be tied up.
To unlock the value of Sanborn Map, Buffett had to purchase enough shares to effectively take control of the company. Its similar to the present-day activism. Due to his influence, the board of directors at Sanborn Map agreed to exchange a portion of the investment portfolio for company shares. As part of the deal, the Buffett partnership tendered all their shares.
Lesson: If a declining yet profitable business with balance sheet protection is appealing to you, think twice before you invest. Without corporate action, the asset's value itself is seldom a good reason to buy a stock.
Case III - Dempster Mill
Dempster Mill was a windmills and water irrigation systems maker in Beatrice, Neb. Buffett accumulated a good amount of Dempster Mill when It had book value of $72 per share and price of $18 per share, or 25% of book value. Over the next few years, he continued to accumulate shares at prices significantly below book value and eventually he owned 70% of the stock with another 10% held by a few associates by August 1961. At the end of 1961, Dempster Mill represented more than 20% of the Buffett Partnership’s portfolio. This time, the Oracle was in trouble: Dempster Mill’s business condition was rapidly deteriorating, and it kept hemorrhaging cash. In the end he had to seek help from Charlie Munger (Trades, Portfolio). Munger referred to Buffett as a great turnaround expert, who eventually successfully turned the business around, and made a lot of money.
Lesson: Time is the enemy of a poor business. Buying a cigar-butt business based on book value may very well turn out to be a foolish decision.
Case IV: American Express and Walt Disney
In the early 1960s, American Express had gotten into serious trouble due to the oil scandal. American Express wrote De Angelis warehouse receipts for millions of pounds of vegetable oil, which he took to a broker and discounted the receipts for cash. When the news broke, American Express stock fell from $65 in October 1963 to $37 in January 1964. Believing this was temporary, Warren Buffett (Trades, Portfolio) began buying shares and established a 5% stake in American Express for $20 million, which worked out really well for him.
A similar case is Buffett’s investment in Walt Disney Company. Here Buffett said:
“We bought 5% of the Walt Disney Company in 1966. It cost us $4 million dollars. $80 million bucks was the valuation of the whole thing. 300 and some acres in Anaheim. The Pirate’s ride had just been put in. It cost $17 million bucks. The whole company was selling for $80 million. Mary Poppins had just come out. Mary Poppins made about $30 million that year, and seven years later you’re going to show it to kids the same age. It’s like having an oil well where all the oil seeps back in....in 1966 they had 220 pictures of one sort or another. They wrote them all down to zero – there were no residual values placed on the value of any Disney picture up through the ‘60s. So (you got all of this) for $80 million bucks, and you got Walt Disney to work for you. It was incredible. You didn’t have to be a genius to know that the Walt Disney company was worth more than $80 million. $17 million for the Pirate’s Ride. It’s unbelievable. But there it was. And the reason was, in 1966 people said, ‘Well, Mary Poppins is terrific this year, but they’re not going to have another Mary Poppins next year, so the earnings will be down.’ I don’t care if the earnings are down like that. You know you’ve still got Mary Poppins to throw out in seven more years…I mean there’s no better system than to have something where, essentially, you get a new crop every seven years and you get to charge more each time…I went out to see Walt Disney (he’d never heard of me; I was 35 years old). We sat down and he told me the whole plan for the company – he couldn’t have been a nicer guy. It was a joke. If he’d privately gone to some huge venture capitalist, or some major American corporation, if he’d been a private company, and said ‘I want you to buy into this’...they would have bought in based on a valuation of $300 or $400 million dollars. The very fact that it was just sitting there in the market every day convinced (people that $80 million was an appropriate valuation). Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street.”
Both American Express and Walt Disney worked out extremely well for Buffett.
Lesson: It is far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price. This is the holy grail to superior investment return.
Although Buffett made money in all four cases, the amount of money he made differed vastly. Sanborn Map and Dempster Mill are prime examples of the Graham approach. They worked for Buffett, but it took him considerable pain to unlock the asset value. National American is a great example of buying a small, unfollowed great business before the quality of business becomes obvious to the general public. It may be hard to accumulate the shares of such businesses but the reward is well worth the trouble. Needless to say, American Express and Walt Disney contributed to Buffett’s thinking enormously. The big money is made by buying wonderful businesses at wonderful prices. Even if you didn’t pay a fair price, the investment will work out okay. As Tom Gayner (Trades, Portfolio) said, if you had purchased American Express the day before Buffett’s purchase and held it through today, your return is not that much different from Buffett.
Let me end with two quotes from Buffett. I get a better understanding of them with each passing day:
“By buying assets at a bargain price, we don't need to pull any rabbits out of a hat to get extremely good percentage gains. This is the cornerstone of our investment philosophy: ‘Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.’”
- 1962 Letter
“Interestingly enough, although I consider myself to be primarily in the quantitative school (and as I write this no one has come back from recess - I may be the only one left in the class), the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a "high-probability insight". This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side - the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.”
– 1967 Letter