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Rupert Hargreaves
Rupert Hargreaves
Articles (1231)  | Author's Website |

Learning From Warren Buffett's Early Investment Strategy

A look back at the approach the guru used to analyze businesses in the 1950s

June 29, 2020

After working for a brief period under Benjamin Graham, when he was managing his hedge fund, the young Warren Buffett (Trades, Portfolio) moved back to Omaha, Nebraska to start his own investment business.

As the story goes, he didn't deliberately decide to set up an investment business. Upon his return, several wealthy family friends offered the young investor some money to manage and he took it, although he demanded complete autonomy when investing the funds.

Over the next decade, the business went from strength to strength. It was so successful that it turned Buffett into a millionaire by the time he was 30.

Buffett invested the majority of his money alongside his partners, so when he made money, they made money as well. He didn't charge a regular management fee. Instead, the funds had a 6% annual performance hurdle whereby Buffett would only get paid if he earned more than 6%.

Above this level, he took a 25% fee of the profits.

Buffett's investment returns

This strategy incentivized Buffett to do well, and that's just what he did. By following the lessons he had learned from Graham, between 1957 and 1969, he produced a 29.5% annual return for partners before fees. In his best year ever, 1968, the Buffett Partnership returned 58.8% versus 7.7% for the Dow.

The year after, the young investor closed down his investment enterprise. He decided to take this course of action because the number of opportunities available for investment in the market was declining, and it was becoming harder to find attractive value investments.

Buffett's strategy was always based around the principle of finding deeply undervalued securities the rest of the market was missing. To do this, he took a very hands-on approach.

The Oracle of Omaha previously said that he relied on the Value Line reports to identify deeply undervalued securities. But this was just the start of his process. When he had identified companies that looked cheap, the young investor went out and investigated the business, its management, customers and reputation in the community.

Andrew Kilpatrick's book, "Of Permanent Value," described the approach Buffett used to investigate Western Insurance Securities common stock, which he bought at around 2 times earnings and only 55% of book value in 1952:

"In the process of researching The Western, Buffett checked at the Nebraska Insurance Department in Lincoln and then began to contact agents in Omaha who either represented or competed against The Western. Both groups gave favorable reviews. He then went to Kansas City and met with CEO Ray B. Duboc. Duboc shared with Buffett the series of stories about the potential proxy fight and the struggle to maintain control of The Western.

Though Western's home office was in a small town, branch offices existed in larger cities such as Los Angeles, Chicago, Phoenix, Denver, Seattle, Jackson, San Antonio, Salt Lake City, Portland, Omaha, Sious Falls, and Detroit. The financial offices, bond department, and a branch office were located in Kansas City, approximately 80 miles north of Fort Scott. A very personal "family" culture permeated The Western, as one might expect from a company with small town Midwestern roots."

After confirming that the business was well run and undervalued, Buffett reportedly sold his other investments and put 50% of his net wealth in this one company.

Even though Buffett was buying Western before his first partnership launched, this a great case study of his investing approach. He was able to earn such high returns because he was confident investing a substantial portion of his net worth in undervalued securities.

The only way he was able to gain the confidence to invest such a high percentage of his net worth in these businesses was through research. He didn't try and look for any shortcuts in this process. Buffett put in the hard work and effort, and he was rewarded for it with profits.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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