The young investor decided to take advantage of the company's distressed share price following the Salad Oil Scandal.
Explaining this trade to students at the University of Notre Dame in a series of lectures in the spring of 1991, the CEO of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) noted that, at the time, American Express had a field warehousing company that was a tiny little subsidiary with $12 million in capital.
The subsidiary's job was to certify that inventories really existed before owners could then borrow against the certification the business issued. A fraudster named Tino De Angelis decided to try and take advantage of the process by filling tanks with water and then a thin layer of salad oil. American Express fell for it and, as Buffett explained in 1991, "at one time, they were authenticating the existence of more salad oil than the Department of Agriculture, in its monthly reports, was saying existed in the United States."
Eventually, in 1962, the scam blew up and several companies went bankrupt as a result. "All of a sudden, they've got this little subsidiary, not the parent company, but the subsidiary, that was on the hook for tens and tens of millions of dollars, and nobody knows how much," Buffett said.
This was a problem not just for American Express, but for all of its owners as well. As Buffett went on to explain:
"There was one other little wrinkle which was terribly interesting. American Express was not a corporation. It then was the only major publicly traded security that was a joint stock association. As such, the ownership of the company was assessable. If it turned out that the liabilities were greater than the assets, [then] the ownership was assessable. So every trust department in the United States panicked. I remember the Continental Bank held over 5% of the company and all of a sudden not only do they see that the trust accounts were going to have stock worth zero, but it could get assessed. The stock just poured out, of course, and the market got slightly inefficient for a short period of time."
Despite these issues, Buffett could see value in the stock. He was particularly interested in the company's credit card and travelers checks business, which was untouched by the salad oil scandal.
Buffett was able to buy 5% of the company for $20 million, valuing the business at $150 million. This was completely out of wack with what the company was worth, Buffett went on to explain:
"The whole American Express Company, synonymous with financial integrity and money substitutes around the world. When they closed the banks, when Roosevelt closed the banks, he exempted American Express Traveler's Checks, so they substituted as U.S. currency. It was not a business that should have been selling for $150 million, but everyone was terrified."
The company shouldn't have been worth $150 million -- that's something Buffett says most people understood -- but the market was just too scared to own the stock. He placed the total value of compensation from the salad oil scandal at somewhere between $60 million and $100 million, a considerable sum, but not enough to bankrupt the business.
This was just one of a handful of landmark trades in Buffett's career. But as he went on to explain in 1991, you only need a handful of big trades throughout your investment career to be a successful investor. All you've got to do is find one, two or three highly exceptional businesses in a lifetime, "load up" when they're cheap and make sure you sit on your hands.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
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- Charlie Munger: An 'Idiot' Can Run Berkshire
- That Time Buffett Issued Stock to Buy Diamonds
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