Case Study: Buffett's 50% Edge Against the Dow in the 1950s

Lessons of idea generation and research from an early Buffett investment

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Nov 23, 2019
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Warren Buffett (Trades, Portfolio) has famously said that if he were managing a small sum such as $1 million, he could guarantee that he would generate an annual compounded rate of return of over 50%. He also said that the best decade for him was the 1950s, when he was earning 50%-plus returns with small amounts of capital. In a letter to Andrew Kilpatrick, author of the book "Of Permanent Value,"Buffett actually wrote the following:

The records I started keeping at the end of 1950, just prior to taking Bens class, when my investment philosophy was about to experience a major change. Starting that year I calculated my results every year compared to those of the Dow. For the decade of the 50s my edge averaged about 50 percentage points per year. Then the base started getting too big.

Well, I dont aspire anything close to Buffetts 50% edge over the Dow for a decade. But I am extremely interested in drawing some lessons from Buffett's best period. Kilpatricks book offered some very good information.

For the year of 1951, Buffetts investment return was 75.8% versus 21.3% for the Dow. Kilpatricks book contains a detailed breakdown of the portfolio at year-end 1950 and 1951.

An obvious observation was that he was very concentrated in both 1950 and in 1951, as Buffett wrote to Kilpatrick: The first page of my journal of 1950. As you can see, I was rather heavily concentrated in one stock (which I unloaded in a couple of months)."

In 1951, he put almost 53% of his total assets in Geico, 14.6% in Greif Brothers Cooperage A, 10.5% in Timely Clothes, 10.3% in Thor Corp. and 8.8% in Baldwin Co. The five largest holdings accounted for 97% of his portfolio. That was expected. GEICOs stock rose more than 100% in the 15 months after Buffett wrote an article about it.

Second, he didnt appear to hold the largest positions for a long time, which is consistent with the cigar-butts strategy as the sooner valuation reverts, the better it is for the investors.

The third thing, and this is the most interesting to me, is how he generated the ideas and how he did his research on these companies.

In another famous article dated April 9, 1953 and titled "The Security I like Best," Buffett talked about why he liked Western Insurance Securities common stock at less than twice earnings and a discount of approximately 55% from the 1952 book value:

The management headed by Ray DuBoc is of the highest grade. Mr.DuBoc has ably steered the company since its inception in 1924 has a reputation in the insurance industry of being a man of outstanding integrity and ability. The second tier of executives is also of top caliber. Operating in a stable industry with an excellent record of growth and profitability, I believe Western Insurance common to be an outstanding vehicle for substantial capital appreciation at its present price of about 40.

Readers will notice that in the whole article Buffett didnt mention what his research process was in terms of validating the hypothesis he has developed for the company. Fortunately, Kilpatrick recounted it for us:

During 1951, the Western popped up on Buffetts radar screen. He said he found information about The Western in the back of Moodys Bank and Finance Manual.

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 Westerns 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 this visit, Buffett sold his GEICO stock and put 50% of his net worth in Western Insurance Securities stock.

What Buffett did was a combination of the following:

  • Developing a hypothesis regarding the competitiveness of the business and the management team, which was the underlying driver of the excellent business performance.
  • Validated his hypothesis through both the financial numbers as well as doing the scuttlebutt work.
  • Buffett was aware of what his blind spots might be and he worked hard at removing them, such as speaking to Westerns competitors.
  • Only after he had validated his hypothesis did he put 50% of his net worth in Western.
  • He also built a feedback mechanism by writing a journal, detailing his thoughts and actions.

This is well-deserved success. Buffett did it over and over again in his early career. Sure, some of the early investments looked ridiculously cheap, but it doesnt mean they are actually cheap. What most investors fail to appreciate is how hard he worked at the scuttlebutt part of the research and how diligently he worked to remove his blind spots.


Many investors are working with small sums, but few have achieved the rate of return Buffett was suggesting. The Western case clearly shows that both the idea generation and the due diligence require lots of work to achieve 50% a year. Even in the 1950s, when it was arguably an easier time, Buffett worked really hard to find an idea and validate his hypothesis. Investors who cant, or are unwilling to commit the time or effort, are better off lowering their expectations.

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A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.