Buffett

by Roger Lowenstein

  Still, Buffett managed a coup in his first year on the job. In 1954, Rockwood & Co., a Brooklyn chocolate concern, offered to redeem some of its stock in exchange for cocoa beans, of which it had a large inventory. Buffett deduced that trading the stock for beans and simultaneously selling beans on the commodities market—where the price had soared—would produce a huge profit. As he later described it:

  For several weeks I busily bought shares, sold beans, and made periodic stops at Schroeder Trust to exchange stock certificates for warehouse receipts. The profits were good and my only expense was subway tokens.74

  Such a trade, taking advantage of price discrepancies in separate markets, is known as arbitrage. Arbitrage was a staple in the Graham-Newman playbook—but Buffett was a couple of subway stops ahead in terms of spotting the application.

  In fact, Buffett was quicker at everything. Graham would amaze the staff with his ability to scan a page with columns of figures and pick out an error. But Buffett was faster at it. Howard Newman, Jerry Newman’s son, who also worked there, said, “Warren was brilliant and self-effacing. He was Graham exponential.”

  Warren and Susie had rented a garden apartment in White Plains, a suburb. As in Omaha, Warren was watching his pennies. Not long after they arrived, they had a son—christened Howard Graham. Though Warren was making a good living now, he borrowed a crib for him.75

  Within their circle of young Wall Street couples, Warren and Susie, for different reasons, were both causing a stir. Roxanne Brandt, whose husband, Henry, was a stockbroker, said:

  They were different from the other young people we knew. They were simpler, or at least they seemed that way. Susie was very interested in why I had not had any children. She drew me out.

  Compared to the stiff, Brooks Brothers culture of the fifties, Warren and Susie were noticeably less formal. At a dinner at the Buffetts’, after young Howie had begun to crawl, Roxanne Brandt had a sense of “kids and toys all over the place.” The Buffett children weren’t “put away” like children at Manhattan dinner parties; they were part of the evening.

  What interested Henry Brandt, who had graduated at the top of his Harvard Business School class, was that Buffett knew more about stocks than anyone. And he explained them so simply and unassumingly. When the Brandts entertained the Buffetts and other Wall Street couples, the group would settle into a curious ritual. After dinner, the men would go into the den and Buffett would nestle into a comfortable black-and-white-tweed club chair with sturdy armrests. And the other men, who were older than Buffett, would sit on the floor and listen to Buffett talk—demurely explaining the universe, just as he had at fraternity parties. Roxanne Brandt called them “Jesus and the apostles.”

  Graham thought that Buffett was the cream of his disciples76 and recognized a similarity between them. One day, as they were going to lunch at a delicatessen near the office, Graham said, “Money won’t make any difference to you and me, Warren. We’ll be the same. Our wives will just live better.”77

  Graham was a thoughtful boss, and got Buffett a movie camera and a projector when his son was born—a generous gift for an employee of only a few months.78 On Graham’s own birthday, he would give out presents to the employees, figuring that he was the lucky one to have been born.79

  But Buffett doesn’t seem to have worked as closely with Graham as he had hoped.80 In Buffett’s words, Graham “had this kind of shell around him. Everybody liked him. Everybody admired him [and] enjoyed being around him … but nobody got close.”81 The same could have been said of Buffett.

  In any case, Buffett was frustrated at Graham-Newman. The fund had only $5 million in capital, which didn’t leave room for many investments. The partners also ran a private fund, Newman & Graham, but between the two operations, the office was managing only $12 million—a very small sum even then.82 And Graham was so nervous about the stock market that he asked the partners of Newman & Graham to withdraw some of their capital.

  In short, Buffett’s opportunities were limited. At one point, he told Bob Dwyer, his high school golf coach, that he was learning a lot, but also that Graham was “sitting on $4 million, trying to decide when to get back in the market.” It was hardly how Buffett wanted to start his career.

  Ironically, shares of Graham-Newman were in such demand that they traded at a $200 premium to the portfolio value, roughly $1,200. (Many people bought a single share just to see the portfolio.) Had he wanted to, Graham could have turned his operation into a big business. But Graham’s first goal was never to make money—it was to avoid losing any.

  Because of his conservatism, he refused to analyze companies subjectively, preferring to stick to his mathematical guidelines. According to Irving Kahn, an assistant to Graham, when anyone tried to talk to Graham about a company’s products, “Ben would look out the window and get bored.”

  Kahn said Buffett and Graham “argued on this”—a phrase that rings of overstatement, given the temperament of each. But their differences were real. Buffett was interested in what made one business better than another and wanted to pursue it. But Graham, who mistrusted corporate managements, discouraged Buffett from visiting companies.83 And his formulaic approach cost him.

  Walter Schloss tried to get him to buy Haloid, a humdrum photographic business that owned the rights to a technology known as xerography. The stock was at $21, of which Haloid’s ongoing business accounted for about $17. Thus, Schloss figured that for $4 you could take a flier on the Xerox machine. But Graham wasn’t interested in any speculation. He said, “Walter, it’s not cheap enough.”84

  When the market roared ahead, Graham grew more nervous still. In 1955, the Dow hit 420—10 percent above the high of 1929. There was no reason, a quarter century having passed, why it should not have risen. But the old-timers kept looking back to 1929. Congress was so unnerved by the prospect of a bust that it scheduled hearings. John Kenneth Galbraith went before the Senate Banking Committee in March with proofs of his forthcoming study of 1929, The Great Crash—which shocked the market into a sharp one-day swoon. Was the next crash on its way?

  No one knew, but the real purpose of the hearings was not the stated one; it was the desire, recurring in politicians, to get to the bottom of Wall Street. From the time of J. P. Morgan, Sr., each generation had summoned the priests of finance to Washington. When Graham appeared, J. William Fulbright, the committee chairman, was all too cognizant that he had the era’s preeminent stockpicker on the stand. Eager to unearth his secrets, Fulbright inquired about every aspect of the trade. At times, he sounded like a man about to call his broker.

  THE CHAIRMAN: Mr. Graham, in connection with your own company … How do you determine whether a special situation is undervalued or not?85

  Graham patiently took the senator to school. At one point, when Graham voiced skepticism of stock options, Fulbright tried to flatter him.

  THE CHAIRMAN: I agree with your views quite often.

  MR. GRAHAM: Senator, I have no intention of shaping my views with the expectation of your agreement.

  Finally, Fulbright got to the heart.

  MR. CHAIRMAN: One other question and I will desist. When you find a special situation and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about—by advertising, or what happens?

  Rephrasing: What caused a cheap stock to find its value?

  MR. GRAHAM: That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. [But] we know from experience that eventually the market catches up with value.

  However elliptical, his answer was the basis for Buffett’s career. Stocks would rise to value; therefore, an investor who trusted his judgment could be patient.

  But Graham himself no longer cared. In 1956, a year after the hearings, he retired to Beverly Hills, to teach at the University of California at Los Angeles and pursue a l
ife of financial writing, skiing, and the classics, accompanied by his wife, and also by a French mistress. He gave much of his money to charity and offered that anyone who died with more than $1 million to his name was a fool.86

  Graham-Newman’s record had been very good, if not spectacular. Over its twenty-one-year life (1936–1956) it had earned an average of nearly 17 percent a year, compared to just under 14 percent for the Standard & Poor’s index. The figure, though, does not include what was easily its best investment, its GEICO shares, which were distributed to Graham-Newman’s stockholders. Investors who kept their GEICO through 1956 did twice as well as the S&P 500.87

  But Buffett, quietly investing on his own, had done better. Since leaving college in 1950, Buffett had boosted his personal capital from $9,800 to $140,000.88 And now that he had a kitty, he was eager to go “home”—to Omaha—yet again. Standing on the train platform surrounded by a sea of New York commuters didn’t seem like a life to him.89

  In the spring of 1956, he and Susie rented a house on Underwood Avenue, two blocks from the Buffett grocery. This time, Buffett had no thought of Working for anyone else. On May 1—virtually as he arrived in Omaha—he organized a pool for family and friends. Seven limited partners—sister Doris and her husband, Aunt Alice, Doc Thompson, his ex-roommate Chuck Peterson and his mother, and Dan Monen, his lawyer—put up $105,000. Buffett, the general partner, put in $100. It was a minuscule sum, but Buffett was running money not for his father or for Ben Graham, but for a partnership of his own: Buffett Associates, Ltd.

  Around that time, Homer Dodge, a physicist and Graham-Newman investor, asked Graham the question that had occurred to not a few of his investors: “Who will carry your mantle?” Graham suggested Warren Buffett. When Dodge was driving west for a summer vacation, he stopped in Omaha, a canoe strapped to his car. He had a brief chat with Buffett and left for the great outdoors—having agreed to put in $120,000.90

  Buffett now had three tiny partnerships, which he ran from his bedroom. And he had begun to envision that his family pool might become something more. In August, he returned to New York for the final stockholders’ meeting of Graham-Newman Corp. He mentioned to Ed Anderson, another Graham disciple, that he was thinking of setting up a partnership along Graham’s model—maybe with a $50,000 minimum. Yet who was to say if he could carry Graham’s torch? As the stockholders formally voted Graham-Newman out of existence, an investor named Lou Green offered an ironic eulogy. Green, the head of a Manhattan brokerage, averred that Graham had made “one big mistake”—that of failing to develop talent. Laying it on the line, Green elaborated: “Graham-Newman can’t continue because the only guy they have to run it is this kid named Warren Buffett. And who’d want to ride with him?”91

  * The New York Society of Security Analysts was established three years later, in 1937. Graham was a cofounder.

  † In later public comments, Buffett shielded Graham. He liked to joke that after he had volunteered, “Ben made his customary calculation of value to price and said no.”

  ‡ He wasn’t bluffing. After he left Wharton, Buffett had lunch with Rep. Jasper Bell, the father of his friend in Washington. The congressman said Buffett “knew more about tax law than any lawyer in the country.”

  § This excerpt is from an off-the-cuff talk to Capital Cities/ABC, in 1987. His classroom lectures were not taped.

  ‖ Howard had vilified Eisenhower in the 1952 primaries and backed Ike’s right-wing opponent, Robert Taft. The then Nebaraska governor, Robert Crosby, later recalled: “The party was badly split between Eisenhower and Taft. Buffett was in the conservative wing. I was in the moderate wing. When Hugh Butler died, there was a big fight in the central committee—my recollection is, at some room of the old Cornhusker Hotel. I was on the telephone to my close political friends. I got them geared up to do what they could for Roman Hruska. I felt—why not be brutally frank?—Roman was a close friend.”

  a Net working capital is the total of current assets such as cash, inventory, and receivables (but not including plant and equipment) after deducting all liabilities.

  Chapter 4

  BEGINNINGS

  A series of market decisions does add up, believe it or not, to a kind of personality portrait

  ADAM SMITH, THE MONEY GAME

  With the partnerships up and running, Buffett was troubled by a seemingly bizarre concern. As he wrote to “Big Boy” (Jerry Orans), he was afraid that his estate would eventually be so big that the money might spoil his children. He couldn’t figure out “the logical thing to do with the dough.”

  This is no problem now but viewing things optimistically it may become one and my thinking produces no results. I am sure I don’t want to leave a barrel of money to my kids, unless I do it at an elderly age when I have time to see what the tree has produced. However, how much to leave them, what to do with the balance, etc. bothers me considerably.1

  Buffett was twenty-six. He had modest savings and no steady income. Another young man fretting over his unearned millions might be worthy of a snicker, yet in Buffett there was no hint of bravado. He knew, as much as anyone can, that he would be rich—not just successful, but rich enough to have trouble figuring out what to do with it all. He had anxiety over spending his “dough”—before, indeed, he had any—but not over making it.

  At a time when his accomplishments were modest, Buffett’s awesome self-confidence was the thing that propelled him. In 1957, he was managing a mere $300,000 for just a few relatives and friends. If he was ever to be more than a quiet stockpicker in Omaha, Buffett would need capital, and lots of it. And if Buffett was to raise capital, what was there—besides that yawning self-assuredness—that would induce investors to trust him?

  Buffett had no track record as an independent operator. He had nothing, on paper, to indicate that he was worthy of people’s trust. And he did not want mere discretion over people’s money, he wanted absolute control over it. He wanted no one to answer to for his decisions on stocks—no wary customers as at Buffett-Falk, no skeptical bosses as at Graham-Newman.

  By now, Buffett was familiar with virtually every stock and bond in existence. Line for line, he had soaked up the financial pages and the Moody’s books; day after day, he had built up a mental portrait of Wall Street. He could measure each stone against the skyline, and there was no one else whose analysis he trusted better than his own.

  Writing to Orans, he could critique the leading mutual funds, dispense advice on Treasury securities, and rip the conventional wisdom as regards investing for capital or income in a couple of breathless paragraphs. And all of that knowledge he focused on a single, unrelenting purpose. When Orans wrote for advice on mutual funds, Buffett breezily replied:

  The objectives you mention in your letter mean nothing. That is all a lot of bull put out by the sponsors. Everyone has the same objective—to end up with more dough than they start with a minimum of risk.2

  If Buffett’s inner confidence and clear-minded design didn’t gain people’s trust, what would? Save for those defining aspects of his character, why would he even try?

  In the summer of 1957, Buffett got a call from Edwin Davis, a prominent Omaha urologist. They had never met, but one of Davis’s patients, a New York investment adviser named Arthur Wiesenberger, had known Buffett in New York.3 Wiesenberger had heard that Buffett was trying to raise money and had suggested that Davis call him. Though skeptical about investing with a greenhorn, Davis agreed to have a look. On the appointed Sunday, he gathered his family to take the young man’s measure. On first impression, Buffett was startling.

  The doorbell rang and in comes this guy—egad—he looked like he was eighteen. He had very short hair, almost a butch. His collar was open, his coat was too big for him. Everybody noticed it. He talked so very fast.4

  This was an important moment for Buffett. Dr. Davis could give him capital and, what was more, cachet. If he could sign up the Davises, he would not be investing merely for his parents and Aunt Alice; he would
have his foot in the door as a professional.

  But Buffett did not have the air of someone trying to please. Indeed, some of his pitch was calculated to set the Davises on notice. He warned them that he would disclose nothing about where their money was invested. He would give them a yearly summary of results, nothing more.

  Also, Buffett would be “open for business” only one day a year. On December 31, the Davises could add or withdraw capital. Otherwise, the money would be Buffett’s to play with (which he would do, he assured them, according to Graham’s principles) and his alone. He presented this evenly, without any edge, but the message was clear. As badly as Buffett wanted the Davises’ capital, he didn’t want it on any terms but his.

  Then he offered the terms. The Davises, as limited partners, would get all of the profits that Buffett could earn up to 4 percent. They would share any remaining profits—75 percent to the Davises and 25 percent to Buffett.5 Thus, Buffett was not asking the Davises to gamble alone; Buffett’s money would be on the same horse. If his results were mediocre or worse, Buffett would get zilch—no salary, no fee, nada. According to Lee Seemann, the doctor’s son-in-law, “The whole thing was laid right out. We liked that. You knew where you stood with him.”

  After Buffett left, the Davises kicked it around. In objective terms, they had nothing to go by. But the doctor’s wife, Dorothy, declared, “I like everything about this young man.” Edwin Davis put up $100,000.

  By year-end, Buffett was running five small partnerships, totaling in the range of $500,000. For the year, Buffett’s first, his portfolios gained 10 percent, easily topping the Dow Industrials, which suffered an 8 percent drop.*