Who would make good the losses? The responsible party was, in the first instance, Allied. But Allied was broke. The American Express subsidiary also filed for bankruptcy. Whether American Express itself had any liability was uncertain. But Howard Clark, the chief executive, grasped that for a company with its name on traveler’s checks, the public trust was all. Clark, to his credit, issued a manifesto the very thought of which would have caused lesser CEOs to shudder.
American Express Company feels morally bound to do everything it can, consistent with its overall responsibilities, to see that such excess liabilities are satisfied.
In other words, the parent company would stand behind the claims whether legally bound to or not. The potential loss was “enormous.” Indeed, he said, it was “more than we had.”5
The company’s stock fell from 60 before the news to 56½ on November 22. When markets reopened after the Kennedy assassination, American Express tumbled to 49½.
It developed that Allied had been run by one Anthony De Angelis, a.k.a. “the Salad Oil King.” De Angelis was a familiar type in American finance, possessed of the combination of brilliance and moral flexibility that produces a first-rate white-collar crook. In a previous incarnation, he had controlled a New Jersey meatpacker that had run afoul of the government and gone belly-up.6 When he resurfaced with Allied, a supplier of vegetable oils for export, his record as a former bankrupt prevented him from getting credit. Thus his canny scheme to park “salad oil” in the American Express warehouse. Once he had receipts with that most hallowed of corporate names, De Angelis was bankable. He borrowed money, bet the house on vegetable oil futures, and lost.
In the scandal’s wake, the portly De Angelis was escorted from his two-story red-brick home in the Bronx to face indictment in federal court in Newark.* And American Express, which had not missed a dividend payment in ninety-four years, suddenly was said to be at risk of insolvency.
As these events were unfolding, Buffett paid a visit to Ross’s Steak House in Omaha, in the same inquiring spirit as when he had earlier dropped in on the clothier Sol Parsow. On this evening, Buffett was interested not in the customers’ steaks, nor in their suits or hats. He positioned himself behind the cashier, chatted with the owner, and watched. What Buffett observed was that, scandal or no, Ross’s patrons were continuing to use the American Express card to pay for their dinners.7 From this, he deduced that the same would be true in steakhouses in St. Louis, Chicago, and Birmingham.
Then he went to banks and travel agencies in Omaha and found that they were doing their usual business in traveler’s checks. Similarly, he went to supermarkets and drugstores that sold American Express money orders. Finally, he talked to American Express’s competitors. His sleuthing led to two conclusions, both at odds with the prevailing wisdom:
1. American Express was not going down the tubes.
2. Its name was one of the great franchises in the world.8
American Express did not have a margin of safety in the Ben Graham sense of the word, and it is unthinkable that Graham would have invested in it. The Graham canon was quite clear: a stock ought to be purchased on the basis of “simple and definite arithmetical reasoning from statistical data.”9 In other words, on the basis of working capital, plant and equipment, and other tangible assets—stuff that one could measure.
But Buffett saw a type of asset that eluded Graham: the franchise value of American Express’s name. For franchise, think: a market lock. The Cardinals own the franchise for baseball in St. Louis; no other team need apply. American Express was nearly that good. Nationally, it had 80 percent of the traveler’s check market, and a dominant share in charge cards. In Buffett’s opinion, nothing had shaken it, and nothing could.10 The loyalty of its customers could not be deduced from Graham’s “simple statistical data”; it did not appear on the company’s balance sheet as would a tangible asset, such as the factories of a Berkshire Hathaway. Yet there was value in this franchise—in Buffett’s view, immense value. American Express had earned record profits in each of the past ten years. Salad oil or not, its customers were not going away. And the stock market was pricing the company as if they already had.
By early 1964, the shares had plunged to 35. Wall Street’s chorus, all reading the same lyrics, was chanting, “Sell.” Buffett decided to buy. He put close to one-quarter of his assets on that single stock—one with a liability of unknown and potentially huge proportions. If Buffett was wrong, his accumulated profits and reputation stood to go up in flames.
Clark, the American Express president, offered $60 million to the warehouse’s creditors in an effort to settle their claims. But he was sued by his own shareholders, who asserted that Clark was “wasting” their assets on a specious moral obligation.
Buffett did not agree. He dropped in on Clark and introduced himself as a friendly shareholder. “Buffett was buying our stock,” Clark recalled, “and anybody who bought it then was a pal indeed.”
When Buffett told Clark that he supported him, an American Express lawyer asked if he would testify. Buffett went to court and said shareholders shouldn’t be suing—they ought to be congratulating Clark for trying to put the matter behind them.11 “As far as I was concerned,” Buffett would explain, “that $60 million was a dividend they’d mailed to the stockholders, and it got lost in the mail. I mean, if they’d declared a $60 million dividend, everybody wouldn’t have thought the world was going to hell.”12
Though the suits dragged on, the stock began to rise. Buffett, however, did not follow the Graham route of taking profits. He liked Clark, and he liked the company’s products. Gradually, Buffett added to his position.
Berkshire Hathaway, meanwhile, was indeed going to hell. With the market for textiles mostly poor, Berkshire was losing money and gradually closing mills. But Buffett continued buying its stock, too, and the partnership won a controlling interest. As in the case of Dempster Mill, Buffett went on the board, hoping to set it straight. He also was charmed by its rugged New England plant. Despite its difficulties, he reported to his partners, “Berkshire is a delight to own.”13
Half of his portfolio now was rooted in two very different stocks, which glared at each other like opposing bookends. In Buffett’s terminology, Berkshire’s appeal was “quantitative”—based on price. American Express was based on a subjective view of “qualitative” factors such as the strength of its products and management. Though he regarded the softer methodology as the less conclusive, Buffett was uncertain where the balance lay. The “main qualification is a bargain price,” he wrote; but he also would pay “considerable attention” to qualitative factors.14
Buffett didn’t disclose the American Express holding to his partners. But concurrent with his experimentation away from Graham, he began to communicate more expansively to his partners in his letters. He used the letters not just to report results, but to talk about his approach and to educate his readers in a general sense about investing. School was in.
Increasingly, the voice that emerged was not Ben Graham’s—not phrases from The Intelligent Investor—but Buffett’s own. It was, by turns, articulate, droll, self-deprecating, and rather more literate than one would expect from an investment manager in his thirties. For a young man, he was astonishingly comfortable with himself. Here is Buffett at thirty-two, on “The Joys of Compounding”:
I have it from unreliable sources that the cost of the voyage Isabella originally underwrote for Columbus was approximately $30,000. This has been considered at least a moderately successful utilization of venture capital. Without attempting to evaluate the psychic income derived from finding a new hemisphere, it must be pointed out that … the whole deal was not exactly another IBM. Figured very roughly, the $30,000 invested at 4% compounded annually would have amounted to something like $2,000,000,000,000 [two trillion] …15
His serious point was that even trifling sums should be invested with the utmost care. To Buffett, blowing $30,000 represented the loss not of $30,000 but of the
potential for $2 trillion.
In another letter, he chided partners for being overly influenced in their financial planning by the desire to avoid taxes. Indeed, many of life’s errors were the result of people forgetting what they were really trying to do.
What is one really trying to do in the investment world? Not pay the least taxes, although that may be a factor to be considered in achieving the end. Means and end should not be confused, however, and the end is to come away with the largest after-tax rate of compound.
It must be, he added, that people’s emotional distaste for paying taxes blinded them to acting rationally—a misstep that Buffett was careful to avoid. “Ultimately,” he reasoned, there were only three ways to avoid a tax: (1) to give the asset away, (2) to lose back the gain, and (3) to die with the asset—“and that’s a little too ultimate for me—even the zealots would have to view this ‘cure’ with mixed emotions.”16
Buffett returned to such thematic grace notes again and again. Indeed, reading the letters front to back, they are full of early sightings of later Buffett melodies. But reading them singly, one is more aware of the tone, and specifically of Buffett’s intense focus on his own development. Written at night, when the rest of the house was asleep, the letters have about them a quality of self-discovery—a pimply, self-conscious honesty. The writer of these letters has the same engaging informality that Buffett did in person.
Of course, Buffett knew many of his readers on a personal basis, as family or friends. But the collective relationship that he had with them as his partners—even though, in a sense, an abstract one—had a special significance to him.
In person, he kept a distance, but as a general partner, Buffett was revealing about what was, in effect, his most intimate concern. If his work in the partnership amounted to a sort of self-portrait, the background motif of the letters was Buffett’s own character. He used these semiannual missives to prepare his partners, and to align their expectations and thinking with his own. He talked to them.
I am not in the business of predicting general stock market or business fluctuations. If you think I can do this, or think it is essential to an investment program, you should not be in the partnership.17
It was enormously important to Buffett that his partners see him as trustworthy. He and Susie put more than 90 percent of their personal money in with the partners’, as did Bill Scott, Buffett’s assistant. “So we are all eating our own cooking,” Buffett assured them.18
He took pains to explain his approach in advance, and in concrete terms—precisely because he knew that a misunderstanding could sunder the union. One time, a partner barged into the reception area at Kiewit Plaza intent on finding out where the money was invested. Buffett, who was meeting with a banker named Bill Brown—later chairman of the Bank of Boston—told his secretary he was busy. She returned in a moment and said the man insisted on seeing him. Buffett disappeared for a minute and then told his secretary, “Price that guy out” [of the partnership]. Turning to Brown, Buffett added, “They know my rules. I’ll report to them once a year.”19
Buffett made no attempt to predict his results, but he was obsessed with the notion that his partners should judge him fairly—meaning unemotionally and according to a neutral, arithmetic scale. (That is how Buffett judged himself.)
I believe in establishing yardsticks prior to the act; retrospectively, almost anything can be made to look good in relation to something or other.20
His own goal, stated at the outset, was to beat the Dow by an average of 10 points a year. On this topic, he took his readers deeper. The Dow, he noted, was an unmanaged group of thirty stocks. Yet most of the pros couldn’t match it. Why was it, he wondered, that “the high priests of Wall Street,” with their brains, training, and high pay, couldn’t top a portfolio managed by no brains at all? He found a culprit in the tendency of managers to confuse a conservative (i.e., reasonably priced) portfolio with one that was merely conventional.21 It was a subtle distinction, and bears reflection. The common approach of owning a bag full of popular stocks—AT&T, General Electric, IBM, and so forth—regardless of price, qualified as the latter, but surely not as the former. Buffett blamed the committee process and group-think that was prevalent on Wall Street:
My perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size.…22
Such decision-via-consensus—then and now the rule on Wall Street—tended to produce a sameness from one fund to the next. It nourished the seductive syllogism “whereby average is ‘safe’ ” and unorthodox is risky. In truth, Buffett countered, sound reasoning might lead to conventional acts, but often it would lead to unorthodoxy.
In some corner of the world they are probably still holding regular meetings of the Flat Earth Society. We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don’t.23
Buffett’s portfolio was decidedly unconventional. With his big bets on American Express, Berkshire Hathaway, and two or three others, the lion’s share of the pool was in just five stocks.24 Ideally, Buffett would have preferred to spread his assets, provided that he could have found, say, fifty stocks that were equally “superior.” But in the real world, he found that he had to work extremely hard to find just a few.25
He ridiculed the fund managers who took the opposite tack—which is to say, most of those working on Wall Street. Diversification had become an article of faith; fund managers were commonly stuffing their portfolios with hundreds of different stocks. Paraphrasing Billy Rose, Buffett doubted that they could intelligently select so many securities any more than a sheik could get to “know” a harem of one hundred girls.
Anyone owning such numbers of securities … is following what I call the Noah School of Investing—two of everything. Such investors should be piloting arks.26
A portfolio with scores of securities would be relatively unaffected if any one stock fell, but similarly unaffected should an issue rise. Indeed, as the number of stocks grew, the portfolio would come to mimic the market averages. That would be a safe and perhaps a reasonable goal for the novice, but in Buffett’s view, it undermined the very purpose of the professional investor, who presumably was being paid to beat the average. Owning so many stocks was an admission that one could not pick the winners.
None of this is to suggest that Buffett was a gambler. He was just as determined as Ben Graham had been to avoid taking a loss. But where Graham had insisted on substantial (if not extreme) diversification,27 Buffett thought he could safeguard his eggs without spreading them around.† Beneath his surface modesty he was, in effect, making a very brassy claim. And he continued to live up to it. The partnership portfolio jumped an astonishing 39 percent in 1963 and 28 percent in 1964. By then, Buffett was managing $22 million. His personal net worth was close to $4 million—at that time, quite a fortune.28
This spiraling accumulation had no noticeable effect on Buffett’s lifestyle. He remained partial to Parsow’s gray suits, Ross’s steaks, and University of Nebraska football games. During the week, aside from an occasional business trip, his X coordinate merely traversed an alley between his home and office; the Y coordinate barely moved at all. Nor was there anything in Buffett’s manner that suggested money. He did add some rooms and a racquetball court to his house, the variously sloping roofs of which now seemed to ramble disjointedly over the lot. But for a multimillionaire, it was remarkably ordinary, and of course remained close to a busy suburban thoroughfare. Outside, a blinking yellow traffic light stood watch like a sentry.
Buffett scarcely thought about spending his wealth on material comforts. That wasn’t why he wanted it. The money was a proof: a score-card for his favorite game.
He did ask Susie to upgrade his VW, explaining that it looked bad when he picked up visitors at the airport. But he didn’t have the slightest interest in it.
“What kind of car?” Susie asked.
“Any car. I don’t care what kind.”29 (She got him a wide-finned Cadillac.)
Scott Hord, a vice president of Data Documents, the Omaha computer-card company, got to the heart of the matter when Buffett and he flew to Houston on a business trip.
“Warren, what’s it feel like to be a millionaire?” Hord asked innocently. “I’ve never known a millionaire.”
“I can have anything I want that money will buy. But I always could.”
Whatever was the object of Scotty Hord’s fantasies—toys, trucks, cars, paintings, jewelry, silks—Buffett could have had. But they didn’t mean a thing to him. Buffett’s fantasy was to be in Kiewit Plaza, piling up more money day after day.
Paradoxically, Susie projected an air of disinterest in having money but was a virtuoso shopper. She dropped $15,000 on a home refurnishing, which “just about killed Warren,” according to Bob Billig, one of his golfing pals. Buffett griped to Billig, “Do you know how much that is if you compound it over twenty years?”
Beneath his becoming lack of acquisitiveness, Buffett had a certain obsession. In his mind, every dime had the potential of Queen Isabella’s lost fortune. When a nickel today could become so much more tomorrow, spending it drove him nuts. He didn’t even buy life insurance, figuring that he could compound the premiums faster than an insurance company.‡ Buffett said of himself that he was “working [his] way up to cheap.”30 (He was not stingy, though, about picking up the check.)
When it came to money, Buffett seemed to have twin personalities—it was nothing to him and it was everything. He had an overly reverent view of money’s proper role, as if spending were a sort of sinfulness. Even when he dieted, he inserted money into the equation. He would write a $10,000 check to his daughter, payable on such-and-such a date unless his weight had dropped. Little Susie would try to ply him with ice cream or drag him to McDonald’s—but it was useless. Her daddy didn’t want the ice cream as much as he wanted to keep the money.
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