Buffett

by Roger Lowenstein

  Jack Stanton, who had been too busy to show Buffett the plant, now realized—too late—that he ought to meet with him. Jack and his then wife, Kitty, hurried to New York and had breakfast with Warren and Susie at the Plaza. But Jack was awed, and in over his head. According to Ralph Rigby, a fabric salesman, Kitty pled harder than Jack did. Buffett joked later, “If I had hired anybody, I would have hired Kitty.”

  Perhaps eager to change the subject, Buffett told Jack about his own career, recounting his rise as an investor. Jack asked, “How do you do it?” Buffett said he read “a couple of thousand” financial statements a year.

  Shortly before the May board meeting, Buffett was secretly named a director.25 On the morning of his big takeover, Buffett flew into New Bedford, crew-cut, his suit tightly buttoned and noticeably creased, with an attaché and an oversized valise and something of the appearance of a down-at-the-heels but earnest traveling salesman.

  Buffett made for the office on Cove Street, and Seabury emerged from the ivory tower for a final time. Calling the meeting to order, Seabury read through the agenda, showing nothing. And then Seabury Stanton resigned. It merely remained to pass the poison cup to Jack. Without a word, the two stormed out of the elegant wood-paneled boardroom. Ken Chace was voted president, Buffett chairman of the executive committee. Otis, in a final stab at his brother, voted with the majority and remained on the board. Though Malcolm Chace retained the title of board chairman, Buffett was now in charge of Berkshire. The stock closed that day—May 10, 1965—at $18 a share.

  Buffett’s tidy script was nearly wrecked when a messenger burst in with a copy of the afternoon Standard-Times, revealing the shake-up on the front page. Seabury had leaked the story, blaming his departure on a rift with “certain outside interests.”26 Buffett, fearing he would be seen as a liquidator—the hated epithet from Dempster Mill—was visibly enraged. But he papered it over in public, praising the departing Stantons and soft-pedaling his plans. Quoted in the next day’s edition, Buffett promised “to sell the same goods from the same plants to the same customers.”

  Over the previous decade, Berkshire had closed all but two of its mills and accumulated a net loss of $10.1 million.27 Its assets had shrunk by half, and merely 2,300 workers—one of every five from the 1955 merger—remained. But its fortunes now seemed on the mend. Demand for synthetics was strong, and the company was—finally—in the black. One yearns to hear what Tillison would have made of Buffett’s arrival, but, alas, the dutiful analyst was benched at the same juncture as Seabury Stanton. Value Line’s May report on Berkshire was signed by a new analyst, who observed that the plans of “the new controlling interest” were not known.

  After the board meeting, Buffett and Ken Chace strolled past the historic mill and sat down to talk. Chace now made ready to hear the new owner’s plans for the mill. But Buffett said anything to do with warps and looms would be up to Chace. Buffett would watch the money.

  Then, in his blunt fashion, he outlined what each of them should expect. The first point was deflating: Buffett would not approve of stock options for Chace or for anyone else.

  Buffett opposed options for the reason that most CEOs were enamored of them. Options conferred potential—sometimes vast—rewards, but spared the recipients any risk, thus giving executives a free ride on the shareholders’ capital.

  More subtly, Buffett wanted managers whose personal interests were in line with those of the stockholders. A manager who owned options, as distinct from shares, had nothing to lose, and would be more inclined to gamble with the shareholders’ capital.

  However, Buffett offered to cosign a loan so that Chace could borrow $18,000 and buy a thousand shares. For Chace, who was making less than $30,000, and who normally didn’t like to borrow a shoelace, that was a huge amount. But Buffett was a supersalesman, especially when he was selling himself. Like some of those early partnership investors, Chace had a feeling that good things would happen with Buffett in charge. Chace took the plunge.

  Then Buffett explained to Chace the basic theory of return on investment. He didn’t particularly care how much yarn Chace produced, or even how much he sold. Nor was Buffett interested in the total profit as an isolated number. What counted was the profit as a percentage of the capital invested. That was the yardstick by which Buffett would grade Chace’s performance.

  To Chace, who had been reared, like most managers, to think of growth as an absolute good, this idea was new. But he grasped that it was pivotal to Buffett’s capitalist credo, and Buffett put it in terms that Chace could understand.

  “I’d rather have a $10 million business making 15 percent than a $100 million business making 5 percent,” Buffett said. “I have other places I can put the money.” He flew back to Omaha that night.

  Buffett was serious about having “other places” to put the money. He leaned on Chace to keep the inventory and overhead as low as possible. As Chace said, “One thing Buffett wanted was to come up with cash quickly.”

  Buffett also followed through with his promise of autonomy. He told Chace not to bother with quarterly projections and other time-wasters. He merely wanted Chace to send him a monthly financial report and to warn him of any unpleasant surprises.

  Indeed, Buffett sculpted the relationship to get the most out of it with a minimum of personal contact. He was easy to reach, but this had the perverse effect of restraining Chace from calling except when he really needed to. And when Chace did call, Buffett didn’t linger on the phone.

  “I’d give the results, and the estimate for the year, and he’d remember them forever,” Chace noted.

  Once, Buffett said Chace had switched a figure from an earlier call—which Chace disputed. After he checked his notes, Chace saw that Buffett was right. From then on, he carefully checked his data before he called.

  Chace’s freedom had one boundary. Only Buffett could allocate capital. And as most of the previous capital that Seabury had poured into textiles had gone for naught, Buffett was extremely reluctant to put in more.

  Still, Chace tried. He would propose an investment, backed by careful research and good-looking projections. And Buffett would reply, “Ken, you won’t beat the historical average.”

  J. Verne McKenzie, Berkshire’s treasurer, who had gotten to know Buffett as the outside auditor for Buffett Partnership, said, “Try to remember, Ken. Warren uses the same rule for measuring a $5,000 investment as he does for $5 million.”

  During the first two years of the Buffett/Chace regime, textile markets boomed. Profits were earned; however, they were not reinvested in textiles. Chace trimmed inventories and fixed assets, just as Buffett had demanded. In a symbolic step, he abandoned the ivory tower. And the company’s cash position grew.28 Buffett paid out a meager ten-cent dividend in 1967—but quickly thought better of it.‡ From then on, Buffett hung on to the money—just as he said he would.

  To Berkshire’s shareholders, most of whom lived in New England, there was no outward sign that the big decisions were being made in Omaha. The headquarters remained in New Bedford, and the annual reports were signed by Ken Chace and Malcolm Chace. But a close reader of those reports might have wondered at the hand behind the tiller.

  The Company has been searching for suitable acquisitions within, and conceivably without, the textile field.29

  Shortly after those words were written, Buffett struck. For some time, he had been studying an Omaha insurance firm, National Indemnity Co. The majority owner was Jack Ringwalt, who had once laughed off Buffett’s request for a $50,000 investment in the partnership. Since then, Ringwalt had heard about Buffett’s record, and Buffett had learned a lot about Ringwalt.

  A college dropout with a rogue wit, Ringwalt had started by providing insurance for taxicabs in the Depression. This led him to conclude that the way to make money was to write policies for risks that other insurers did not want to touch.

  This was particularly true in my case since my competitors had more friends, more education, more determinat
ion, and more personality than I.30 §

  His bread and butter was unusual-risk auto insurance, but Ringwalt was willing to insure any risk—bootleggers, lion tamers, you name it—that nobody else wanted, since the premiums on such were typically higher. He was known for underwriting radio station treasure hunts in cities around the country. Typically, a station would broadcast a series of clues, hinting at the location of a $100,000 bank draft. Ringwalt was liable if the draft was discovered—quite unlikely, given that it was Ring-wait who hid them, usually in a lipstick container underground. His clues were obscure, along the lines of “A dandelion is not a rose; you are within a block when you pass by Joe’s.”31 He had to pay up only once, in San Francisco.

  Ringwalt stated his philosophy in simple terms: “There is no such thing as a bad risk. There are only bad rates.”32 This was an insight worth its weight in gold. Buffett, who had learned this truth at the racetrack, felt that Ringwalt was another of his guys. Each liked to take risks, but only when the odds favored them. Ringwalt also was possibly the cheapest of the long line of tightwads in Buffett’s acquaintance. He even left his coat in the office when he went downtown for lunch so as to avoid a coat check.

  In 1967, Buffett asked if Ringwalt could stop by Kiewit Plaza to discuss a matter that Buffett said would take only fifteen minutes. By then, Buffett had learned from Charles Heider, an Omaha broker, how much it would take to persuade Ringwalt to part with National Indemnity.

  “How does it happen that you never sold your company?” Buffett asked.

  “Because only crooks and bankrupt people have wanted it.”

  “What other reason?”

  “I would not want the other stockholders to take less per share than I would receive myself.”

  “What else?” Buffett prodded him.

  “I would not want my employees to worry about losing their jobs.”

  “What else?” Buffett insisted.

  “I would want it to remain in Omaha.”

  “What else?”

  “Isn’t that enough?”

  “What is your stock worth?” Buffett asked, getting to the point.

  “The market value is $33 per share, but the stock is worth $50 per share.”

  “I will take it,” Buffett said.33

  The total price was $8.6 million. The apparent riddle was why a New Bedford fabric mill would want to acquire an Omaha insurance company. But Buffett did not think of Berkshire as necessarily a textile company, but as a corporation whose capital ought to be deployed in the greenest possible pastures.

  Whereas textiles, which required reinvestment in plant and equipment, were cash-consuming, insurance was cash-generating. Premiums were collected up-front; claims were paid out only later. In the interim, an insurance company could invest the funds, known in the trade as the “float.”

  Traditionally, insurers had managed their float conservatively, keeping far more capital than needed. But Buffett, who had thought long and hard about insurance since his early fling with GEICO, thought that float from insurance could be as dynamic as rocket fuel. Float was merely money, and an insurance firm was, in effect, a conduit for in-vestable cash.

  Buffett’s view would soon be a commonplace, but at the time, insurance was a backwater.‖ Many insurance companies didn’t even bother to publish their earnings, and few investors were interested in seeing them. Charles Heider, who brokered the deal, said, “Buffett understood float before anyone in the country.”

  Once Buffett had gobbled up National Indemnity, Berkshire had a stream of funds for him to play with. In successive years, Berkshire acquired Sun Newspapers of Omaha Inc., a group of weekly papers in Omaha, and the far bigger Illinois National Bank & Trust, in Rockford, Illinois. The Rockford bank was run by Eugene Abegg, who had taken charge in 1931, when it was virtually worthless and when other banks in town were failing. He was another of the nose-to-the-grind-stone, Depression-schooled, Grandpa Buffett-type figures that Buffett seemed to produce from central casting whenever he bought a business. From his 1930s beginnings, Abegg had proceeded to build a $100 million base of deposits and an earnings-to-assets ratio (the key measure in banking) that was close to the highest among large commercial banks.34

  Most older entrepreneurs such as Abegg are eager to retire when they sell out, and the new owners (while praising their storied careers) usually are anxious to show them the door. Buffett was different. Running a bank, a claims office, or a retail chain was out of his arc, and he had no desire to try. Indeed, he felt, if he didn’t like the way the business was run, why buy it?

  He looked for a type: the self-starter with a proven record. What is interesting is that they stuck with him. Abegg, who was seventy-one when he sold to Buffett, continued to manage under Buffett’s ownership—as did Jack Ringwalt at National Indemnity and Ben Rosner at Diversified. (Abegg would run the bank until he was eighty.)

  None of these multimillionaires needed to work, but Buffett understood that most people, regardless of what they say, are looking for appreciation as much as they are for money. He made it clear that he was depending on them, and he underlined this by showing admiration for their work and by trusting them to run their own operations.

  One time, a discontented fabric buyer at Sears, Roebuck called Buffett and tried to pull an end run around Ken Chace. The buyer reminded Buffett that they had a common friend from college, and asked him to change the salesman on his account. Buffett despised the old-boy routine (it appealed to sentiment, not reason) and bluntly told the man from Sears that such matters were up to Chace.35 Naturally, such shows of loyalty only increased Chace’s dedication to Buffett.

  But as Buffett plowed Berkshire’s capital into insurance, banking, and publishing, he continued to siphon it out of textiles. In 1968—three years after promising to sell the same goods from the same plants—he closed the smaller of Berkshire Hathaway’s mills, in Rhode Island, which was irreversibly tied to cotton fabrics and was doomed by the dwindling market for such niceties as petticoats and dress stiffeners. The onetime king of cotton was down to a single mill—the factory in New Bedford. A year later, even the Cove Street plant stopped spinning cotton, the business launched by Horatio Hathaway, leaving only rayon linings and synthetic curtains.

  And Buffett was keeping his thumb on every capital outlay down to the office pencil sharpener. The minutes of Berkshire’s “finance committee”—convened, one summer, over the telephone between New Bedford and Buffett’s vacation haunt in California—suggest that no expense was too trifling to escape his scrutiny:

  Voted: To approve the purchase of a secondhand Reiner Warper and Creel at an approximate cost of $11,110.

  Voted: To approve the purchase of 50 secondhand 64 inch XD looms at an approximate cost of $71,160, installed.

  Voted: To approve the repair of office building roofs at an approximate cost of $9,340, and the repair of the shipping room floor at an approximate cost of $9,940.36

  Corresponding with Chace on the risk of deadbeats, Buffett specifically reminded him not to trust in anything but cash:

  Also, let’s look at all of our customers especially hard so that no one gets into us too heavily. If anyone is slow in paying, let’s make sure we don’t ship them more goods until they pay whatever amount is past due, and the check has cleared.37

  Buffett made no exceptions, even for a very “special” customer. Susie came to Berkshire’s New York office in the early seventies to buy some draperies. Ralph Rigby, the salesman, said, “We gave her the highest price we could. It was a good thing. Buffett called and asked what we had charged.”

  In 1970, with the dissolution of Buffett Partnership, Buffett personally became the owner of 29 percent of Berkshire’s stock. He installed himself as chairman and, for the first time, composed the letter to shareholders in Berkshire’s annual report.

  Writing to the investors, Buffett used the same yardstick as he had in private with Ken Chace: the return on equity capital—that is, the percentage profit on each do
llar invested. Buffett was extremely consistent abut such things. He did not have one yardstick in Kiewit Plaza, another in New Bedford, and another for the public.

  Moreover, in measuring investments, Buffett was absolutely unwilling to relax his standards. Many a portfolio manager has been known to explain, “This doesn’t look so hot, so we’re only investing a little.” Buffett refused to make such compromises, and he could be brutally honest about shooting down a prospect. Scotty Hord, his Omaha Data Documents cohort, discovered this in the period that Buffett was reinventing Berkshire. Hord had gotten a cash windfall, and he was hoping to buy a business of his own. Buffett offered to check out any prospects before he went ahead. Hord recounted:

  I brought him four or five companies. I went to his house each time. One of them made a new product—a kind of dispenser of thin sheets of paper for hospitals, restaurants. They wanted me to put up $60,000. Buffett said, “What do you think the odds of this thing making it are?” I said, “Pretty good. One out of two.” He said, “Do you think that’s good? Why don’t you go up in an airplane with a parachute that opens one out of every two times and jump?” I brought him another one—Jubilee Manufacturing Co. It made novelty automobile horns. I said, “Do you think enough of it to invest with me?” He said, “No.” I said, “Do you think enough of me to invest in it with me?” He said: “No.” He said it that quick. It was so refreshing to hear, without all kinds of excuses.

  Buffett increasingly believed that textiles amounted to the same sort of wishful parachute drop. No matter how much they invested, manufacturers couldn’t raise prices, because the product was a commodity and usually in oversupply. Thus they never recouped their investment.