Investing - what Buffett can do and you cannot

kw: book reviews, nonfiction, investing, short biographies, letters

Warren Buffett, the Sage of Omaha, is legendary for parlaying a modest fortune into billions, primarily by investing. He is considered a genius at stock picking. Warren Buffet's Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor, by Jeremy C. Miller, tells the real story, at least about the first 13 years, the BPL years.

Probably the impression most people have is that Buffett was somehow prescient, and could time the market. The reality is much more prosaic. Ground Rules is about half large extracts from the Partnership Letters that Buffett wrote to his partners (initially three family members), from 1956 to 1969; and about half Miller's analysis, a valuable asset in its own right.

Buffett's style of active investment management bore (and bears) no resemblance to that of the managers of the roughly 2,000 funds of the "Growth" variety, and even of most of the 1,500 or so "Value" funds, let alone all the other categories. He was an early Value investor, but Value has a different meaning nowadays.

After working in the investment field on his own and for Benjamin Graham, the "father of Value investing", he set up Buffett Partnership Ltd., with his own money and that of a few relatives. When Graham retired, Buffett already had savings of about $175,000 (more than $1.5 million in today's dollars). BPL was set up with about $100,000, having the stated goal to beat the performance of the Dow Jones Industrial Average by 10% yearly. In those 13 years he never had a down year, and usually beat the Dow by much more than 10%. He had parlayed the $100,000, plus other funds added as partners were added, into about $50 million (in 1970 dollars; more than $300 million in today's dollars). How?

Buffett had learned deep value investing from Ben Graham. His motto was, "You don't buy stock, you buy the business." That is, even owning one share, you should think like someone running the business. He developed his own ideas upon that foundation, so that he soon had three kinds of investments in the BPL partnerships:

• General – Graham-style value stocks: with much research, companies were found whose total stock value was less than the raw asset value of liquidating the company. Stock of companies with management who had a reasonable chance of keeping the business from foundering could be purchased with almost total certainty that the stock value would increase, probably by a great amount. Such "low hanging fruit" are very rarely to be found today, nor at nearly any time since about 1970. Buffett liked a stock to not grow fast, at first, giving him time to buy a lot of it, a little at a time so as not to stir up market activity around it. Later he split this category into two based on size, particularly once BPL had much greater funding. Most General stocks represent small companies, and a million-dollar investment could buy the whole company, or totally skew the market for it.
• Workouts – Arbitrage opportunities in today's lingo: companies in trouble, or with more cash and idle capital assets on hand than the value of all shares of stock. He would obtain a large amount (10-20%) of a small company's stock, giving him leverage (and often a seat on the Board), so that he could influence company operations. He would influence, or force, company management to get rid of unprofitable operations and concentrate capital where it could do more good, both in a business sense and a financial sense. Sometimes he was vilified in the press, much as T. Boone Pickens was a generation ago, and Nelson Peltz has been in recent years. With no more than a couple of exceptions, he avoided eliminating jobs in large numbers, even at the cost of a few more percentage points in a stock's value. I don't think either Pickens or Peltz ever cared one whit how many jobs they eliminated.
• Controls – Ownership of more than 40%, and of course more than 50%, of a company's stock would give Buffett total control of operations. His last Control was Berkshire Hathaway, which he still controls. 

Does any of this sound like "timing the market"? Buffett repeatedly expressed his disdain for the very thought, and claimed he had no interest in market timing. He preferred stocks that were independent of market movements, and chose Generals in particular for this characteristic. This took a lot of research, in an era without electronic research tools.

So, whichever sort of investment one plans to make (most of us will find Workouts and Controls out of our reach!), these simple steps must be adhered to:

• Set a goal toward which you are willing to work, hard.
• Research, research, and research some more to locate publicly-traded companies that offer a great chance to meet that goal. This minimizes risk.
• Follow a disciplined plan to obtain an appropriate amount of the stock (this can take months or even years).
• When the goal is met, sell, perhaps as gradually as you bought in. The whole process is likely to take several years. Buffett didn't care for any time horizon shorter than 3-5 years.

Doing so sounds simple, but is emotionally impossible for more than about one person in a million. Buffett had an emotional detachment from the decisions he made that just might be unique. He also had the business acumen to successfully arbitrage or control a company he had bought. It is one thing to understand what he did. It is another to do any part of it. That is why there are so few investment billionaires.

This reminds me, in a sideways way, of something Art Linkletter said when he was interviewed late in his life. He was asked how he had such success interviewing children for his show "Art Linkletter's House Party" (I was in the audience once, at age 8, but wasn't called up on stage to talk with him). He said, "I can tell you my secret, but you can't do it. The kids have to know you are at the same mental level." Ground Rules tells you Buffett's secrets. Bet you can't do it.