The Warren Buffett Way

Robert G. Hagstrom

• Publisher: Wiley
• Year: 2013
• ISBN:
  9781118793992
• Edition: 3
• Topic: Business
• Subtopic: Investimenti e titoli
• Index: Business

Warren Buffett is the most famous investor of all time and one of today's most admired business leaders. He became a billionaire and investment sage by looking at companies as businesses rather than prices on a stock screen. The first two editions of The Warren Buffett Way gave investors their first in-depth look at the innovative investment and business strategies behind Buffett's spectacular success. The new edition updates readers on the latest investments by Buffett. And, more importantly, it draws on the new field of behavioral finance to explain how investors can overcome the common obstacles that prevent them from investing like Buffett.

New material includes:

• How to think like a long-term investor – just like Buffett
• Why "loss aversion", the tendency of most investors to overweight the pain of losing money, is one of the biggest obstacles that investors must overcome.
• Why behaving rationally in the face of the ups and downs of the market has been the key to Buffett's investing success
• Analysis of Buffett's recent acquisition of H.J. Heinz and his investment in IBM stock

The greatest challenge to emulating Buffett is not in the selection of the right stocks, Hagstrom writes, but in having the fortitude to stick with sound investments in the face of economic and market uncertainty. The new edition explains the psychological foundations of Buffett's approach, thus giving readers the best roadmap yet for mastering both the principles and behaviors that have made Buffett the greatest investor of our generation.

Chapter 1

A Five-Sigma Event

THE WORLD’S GREATEST INVESTOR

Brace yourself,” Buffett said, with a sly grin. He was sitting in a Manhattan living room on a spring morning with one of his dearest and oldest friends, Carol Loomis. A New York Times best-selling author and an award-winning journalist, Carol is senior editor-at-large at Fortune magazine, where she has worked since 1954, and is considered to be the magazine’s resident expert on Warren Buffett. It is well known among the Buffett faithful that she has also been editing Berkshire Hathaway’s annual reports since 1977.

On that spring day in 2006, Buffett told Carol that he had changed his thinking about how and when he was going to give away his fortune in Berkshire Hathaway stock. Like most people, Carol knew that Buffett, after a small allocation to his three children, was going to leave 99 percent of his wealth to charity, but it was always thought it would go to the Buffett Foundation established by his late wife, Susan. Now he was telling Carol he had changed his mind. “I know what I want to do,” he said, “and it makes sense to get going.”1

So, shortly before lunch, on June 26, 2006, Warren Buffett, who was then the second richest man in the world, stepped up to the microphone inside the New York Public Library. The audience—hundreds of the wealthiest people in the city—greeted him with a standing ovation. After a few brief words, Buffett reached inside his jacket pocket and pulled out five letters. Each one announced the disposition of his fortune, and only awaited his signature. The first three letters were easy; he just signed “Dad” and then handed them to his children: daughter Suze, eldest son Howard, and second son Peter. The fourth letter was turned over to a representative of his late wife’s charitable foundation. Together, these four letters promised to give away a combined $6 billion.2

The fifth letter was the surprise. Buffett signed it and handed it to the wife of the only man on the planet who was richer than himself, Bill Gates. With that last letter, Buffett pledged over $30 billion in Berkshire Hathaway stock to the world’s largest philanthropic organization, the Bill and Melinda Gates Foundation. It was by far the single greatest amount of money ever given away, miles bigger than the contributions by Andrew Carnegie ($7.2 billion when adjusted to current dollars), John D. Rockefeller ($7.1 billion), or John D. Rockefeller Jr. ($5.5 billion).

In the days that followed, there were countless questions. Was Buffett ill, perhaps even dying? “No, absolutely not,” he said. “I feel terrific.” Did his wife’s passing have anything to do with his decision? “Yes, it does,” confessed Buffett. It was well known that Susie would have inherited Buffett’s fortune for the Buffett Foundation. “She would have enjoyed the process,” he said. “She was a little afraid of it, in terms of scaling up. But she would have liked doing it, and would have been very good at it.”3

But after his wife’s death, Buffett changed his thinking. He realized that the Bill and Melinda Gates Foundation was a terrific organization, already scaled to handle the billions of dollars Buffett was going to send its way. They “wouldn’t have to go through the real grind of getting to a megasize like the Buffett Foundation would—and they could productively use my money now,” he said. “What can be more logical, in whatever you want done, than finding someone better equipped than you are to do it?”4

It was quintessential Buffett. Rationality prevailed. At Berkshire Hathaway, Buffett reminds us there are scores of managers running businesses that do a much better job of running their operations than he ever could. Likewise, the Bill and Melinda Gates Foundation would do a better job of managing his philanthropy than he could do himself.

Bill Gates said of his friend, “Warren will be remembered not only as the greatest investor, but the world’s greatest investor for good.”5 This will most certainly be true. But it is important to remember that the good his philanthropic generosity will do was made possible in the first place by his unparalleled investing skill. When Buffett handed the letter and check for $30 billion to Melinda Gates, I immediately thought back to another check he had written 50 years earlier—for $100, his initial investment in the Buffett Partnership, Ltd.

Buffett has always claimed he won the ovarian lottery. He figures the odds of him being born in 1930 in the United States were about 30:1. He admits he couldn’t run fast and would never have been a good football player. Neither, despite his talents at plucking a ukulele, would he ever become a concert violinist. But he was “wired in a particular way” that would allow him “to thrive in a big capitalist economy with a lot of action.”6

“My wealth has come from a combination of living in America, some lucky genes, and compound interest,” said Buffett. “My luck was accentuated by my living in a market system that sometimes produces distorted results, though overall it serves our country well.” To keep it all in perspective, Buffett humbly reminds us that he happens to work “in an economy that rewards someone who saves lives of others on a battlefield with a medal, rewards a great teacher with thank-you notes from parents, but rewards those who can detect the mispricing of securities with sums reaching into the billions.” He called it fate’s capricious distribution of “long straws.”7

That may be true. But in my mind, Buffett carved his own destiny, which determined his own fate—not the other way around. This is the story of how Warren Buffett made his own long straw.

Personal History and Investment Beginnings

Warren Edward Buffett was born August 30, 1930, in Omaha, Nebraska. He was the seventh generation of Buffetts to call Omaha home. The first Nebraskan Buffett opened a grocery store in 1869. Buffett’s grandfather also ran a grocery store and once employed a young Charlie Munger, the future vice chairman of Berkshire Hathaway. Buffett’s father, Howard, was a local stockbroker and banker who later became a Republican Congressman.

It was said that as soon as Warren Buffett was born he was fascinated by numbers. That may be a stretch, but it is well documented that before he entered kindergarten he was already a calculating machine. As young boys, he and his best friend Bob Russell would sit on the Russell family porch recording license-plate numbers of the cars that passed by. When darkness fell, he and Bob would go inside, spread the Omaha World-Herald on the floor, and count the number of times each letter appeared in the paper. They then tallied their calculations in a scrapbook, as if it was top-secret information.

One of young Buffett’s most prized toys came from his Aunt Alice, who was quite fond of her peculiar but immensely likable nephew and made him an irresistible offer: If he would agree to eat his asparagus, she would give him a stopwatch. Buffett was mesmerized by this precise counting machine and used it in endless little-boy ventures, like marble races. He would summon his two sisters into the bathroom, fill the tub with water, and then direct them to drop their marble into one end. The one whose marble reached the drain stopper first was the winner (utilizing the tub’s sloped shape). Buffett, stopwatch at the ready, timed and recorded each race.

But it was the second gift from Aunt Alice that sent six-year-old Buffett into a new direction—a fascination not with just numbers, but with money. On Christmas day, Buffett ripped open his present and strapped onto his belt what would become his most treasured possession—a nickel-coated money changer. He quickly found many ways to put it to good use. He set up a table outside his house and sold Chiclets to anyone who passed by. He went door-to-door selling packs of gum and soda pop. He would by a six-pack of Coke at his grandfather’s grocery store for 25 cents and sell the individual bottles for a nickel: 20 percent return on investment. He also sold, door-to-door, copies of the Saturday Evening Post and Liberty magazines. Each weekend he sold popcorn and peanuts at local football games. With him through all these enterprises was his money changer, taking in dollars and making change.8

What now sounds like an idyllic childhood took an abrupt turn when Buffett’s father returned home one night to inform the family the bank where he worked had closed. His job was gone and their savings were lost. The Great Depression had finally made its way to Omaha. Buffett’s grandfather, the grocery store owner, gave Howard money to help support his family.

Fortunately, the sense of hopelessness did not last long. Howard Buffett soon pulled himself up and got back on his feet, announcing that Buffett, Sklenicka & Company had opened for business at the Union State building on Farnam Street, the same street where Buffett would someday buy a house and start his investment partnership.

The effect of the Great Depression, albeit brief, was hard on Buffett’s family. It also made a deep and profound impression on young Warren. “He emerged from those first hard years with an absolute drive to become very, very, very rich,” wrote Roger Lowenstein, author of Buffett: The Making of an American Capitalist. “He thought about it before he was five years old. And from that time on, he scarcely stopped thinking about it.”9

When Buffett turned 10, his father took him to New York. It was a birthday gift Howard gave to each of his children. “I told my Dad I wanted to see three things,” said Buffett. “I wanted to see the Scott Stamp and Coin Company. I wanted to see the Lionel Train Company. I wanted to see the New York Stock Exchange.”10 After an overnight ride on the train, Buffett and his dad made their way to Wall Street, where they met with At Mol, a member of the exchange. “After lunch, a guy came along with a tray that had all these different kinds of tobacco leaves on it,” recalled Buffett. “He made up a cigar for Mr. Mol, who picked out the leaves he wanted. And I thought, this is it. It doesn’t get any better than this. A custom-made cigar.”11

Later, Howard Buffett introduced his son to Sidney Weinberg, a senior partner at Goldman Sachs, then considered the most famous man on Wall Street. Standing in Weinberg’s office, Buffett was mesmerized by the photographs and documents on the wall. He took note of the framed original letters, knowing full well they were written by famous people. While Howard and Sidney talked about financial issues of the day, Buffett was oblivious, walking around and around Weinberg’s office staring at the artifacts. When it was time to go, Sidney Weinberg put his arm around Buffett and jokingly asked him what stock he liked. “He’d forgotten it all the next day,” Buffett recalled, “but I remembered it forever.”12

Even before Buffett traveled to New York, he was already intrigued with stocks and the stock market. He was a frequent visitor to his dad’s brokerage office, where he would stare at stock and bond certificates that hung on the wall, just like in Sidney Weinberg’s office. Often he would bounce down the two flights of stairs right into the Harris Upham brokerage firm. Many of the brokers became fond of the pesky kid who never seemed to stop asking questions. From time to time they would allow young Warren to chalk the prices of stocks on the blackboard.

On Saturday mornings, when the stock exchange was open for two hours, Buffett would hang out with his paternal great-uncle Frank Buffett and his maternal great-uncle John Barber at the brokerage office. According to Buffett, Uncle Frank was a perpetual bear and Uncle John was the ever-optimistic bull. Each competed for Buffett’s attention with stories of how they thought the world would unfold. All the while, Buffett stared straight ahead at the Trans-Lux stock ticker, trying to make sense of the continually changing stock prices. Each weekend he read the “Trader” column in Barron’s. Once he finished reading all the books on his father’s bookshelf, he consumed all the investment books at the local library. Soon he began charting stock prices himself, trying to understand the numerical patterns that were flashing by his eyes.

No one was surprised when 11-year-old Buffett announced he was ready to buy his first shares of stock. However, they were shocked when he informed his family he wanted to invest $120, money he had saved from selling soda pop, peanuts, and magazines. He decided on Cities Service Preferred, one of his father’s favorite stocks, and enticed his sister Doris to join him. They each bought three shares, for an investment of $114.75 each. Buffett had studied the price chart; he was confident.

That summer the stock market declined, hitting its yearly low in June. The two junior Buffetts saw their stocks decline 30 percent. Not a day went by when Doris did not pester ...