Buffett: The Making of an American Capitalist

by Roger Lowenstein

Buffett’s genius was largely a genius of character—of patience, discipline, and rationality.

Unlike the modern portfolio manager, whose mind-set is that of a trader, Buffett risked his capital on the long-term growth of a few select businesses. In this, he resembled the magnates of a previous age, such as J. P. Morgan, Sr.

He once wrote that he would no more take an investment banker’s opinion on whether to do a deal than he would ask a barber whether he needed a haircut.

From the start, Warren was cautious beyond his years. When he learned to walk, it was with his knees bent, as if ensuring that he wouldn’t have far to fall. When his mother took Doris and Warren to church-circle meetings, Doris would explore and get lost, but Warren would sit dutifully by her. “Never much trouble as a little child,” Leila would write.

He adopted his father’s ethical underpinnings, but not his belief in an unseen divinity. In a person who is honest in his thoughts, and especially in a boy, such untempered logic can only lead to one terrifying fear—the fear of dying.

Graham’s approach—an oddity in the speculative climate of the late 1920s—was to look for companies that were so cheap as to be free of risk. In 1926, for example, he discovered that Northern Pipe Line, an oil transporter, owned, in addition to its pipeline assets, a portfolio of railroad bonds worth $95 for each of its shares. Yet the stock was trading for only $65.

Loeb stressed that the thing to watch was not the earnings of an enterprise but the public psychology: The importance of full consideration of popular sentiment, expectations and opinion—and their effect on the price of the security—cannot be overstressed.

Security Analysis offered an escape from such a trap. Graham and Dodd urged that investors pay attention not to the tape, but to the businesses beneath the stock certificates. By focusing on the earnings, assets, future prospects, and so forth, one could arrive at a notion of a company’s “intrinsic value” that was independent of its market price.

The market, they argued, was not a “weighing machine” that determined value precisely. Rather, it was a “voting machine,” in which countless people registered choices that were the product partly of reason and partly of emotion.18 At times, these choices would be out of line with rational valuations. The trick was to invest when prices were far below intrinsic value, and to trust in the market’s tendency to correct.

Left unresolved was the nagging question of what to do when a cheap stock, after its purchase, became even cheaper. For if prices were sometimes wrong, the authors admitted, it could take an “inconveniently long time” for them to adjust.23 The answer appeared the year before Buffett arrived at Columbia. The Intelligent Investor boiled Graham’s philosophy down to three words—“margin of safety.”24 An investor, he said, ought to insist on a gap—a big gap—between the price he was willing to pay and his estimate of what a stock was worth. This was identical to leaving room for error in driving an automobile. If the margin was great enough, the investor ought to be safe. But what if he was not? Suppose, that is, that the stock kept dropping. Assuming that nothing about the business had changed, Graham said, the investor should pay no heed to the ticker, no matter how grim its tidings.

At Columbia, Buffett found that Graham was personally captivating. He looked a good deal like Edward G. Robinson, and his lectures had an air of drama. In one class, Graham depicted the vastly different balance sheets of Company A and Company B. It turned out that each was Boeing—at an up and down moment in the aircraft manufacturer’s history.

Every stockpicker worth his salt eventually comes to such a crossroads. It is extremely difficult to commit one’s capital in the face of ridicule—and this is why Graham was invaluable. He liked to say, “You are neither right nor wrong because the crowd disagrees with you.”38 Picking a stock depended not on the whim of the crowd, but on the facts. And Buffett took this to heart, partly because he saw Graham in idealized terms—as a “hero,” like his father.39

Anyway, there was no way that Buffett was going to wait. Having racked up the only A+ that Graham had awarded in twenty-two years at Columbia,45 Buffett made what seemed an irresistible offer: to work for Graham-Newman for free. But Graham turned him down. These were the days when Jews were locked out of Wall Street’s gentile firms, and Graham preferred to hold his spots for Jews.46 † (Morgan Stanley would not hire its first Jew until 1963.)

Buffett turned it down, preferring the familiar confines of Buffett-Falk & Co., his father’s brokerage. A friend of Howard’s asked: “Will you be known as Buffett & Son?” “No,” Warren cracked. “Buffett & Father.”49

“To be free of pain is a great state of being. I learned that at a very young age.”

I will tell you the secret of getting rich on Wall Street. [Pause.] Close the doors. You try to be greedy when others are fearful and you try to be very fearful when others are greedy.§

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?”

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.

One year, about 1961, when Warren and Susie were visiting the Oranses in New York, Buffett spent much of the evening arguing that overpopulation was the world’s most serious problem. It was a typically Buffett-like position: logical and mathematically derived. Also, it touched on his morbid fear for human survival. But Buffett wasn’t confrontational about it; his touch was much lighter. Quoting Jane Orans: He injected it all with humor. He was very convincing, very logical, but it wasn’t lecturing. He made you feel you had reached the same conclusion with him, though obviously he had given it more thought. When he left you felt he had shaped the evening, but you didn’t feel that you hadn’t enjoyed it.

Physically, Munger was unimpressive. He had an elfin face, pasty skin, and glasses an inch thick. Though something of a snob and highly judgmental, he had a deep sense of ethics. His smarts were matched by a Churchillian self-assurance and joie de vivre. Asked once if he could play the piano, Munger replied, “I don’t know, I never tried.” Buffett saw in him a kindred intellect and blistering independence.

Three things had made it work: the initial bargain price, Buffett’s patience in holding on, and his and Bottle’s turnaround.

This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.

Warren was emphatically on the other side. He quit the Omaha Rotary Club specifically because he objected to its racist and elitist policies.34 Discrimination collided with his belief in merit and his faith in neutral yardsticks, which lay at the heart of his investing. In the same vein, he thought it was wrong that rich kids got a big head start over everyone else.

One wonders how such silk-stocking paragons could be so gullible. The answer is, they were afraid to be left behind. The choice was to buy the popular stocks, which, after all, were rising, or to risk momentarily lagging the pack. And those who lagged, even for a quarter or two, could not raise new capital. For a money manager in the Go-Go days there were no second acts.

30 In Munger’s view, it was better to pay a fair price for a good business than a cut rate for a stinker.

“It takes twenty years to build a reputation and five minutes to ruin it. If you think about that you’ll do things differently.”

“Price is what you pay, value is what you get.”

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.

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.

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.

He was stingy about paying Chace, who made less than competitors at other textile mills.40 In 1970, after Chace had been at the helm for five years, his salary was $42,000 a year. Also, Buffett tightened up considerably—as did other textile companies—on the pension plan. “Warren had a strong negative feeling about management benefiting at the expense of shareholders,” Chace noted. Yet Chace deeply appreciated his autonomy under Buffett and was extremely devoted to him. This says a lot about Buffett’s effect on people. Though he wouldn’t loosen his wallet, he was uncanny as a motivator.

Like his father, he hated free riders (e.g., his disdain for stock options), but he saw more of them within the country clubs and boardrooms than without. Once, at a formal dinner, when a guest complained about the cost of welfare programs for the poor, Buffett replied tartly, “I’m a lot more concerned about welfare for the rich.”

He would run his finger down the price-earnings column of the stock table, and practically every P-E was in single digits. It was one of those rare times on Wall Street: America was being given away, and nobody wanted it. Buffett’s reaction was instinctive: Be greedy when others are fearful.

Buffett’s decision to sell notes was based on a Buffett rule of thumb: get the money when it is cheap. (If you wait to borrow until you need a loan, it is likely to be when others are also borrowing, when—perforce—rates will be higher.)

It’s a lot different going out to Kalamazoo and telling whoever owns the television station out there that because the Dow is down 20 points that day he ought to sell the station to you a lot cheaper. You get into the real world when you deal with a business. But in stocks everyone is thinking about relative price. When we bought 8 percent or 9 percent of the Washington Post in one month not one person who was selling to us was thinking that he was selling us $400 million [worth] for $80 million. They were selling to us because communication stocks were going down, or other people were selling, or whatever reason. They had nonsensical reasons.

Buffett was as fearful of inflation as anyone. His response was to hunt for stocks, such as newspapers, that would be able to raise rates in step. Similarly, he avoided companies with big capital costs. (In an inflationary world, capital-intensive firms need more dollars to replenish equipment and inventory.)

Buffett chose to ignore this view and stay within “the realm of his specialty.” He could not size up how the country’s problems would influence the shares of the Washington Post. His genius was in not trying. Civilization is too variegated, its dynamics far too rich, for one to foresee its tides, let alone the waves and wavelets that affect securities prices. Wars would be won and lost; prosperity would be hailed as everlasting and bemoaned as ne’er recurring, as would politics, hemlines, and the weather enjoy their seasons. Analyzing them was Wall Street’s great game—and its great distraction. In its floating salon, everything was interesting and nothing was certain—the President, the economy, the effect of OPEC on sales of Pepsi-Cola. None of these would substitute for critically evaluating an individual stock. When you purchased a share of Washington Post stock, ultimately you would not be rewarded on the basis of whether war broke out in the Middle East. You were buying nothing more, nothing less, than a share of the business—a claim on the future profits of its publishing and television assets. Yet if you knew what the Post, or any one business, was worth, it rang with the clarity of a single note. That was the sound Buffett strained for. Nothing else mattered, least of all the thousand cacophonous voices debating the future. Stein was searching for a glimpse of “more stable and anticipatable times,” but Buffett was unwilling to wait. As he had once told his partners,...

Investing, he reminded them, did not require a genius. What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character.

Munger was so deeply skeptical of his fellow man that Buffett dubbed him “the abominable no-man.” This, in fact, provided a clue to Munger’s unique talent as Buffett’s consigliere. His approach to life—of particular use to an investor—was to ask what could go wrong. He liked to quote the algebraist Carl Jacobi: “Invert, always invert.” Thus, at a high school commencement, Munger gave a sermon not on the qualities that would lead to happiness, but on those that would guarantee a miserable life. Always

Blue Chip belonged to a fading slice of Americana. It collected a fee from supermarkets that distributed its trading stamps and redeemed these stamps for “free” toasters, lawn chairs, and the like. Buffett, of course, had no interest in toasters. He was interested in the money. The secret of its appeal was that Blue Chip gathered in cash up-front, but disgorged its funds only over time, as shoppers brought in stamp books. Often the stamps were stuffed into drawers and forgotten. In the interim, Blue Chip had free use of the float. To Buffett, Blue Chip was simply an insurance company that wasn’t regulated.

Investors often assume that book value approximates, or at least is suggestive of, what a company is “worth.” In fact, the two express quite different concepts. Book value is equal to the capital that has gone into a business, plus whatever profits have been retained. An investor is concerned with how much can be taken out in the future; that is what determines a company’s “worth” (or its “intrinsic value,” as Buffett would say).

The daughter of Eugene Meyer, a financier-cum-statesman and head of the Federal Reserve Board, and a worldly but indifferent mother, Graham grew up with the peculiar loneliness of the rich. She was raised in a world of governesses and private schools, and was accustomed to receiving replies to her letters from her mother’s personal secretary.

Buffett’s point was that overall growth didn’t matter—merely growth per share.

Buffett sensed that his wife needed a Washington Post in her life. At one point, referring to their nearly grown kids, he said, “Susie, you’re like somebody who has lost his job after twenty-three years. Now what are you going to do?”23

Opportunities were missed, but he saved the Post from the business error that is truly a tragic error—throwing the profits from a good business into a bad one.

What he had retained from Graham was “the proper temperamental set”—that is, the principle of buying value, the conservatism embedded in Graham’s margin of safety principle, and the attitude of detachment from the daily market gyrations.

Buffett figured that well-known consumer brands, such as Post cereals and Winston cigarettes, would be able to raise prices at a pace with inflation. He also bought hard-commodity stocks, such as Aluminum Co. of America, Cleveland-Cliffs Iron, Handy & Harman, and Kaiser Aluminum & Chemical. But as Buffett would remind his readers, neither Berkshire nor anyone had a “remedy” for the problem. Inflation was a “gigantic corporate tapeworm” that “preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism.”

“In the long run,” Buffett warned, “managements stressing accounting appearance over economic substance usually achieve little of either.”46

One question Buffett always asked himself in appraising a business is how comfortable he would feel having to compete against it, assuming that he had ample capital, personnel, experience in the same industry, and so forth.