Buffett: The Making of an American Capitalist

by Roger Lowenstein

The average home buyer probably looks at more pieces of paper than Buffett did in spending $60 million. His approach seems strange in a modern context, but it was in accord with the notion of J. P. Morgan, Sr., that the principal judgments in business are those concerning character.

store. In a spiritual sense, the Mart replaced the red-brick New Bedford textile mill as the company’s flagship. In fact, Buffett made about as much money in fifteen months in furniture as he had in nineteen years in textiles. The comparison is illustrative, because the Hathaway mill was everything the Mart was not. The mill was indistinguishable from its competitors; the end consumer didn’t know it existed.

Whereas the fast turnover at Mrs. B’s resulted in precious little capital being tied down in inventory, the textile mill consumed capital. Every time one manufacturer upgraded its plant, Berkshire’s mill and all the rest were forced to match it. Thus, no one would gain any advantage—any moat—but every manufacturer would have sunk in more capital.

Buffett drew from this a broad maxim: a good manager was unlikely to overcome a bad business.

“A horse that can count to ten is a remarkable horse—not a remarkable mathematician.”35 And a brilliantly run textile firm was not a brilliant business.

One time, when Buffett was speaking off-the-cuff to a group at Cap Cities, he was asked what techniques he recommended to managers. He launched into a tale about a stranger in a small town. The fellow wanted to get acquainted with folks, so he went over to the village square and saw an old-timer with “kind of a mean-looking German shepherd.” Buffett continued: He looked at the dog a little tentatively and he said, “Does your dog bite?” The old-timer said, “Nope.” So the stranger reached down to pet him and the dog lunged at him and practically took off his arm, and the stranger as he was repairing his shredded coat turned to the old-timer and said, “I thought you said your dog doesn’t bite.” The guy says, “Ain’t my dog.”28 The moral for managers: It’s important to ask the right question.

“Hey, Steve,” he said, “you know, when you go into a poker game, you look around, there is always one patsy. If you look around and you can’t tell who the patsy is, that’s ’cause it’s you.”

This spartan style was part of a deliberate effort to minimize what Buffett termed “institutional dynamics.”37 he had hired a floor of traders, they would have found something to trade; lawyers, no doubt, would have found someone to sue. A compact organization lets all of us spend our time managing the business rather than managing each other.

The modern era is one of specialization; it has, in fact, made a cult of specialization. This is why historians churn out dissertations on shoe sizes in Bonapartean France and why the average pro football team now has a larger staff than did President Coolidge. In the corporate suite, its manifestation is chronic overstaffing. The common thread is that historians, football coaches, and CEOs are equally fearful of shouldering, or even delegating responsibility for, big decisions.

As CEO, Buffett hired (and, potentially, fired) the operating managers. He controlled their capital in-flow or out-flow. His third, unspoken job was motivating his managers-some of whom, such as Stan Lipsey, were his friends, but many of whom were not.

okay. But Buffett made it clear that he didn’t want to spend a lot of time answering questions.5 What he did do was provide Goldberg’s group with a strong sense of direction.

Convertibles are the half-breeds of Wall Street. They have attributes of a bond: a fixed coupon and security of principal. They also enable a holder to convert to common stock. They are aptly described as Treasury bills with a lottery ticket attached. The holder has a safe investment and a chance to make a killing—though not as big a profit as on ordinary common.

Buffett was not making a forecast; he was merely obeying two cherished rules. Rule No. 1: “Never lose money.” Rule No. 2: “Never forget Rule No. 1.” Munger said, “Warren would never claim that he could call the market.” But perhaps Buffett had been glancing a bit more anxiously at the newspaper clipping on his wall—the one from 1929. In the week following, interest rates climbed above 10 percent. Japanese shares continued to rise, but now no one on Wall Street cared about Japan. On Friday, October 16, the Dow plunged 108 points.

The premise of Buffett’s career was that stockpicking, though difficult and subjective, was susceptible to reasoned analysis. Occasionally, certain stocks sold for far less than they were “worth.” An astute investor could profit by buying them. In place of that rather modest maxim, scholars had substituted a seductively simple but unifying design, the Efficient Market Theory. In a nutshell, the theory said that at any moment, all the publicly available information about a company was reflected in the price of its stock. Whenever news about a stock became public, traders pounced, buying or selling until its price reached equilibrium. Underlying this truism was an assumption that the old price had been as “wise” as traders could make it. Therefore, the new price—and each succeeding new price—would be wise as well. The traders merely did the work of Adam Smith’s Invisible Hand.

Since everything worth knowing about a company was already in the price, most security analysis was, to cite a popular text, “logically incomplete and valueless.”2 The future course of a stock would depend on new (as yet unknowable) information. A stock, then, was unpredictable; it followed a “random walk.”

If markets were random, investing was a game of chance. Buffett, then, was a lucky investor but not a skillful one, just as the person who repeatedly got heads when flipping a coin was a lucky—not a skillful-flipper. This challenged nothing less than the validity of Buffett’s career. Buffett’s record also posed a challenge, for it was the inconvenient fact that failed to follow the form. Buffett would taunt the scholars with the evid...

One striking contrast was in the rival camps’ definition of “risk.” Risk, to Buffett, was the risk of paying more than a business would prove to be worth. And the range of variables was nearly infinite. Was a company dependent on too few customers? Did the chairman drink? Since the sum (or even the number) of such risks could not be figured with precision, Buffett looked for companies—the very few companies—in which the risks seemed tolerable even allowing for error.

“He told me very frankly he didn’t think education was enhanced by money and secondly that he didn’t think business schools were teaching the things he wanted to support. He was very hostile to the idea of efficient market research.”

Futures are zero-sum bets on the market direction. They do not raise capital for business, which is the essential purpose of the stock market. They do not represent a stake in a business—merely a stake in a wager.

With this notion of value in mind, Buffett tried to find stocks whose “value” was greater—significantly greater—than their price. Buffett’s guides to finding such a stock could be summarized quickly: • Pay no attention to macroeconomic trends or forecasts, or to people’s predictions about the future course of stock prices. Focus on long-term business value—on the size of the coupons down the road. • Stick to stocks within one’s “circle of competence.” For Buffett, that was often a company with a consumer franchise. But the general rule was true for all: if you didn’t understand the business—be it a newspaper or a software firm—you couldn’t value the stock. • Look for managers who treated the shareholders’ capital with ownerlike care and thoughtfulness. • Study prospects—and their competitors—in great detail. Look at raw data, not analysts’ summaries. Trust your own eyes, Buffett said. But one needn’t value a business too precisely. A basketball coach doesn’t check to see if a prospect is six foot one or six foot two; he looks for seven-footers.

• The vast majority of stocks would not be compelling either way—so ignore them. Merrill Lynch had an opinion on every stock; Buffett did not. But when an investor had conviction about a stock, he or she should also show courage—and buy a ton of it.

They had a long discussion, in which Warren explained that if he were the quarterback of the Nebraska football team it wouldn’t be fair of him to pass down the job to a son or daughter, and that he felt the same about his money. This was a “rational” response with his daughter’s “best interests” in mind. That was the rub; it was too rational, as if Susie had been just anyone. His daughter was troubled by it.6

Traditional charities would have “spent” his money. On the other hand, giving to population control could be construed as “investing”—sort of a global share buyback—because it would reduce the number of future divisors clamoring for the social pie. Charlie Munger, who was equally Malthusian, articulated this mind-set at a party for Keith Russell, a doctor who had been a Munger-Buffett ally in the Belous abortion rights case in California. After some of Russell’s patients presented a toast to the many babies he had delivered, Munger rose, glass held high, and solemnly declared, “I want to toast Dr. Russell for the thousands of babies he didn’t deliver.”

Once, at a Q&A at Cap Cities, Buffett was asked how he would rewrite the tax code. “If I really could do it, it would shock you,” he said. He’d tax the hell out of personal consumption—at progressively higher rates—and impose an “enormous” inheritance tax. If I want to run around in a jet, which I do, fine, I have the claim checks to pay for it, but that should be taxed heavily, because I am withdrawing people, fuel and so on—resources—from society.

Buffett blamed himself in a deeper sense, too. He had understood the dynamics of airlines—lots of competition, high fixed costs—but invested anyway. In public, he was up-front about this mistake. With a touch of Will Rogers, he wrote to his shareholders, “No one pushed me; in tennis parlance, I committed an ‘unforced error.’ ”48 It was easily his worst investment, and violated Buffett’s own guidelines.

Buffett’s emphasis on reputation was oddly reminiscent of Morgan’s testimony that character—not money—was the basis of credit. There the similarity ended. Morgan, whatever else, epitomized Wall Street. Buffett, who had made a fortune in the stock market, was hailed as a Main Street antidote to Wall Street’s excesses.

Our pay-for-performance philosophy will undoubtedly cause some managers to leave.… In the end we must have people to match our principles, not the reverse.

As painful as such betrayals were, Buffett relentlessly insisted that Salomon was on track. When the dust settled, he maintained, Salomon would be stronger, in all areas, than ever. No one on the staff saw him waver, even in the slightest. This was Buffett’s essential virtue—the courage to stick to his course. Don Howard, the chief financial officer, said, “He conveyed to me that every problem was surmountable.”

Buffett’s moves of the early nineties may be quickly sketched. After the Soviet Union collapsed, there was talk of a peace without end, and defense stocks were cheap. Buffett scooped up 14 percent of General Dynamics at 11 a share.1 Rather soon, a civil war raged in the former Yugoslavia, utopia was put on hold, and General Dynamics went to