None of the following is investment advice.

Warren Buffett 2023 – “What gives you opportunities is other people doing dumb things.”

At 93 years old, Buffett says these words tongue in cheek to a crowd chock full of young investors, such that Michael Jordan might harangue an audience of old men. At 93 years old, Buffett has gained confidence and power that allows him to both see and exploit those opportunities. Throughout his career, he has endeavored to both learn the strategies that the most powerful people in world history have used and to package them up for us in books and interviews like so many boxes of his See’s Candies. In my view, Warren Buffett is the greatest human that has ever lived. If you want to empower yourself, study Buffett.

In this memo, I continue describing a remarkable change in Buffett’s strategy in the 1960’s, which needs to be described without philosophical reverie but with tangible, concrete details of his life. My aim is to show Buffett gaining that confidence and power which eluded him for years and of which he now talks of as if they were always his. In the prequel to this memo, I concluded that ‘the system’ has tended to keep running despite any issues, including inflation and moral hazards. Looking at Buffett’s portfolio today, there is no doubt that he invests significantly in the system’s continuation, rather than investing with a more complicated philosophy.

In the late 1950’s, Buffett met a Harvard educated attorney and son of a prodigious, erstwhile Harvard educated judge. This man was Charlie Munger, who, at the time, was in his early 30’s and ran his own fledgling law firm in Los Angeles. Although he was well versed in many disciplines of law, Munger specialized in structuring mergers and acquisitions, mostly in real estate. Though nearly all reports of Munger will describe a very hard early career, he seemed to have much success in learning from his many rather small mistakes, and, of course, he was critical to Warren Buffett’s success early on.

The first deal they significantly worked on together was Dempster Mill, a windmill company located near Buffett in Beatrice, Nebraska. From 1956, Buffett was buying this Microcap company at a valuation of around $2 Million. There was no way to buy this company outside of visiting shareholders at their homes to negotiate the price. Buffett, in his 20’s, visited shareholders, mostly around his home state of Nebraska, to buy this company, which he believed was worth more than twice what he paid. Buffett, after meeting Munger, seemed to determine that he could take control and name a new CEO to manage Dempster’s assets. If you have ever used a property manager for real estate, you will know that you can hire and fire property managers at will – this is what Buffett did at Dempster.

Fortunately, Munger was in business with a man, in Ventura, California, that was perfect for Buffett in Nebraska. This man, Harry Bottle, would sell off the assets, layoff Dempster’s employees, and realize Buffett’s more than 200% return. To reiterate, Buffett’s investment almost would have been impossible to profit from without Munger. Munger gave Buffett an entirely new dimension of power – a brilliant legal mind to complement Buffett’s brilliant financial mind.

Coincidentally, Buffett’s long-held, now-legendary investment in Sanborn Maps also became profitable shortly after meeting Munger. It’s no surprise to me that Buffett ramped up his ownership and control after being armed with Munger’s legal knowledge and network of potential operators like Harry Bottle.

Make no mistake, Munger has repeatedly explained how little he thought of Buffett’s early investments. Buffett soon agreed with Munger that “It’s far better to own a wonderful company at a fair price than a fair company at a wonderful price.” Anyone studying Buffett will know this quote, but how easily we gloss over it as tongue in cheek. Just like his other folksy quotes, it’s an incredible by-product of Buffett’s 80 years of experience.

Munger ostensibly rescued Buffett – from Buffett’s Dempster and Sanborn investments and from Buffett’s purchases of ‘cigar-butts’ which were nothing more than companies with horrible businesses but lots of marketable assets.

So, before the mid-60s, Buffett did not purchase well-known investments. In 1964, he bought American Express, in 1965, Walt Disney. Although he still dabbled in microcap companies, buying majority control almost in each case, Buffett seemed to opt for the conservativeness of very large businesses with stronger and stronger business models. He learned through Munger that problem businesses like the cigar-butts were not to be invested in, but avoided.

Sitting in downtown Omaha, earning a salary of only $50,000, Buffett naturally would concede that the decade following 1965 was most critical to his later success, despite now lamenting his investment in Berkshire Hathaway itself. Let’s take a look at some major transactions:

  • 1969 – Buffett* ends partnerships to focus on Berkshire Hathaway
  • 1972 – Buffett* purchases majority control of See’s Candy after being introduced to the company by Charlie Munger.
  • 1973 – Buffett* purchases influential stake of Washington Post
  • 1974 – Buffett* purchases majority control of Wesco Financial after being introduced to the company by Charlie Munger.
  • 1976 – Buffett* purchases majority control of GEICO

*Buffett used controlled entities to execute these transactions.

Here are the three most important takeaways I had when researching Buffett’s transition from cigar butt investing to the style he still uses today:

  1. Charlie Munger, a Harvard educated lawyer, was absolutely integral to Buffett succeeding. Using Munger’s advice was perhaps the greatest business move Buffett made in his investing career. Hence – get a good lawyer
  2. Buffett stopped needlessly wasting time and energy on companies with bad business models to focus on investing on companies with good business models. He began investing in the system rather than flipping poor businesses with surplus assets.
  3. Buffett bought large stakes (rather than small stakes) in businesses (rather than other assets like real estate), and he seemed to never care about the state of the economy.

Difficult times were sparked by a spike in Federal Funds’ rates from as low as 3% (1972) to as high as 12% (1974). During those years, Berkshire Hathaway A share prices careened from $80 to $38, meaning that the total valuation of A shares, more than cut in half, was roughly $55 Million at the lowest point. From Buffett’s report that year (Berkshire Hathaway’s Annual Report) – “We consider such market fluctuation of minor importance as our liquidity and general financial strength make it highly improbable that bonds will have to be sold at times other than those of our choice.”

1975 is the closest we get to seeing Buffett sweat. Many of the investments listed above that had been purchased in years prior simply continued dropping. He had no choice to hold them, and, as something of a victory lap the following year (1976), he listed out the holdings of Berkshire for the very first time. Almost 50 years later, Berkshire Hathaway A shares are now worth about 13,000 times that 1975 price. What would Berkshire be today without those purchases in the early 1970’s, purchased while share prices were dropping and/or stagnating?

Here’s another intuition that Buffett has that is unique to great investors – they can handicap duration of drawdowns; they know that those drawdowns won’t last, and at what prices they will trade at in the relatively near future. So what if American Express dropped 60% in a few weeks? It would come back because the strong business model. So what if interest rates became historically elevated? The country would come back because the system is strong. To be sure, American Express would continue on even stronger and the American system would continue on to thwart those higher rates.

And what of those liquidity advantages Buffett touted in the 1975 annual report? That liquidity advantage very likely led to Berkshire’s purchase of GEICO in 1976, which had no liquidity and was then close to bankrupt, having fallen from $61 per share in 1972 to then $2 per share. Buffett bought majority ownership in 1976.

Today’s Environment

For the first time in my career, I say with almost certain confidence that today’s economic variables really don’t matter to an investor. The vicissitudes of interest rates and money supplies seem little more than what Buffett describes as “all kinds of variables… arcane methods of approach.”

To qualify that – a professional investor must be able to assess the strength in businesses, which businesses are important enough to be systemic and to continue like American Express has. If you can buy those at ordinary prices, you’ll do fine. If you buy them as Buffett did (AmEx at a 60% discount), you’ll do exceptionally well. It’s not terribly easy to assess business strength, and that’s why you will find certain great businesses at those discounted prices from time to time.

Arguably, Buffet’s oft-mentioned circle of competence is simply not betting in those things that don’t have power and strength, opting for those that do. It’s romantic to bet on the underdogs, but if Buffett teaches us anything, you can’t win very consistently by doing so. Bet on the big guys. Bet on the system.

Most importantly on this subject, the time you save on not worrying about these economic variables can lead you to find more power and confidence in yourself. You can find someone like Munger that can not only be an incredible business resource, but also a lifelong great friend. After all, even Pharaoh Tutankhamun had his lawyer Horemheb.

The American Dream

Is it important to understand what Buffett has done? As stated previously, I believe Buffett is the greatest human that has ever lived. He strived to learn the ways of the most powerful people throughout history, assimilate his own behavior to theirs, and then teach everyone he could about those behaviors. It’s all there – centuries of opaque power strategies packaged in books and interviews like so many bottles of Coca Cola.

Why does Buffett have so much faith in the American system? This is not a question that can be answered, and I don’t aspire to give a complete answer, though a strong compulsion of Americans has been to work hard and be rewarded, a dynamic historically outsized when compared to any other nation in the world, past or present. In other words, the American Dream and the system of America itself promises with unyielding precedence that if you work hard, you will be rewarded in ways unknown in any other culture. Should a group of people with such a dream get together and dream together, you have such a powerful system.

Such a realization is pure brilliance. Why would Buffett spend his time toiling in fields or buying cigar butts when he can produce more by capitalizing on the system itself? Buffett dreamed as big as he could because he knew the most powerful people in the world didn’t work in the fields nor did they toil at all. They let the American Dream work for them.

Historically, Buffett has done so well because, in those early days with Munger, he began looking for strength in businesses and himself. What he found is his message – that America will continue that dynamic of outsized work and reward. If we believe what Buffett did and does, we will never again question politics, infrastructure, or important decisions. We will instead discover a strength that we never knew we had, and a confidence that is the greatest reward of believing in the system. This is Buffett’s America. This is our America.

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