Buffett

by Roger Lowenstein

  In fact, the big agencies had been quite stable. What’s more, because Wall Street was so gloomy, Buffett and Ruane were buying them in the subbasement range of three to four times earnings.

  By 1974, Berkshire owned 17 percent of Interpublic. Alarmed that Buffett might be thinking takeover, Carl Spielvogel, an executive vice president, called to ask what his plans were.

  Buffett chuckled. “My plans?”

  Now, Spielvogel was really worried. Buffett invited him to stop in Omaha the next time he flew to the West Coast. “By coincidence, I’m going to California next week,” Spielvogel lied. In Omaha, he remembered, “it must have been about minus ten degrees. I was slipping and sliding. I wasn’t wearing galoshes because I was supposedly on my way to California.”

  Buffett assured Spielvogel that he had bought Interpublic as an investment. He spun out his philosophy: toll bridges, Ben Graham … the entire catechism. To Spielvogel, it all sounded too simple. Being wise to Madison Avenue, he was not prepared for a prairie philosopher. He didn’t believe Buffett.33

  This was not surprising. Despite Buffett’s activity in the market, he was still rather invisible. His letters in Berkshire’s annual reports were factual and terse, with none of the flourish of his partnership letters. And Berkshire Hathaway was more invisible still.

  Its annual meetings were held in New Bedford, in Seabury Stanton’s old ivory tower. After the formal business, Buffett would throw the meeting open to questions. It was a once-a-year shot to ask Buffett about investing. But hardly anyone showed up. Conrad Taff, who had taken Graham’s class with Buffett, and Taff’s brother Edwin, a security analyst, would attend, so Buffett would spend hours taking questions from the Taffs.34

  There was so little interest in Berkshire that newspapers didn’t quote its share price. Anyone in the public could have bought the stock and gotten a free ride on Buffett’s coattails (without paying an override, as in the partnership). But interest in it was nil. After hitting a high of 87 in mid-1973, Berkshire slumped with the general market. In 1974, it retreated, sickeningly, to 40. According to Edwin Taff:

  There was a general disinterest, even among investment pros who knew Warren. One guy said he’d rather buy it at 80. He wanted to see it move. Warren’s announcement that he was retired threw people off.

  Buffett, though, seemed to have some future for Berkshire in mind. He was steadily buying more of it. He even told his friends in the securities business to lay off, so that when some of the thinly traded stock became available he could get first dibs.35 Charles Heider, Buffett’s broker in Omaha, said, “Warren didn’t like anyone buying Berkshire.” Buffett was so set on firming up his control that he asked Verne McKenzie, the treasurer, not to invest in his own company. (Buffett finally told McKenzie he could go ahead in 1978—twelve years after McKenzie had been hired.)

  Meanwhile, the stocks Buffett had bought for Berkshire were sinking. By the end of 1973, the market value of Berkshire’s portfolio, which had cost a total of $52 million, had sunk to only $40 million. Buffett wrote to the Rockford Bank’s Gene Abegg:

  However poorly you may think the [bank] Plan did during 1973, be assured that my record was even worse. It’s a good thing for my partners that I terminated the Partnership when I did.36

  His paper losses worsened significantly in 1974. And his net worth, as measured by Berkshire’s price, fell by half. Yet it seemed to dampen his spirits not at all. Stan Perlmeter, a money manager who also worked in Kiewit Plaza, said, “You couldn’t tell from talking to him that Warren was aware of it.”

  Buffett’s rare ability to separate his emotions from the Dow Jones Industrial Average was a big part of his success. In the sixties, when he had been making tons of money, he had been full of fearful prophecies. But now, with his portfolio underwater, he was salivating. Writing to Berkshire’s shareholders, his optimism was evident:

  We consider several of our major holdings to have great potential for significantly increased values in future years, and therefore feel quite comfortable with our stock portfolio.37

  One such holding, Affiliated, reported a 40 percent earnings increase for 1973. Nonetheless, the stock fell like a stone. Having gone public at 10 a share, it sank within months to 9, 8, 7½—less than five times earnings. This was the acid test of an investor. When a stock drops by 25 percent, it is only human to wonder if one has made a mistake. Buffett, though, truly believed that he knew better than the crowd. On January 8, 1974, he bought more Affiliated—and more still on January 11 and January 16. He was back in the market on February 13, 14, 15, 19, 20, 21, and 22. He went on all year, like a thirsty man holding a bucket out in the rain. He bought Affiliated on 107 days, down to a low of 5½ a share.

  The market collapse of 1973–74 has been oddly ignored in the annals of investing. Yet it was truly epochal, and on a par with the 1930s. Stocks fell from the sky and sat like overripe fruits. Fund managers who had been eager to buy the nifty fifty at eighty times earnings were unwilling to buy Affiliated at five times. What these managers feared was the possibility not of being wrong, but of being out of step. They were worried about being second-guessed—not over the long term, but quarter by quarter. An interview with Eric T. Miller, a manager at Oppenheimer, in the Wall Street Transcript, stands as a sort of period piece. Miller lived in the pristine suburb of Bronxville, New York. He enjoyed racquet sports. He did not enjoy bear markets.

  I wish we could say that we have strong preferences for areas that are unique right now, but we don’t, partly because we don’t think it’s time to try to be a hero … to be terribly venturesome, unless you could put me on [an] island and we were taking a three-year view.38

  It was, it needs repeating, the ideal time to be a hero. Yet where managers had once been willing to gamble on the most dubious of stocks, they now refused the soundest. Where optimism had been second nature, it was now unknown. Fear was all they had left.

  The headlines in 1974 described the ever-worsening funk. Business Week: “Whistling Past the Graveyard”; Forbes: “Why Buy Stocks?” Business Week: “The Sickening Slide”; Banon’s: “Running Scared”; Forbes: “The Gloom Is Deepening”; Forbes: “Uncharted Waters”; Fortune: “A Case for Gloom About Stocks”; Forbes: “Is the Economic Situation out of Control?”

  The economy was in a recession, and the usual solution of priming the pump was unavailable. Inflation in 1974 was 11 percent. This was a novel predicament, unknown even in the thirties: inflation and recession. The cure for each seemed ruled out by the presence of the other. Economists coined an ugly word: “stagflation.” Interest rates soared to twentieth-century highs. Government was at a loss—and increasingly distracted by the question of what the President knew about Watergate and when he had known it. Nixon ventured the opinion that he was not a crook. Wall Street held its breath. In political circles, the talk was of impeachment; in financial circles, of depression.

  Internationally, American capitalism was in retreat. The Third World was organizing cartels, spurred by the success of OPEC. Economists held that the millennium of growth was over; it only remained to divide a fixed pie into smaller shares. The evidence was plain at the corner gas station.

  Wall Street wore the country’s dismal mood for a mask. The nifty fifty stocks plunged by 80 percent. Peak to trough, Polaroid went from 149 to 14⅛, Xerox from 171 to 49, Avon from 140 to 18⅝. Morgan Guaranty, the largest pension-fund manager on the Street and a rigid adherent of the nifty fifty, lost an estimated two-thirds of its clients’ money. Bankers Trust stopped buying equities for its trust accounts altogether. Paradoxically, it was time to be buying every stock in sight.

  The Dow ended July at 757. By September, it had plunged to 607. As measured by the Dow, 40 percent of American industry had evaporated into thin air. But the Dow did not begin to measure the damage. Since 1968, the average stock had fallen an astonishing 70 percent.39 On a single summer day, 447 stocks touched new lows. The old-timers’ refrain that things had been much worse in the Depression no l
onger played. The bear market was in its sixth year—twice as long as the bear of 1929–32.

  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.)

  What Buffett did not do was buy or sell stocks on the basis of macroeconomic predictions. In an extreme case, Yarnall, Biddle & Co. of Philadelphia urged clients to sell shares of Coca-Cola, Pepsico, Dr Pepper, and Seven-Up because of the energy crisis:

  Already supermarkets are noticing a trend for shoppers to make fewer trips while buying more per trip. Shoppers may be increasingly unwilling to load up on the relatively bulky soft drinks.…40

  Invited to speak at the Harvard Business School—which had stunned him with a rejection years earlier—Buffett remarked that investors were behaving in an irrational and “manic depressive” fashion. Perhaps he had in mind Howard Stein, who had appeared the previous week at the New York Society of Security Analysts. Stein was the chairman of Dreyfus, an investment firm known for a long-running television commercial in which a lion prowled the byways of Wall Street. But now, the lion sounded more like Chicken Little. Stein admitted that stocks were cheap, but he was obsessed with “the enormity of the problems confronting us.” He envisioned a fearful new world of scarcity, in which the standard measures of value would no longer apply:

  Price-earnings ratios, historic gains in earnings, projections of earnings per share and the many other analytical devices that you and I work with seem to have little relevance of late.… For so much that will affect security prices, I feel, will be influences emanating from outside any particular industry—causing the better analyst to lift his eyes and stretch his imagination beyond the immediate realm of his specialty.41

  In Stein’s apocalyptic vision of a world spinning off its axis, earnings per share no longer mattered. 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, the future was never clear. What was very clear to him was that certain securities were available for less—far less—than the value of their assets. Everything else—his son’s strained back, the cries of Chicken Little—he cleared away.

  There remained Stein’s labored question as to whether the old standards of value had been outlived. One recalls Graham’s response to Senator Fulbright, who had asked him two decades back: Why would stock prices, even if cheap, necessarily go up?

  That is one of the mysteries of our business.

  In September, Graham emerged from retirement to speak to security analysts, urging them to awaken to what he termed a “renaissance of value.” 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.42

  There were others, such as Bill Ruane and John Neff, who said publicly that it was time to take the plunge. But in the main, the Street indulged in a Hamlet-like exercise in navel-gazing. “To Be or Not to Be—in Stocks,” wondered the Wall Street brokerage Hayden Stone. The facts were clear; P-Es were at postwar lows, stocks were cheap. Yet Hayden Stone agonized:

  So many problems remain that this time things may not work out.… our whole social structure is so different.… no one can predict.… can we comprehend and cope?43

  It made one’s head hurt. Hayden Stone advised postponing major stock purchases “until there is more certainty.” Would someone kindly ring a bell, advising Hayden Stone in advance of the market’s turn? What was missing was not intelligence but, as Graham suggested, moral fiber: the “firmness of character” to act on one’s beliefs. At that point—early in October 1974—Buffett, for the first time in his life, made a public prediction about the stock market. The occasion was an interview with Forbes. The Dow Jones Industrial Average was at 580.

  “How do you feel?” Forbes asked.

  “Like an oversexed guy in a whorehouse. This is the time to start investing,” Buffett said.

  His doubts about the future had vanished. His stock was at a low, but his sap had never been higher. Berkshire was stuffed with securities, and Buffett was buying them day by day.

  I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.44

  He had quit in 1969, but now, with the market at a low, his spikes were laced and his bat was cocked. There was no “To Be or Not to Be,” no equivocation. As he said to Forbes, “Now is the time to invest and get rich.” Buffett was back.

  * For comparison with current prices, by 1995 Post shares had split four-for-one.

  † Buffett was still as secretive as possible. However, all investors are required to disclose 5 percent holdings.

  Chapter 9

  ALTER EGO

  Howard Buffett, Warren’s older son, thought his father was the second-most-intelligent man he knew. The smartest, in his estimation, was his father’s West Coast philosopher friend Charlie Munger. To the writer Morey Bernstein, Munger was “the real mystery man,” the quirky thinker who stood a heartbeat away. Munger was Buffett’s sounding board; Munger—and only Munger—he let into the tent. The two of them had a peculiar symbiosis and, as in a good marriage, an aura of inevitability. Dr. Edwin Davis, who had helped to arrange their meeting, had been impressed by their similar mannerisms and wit. Buffett’s daughter thought them “clones,” walking with the same foot forward and even bearing a slight resemblance.

  Yet where Buffett was cheerful, his Los Angeleno compadre was dour. He lacked Buffett’s easy grace and suffered fools not at all. Frequently, he did not bother to say goodbye, preferring to bolt from his chair at the conclusion of his business.

  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 invert.

  Buffett had used Munger as his lawyer in a couple of acquisitions, and Munger owned a tiny slice of Diversified Retailing, which Buffett controlled. Otherwise, their careers were separate. Since the
sixties, Munger had been managing Wheeler, Munger & Co., an investment partnership, located in a convenient but decrepit pipe-strewn office on the mezzanine deck of the Pacific Stock Exchange. This setup suited Munger, as it showcased his contempt for pretentious corporate suites. Just to grace the point, Munger put his secretary in the private room in back; he and his partner worked in the open anteroom.

  Scarcely an hour would pass but that Munger would roar at the secretary, “Get me Warren!” Ira Marshall, Munger’s partner, had the sense that Munger was cultivating Buffett, and that he wanted to become his partner. Yet, oddly, their professional linkage was accidental. Each, independently, had been buying stock in a Los Angeles company known as Blue Chip Stamps.1 Buffett bought it for himself, personally, and also for Berkshire Hathaway. By the early seventies, Buffett was the biggest owner of Blue Chip, and Munger was the second-biggest.

  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.

  Its “premiums”—that is, the stamps sold to retailers—amounted to $120 million a year. This gave Buffett a hefty bankroll, in addition to the one he had at Berkshire. He and Munger went on Blue Chip’s board, took over the investment committee, and began to put the float to work.