When he stepped down, though proud of having rescued the firm, Buffett was rather eager to have the burden lifted. Peter spoke to him after the settlement and thought he sounded like a different person. Soon after, Warren and his wife flew into Buffalo for a Buffalo News picnic, where Warren stood for a pie-throwing contest. Then Stan Lipsey, the publisher, led Warren and Susie on a tour. It had just rained, and Lipsey turned to make sure that his guests were dodging the puddles and saw them walking arm in arm. They went through an old graveyard, where Warren gazed at the headstones, and to the foot of the Albright-Knox Art Gallery, where a jazz band was playing. After a while, Lipsey and Susie went to see the art, and a relaxed Warren stood on the steps, listening to the jazz. Then they met Lipsey’s girlfriend and the editor Murray Light and his wife for steaks—which Lipsey had ordered from Omaha.
Buffett was thrilled to get his life back. The Salomon escapade, he wrote, was “interesting and worthwhile,” but “far from fun.”63 Now the sanctuary of Kiewit Plaza beckoned. To his shareholders, Buffett left no doubt: “Berkshire is my first love and one that will never fade.”64
* Lewis said, “In the middle of 1988 [Buffett] broke with his strict rule of long-term investing and became an arbitrageur.…” In fact, Buffett had done arbitrage since 1954 and had often written of it. Lewis said Buffett had offered to finance the RJR Nabisco deal; in fact, he had refused to back it. Lewis, making light of Buffett’s disclaimer, said: “He even once suggested, in 1985, that his bogey was merely to outstrip the average returns of corporate America.” Buffett did not “suggest it once,” he had explicitly stated it in each annual report for years. Lewis said Buffett invested in bonds of RJR, “nearly … the largest bankruptcy in history.” That was true—but Buffett had invested after the bonds had fallen, and had made a killing on them.
Chapter 23
BUFFETT’S TROLLEY
Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.
WARREN BUFFETT, BERKSHIRE HATHAWAY INC., 1980 ANNUAL REPORT
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 59⅛.*
Buffett raised his stake in Wells Fargo. When the recession in real estate ended, the bank recovered. Its earnings soared, and Buffett’s much-maligned investment, acquired at an average of 62 a share, took wing to 216.
Buffett also bought big stakes in two familiar-type companies-Guinness, the distiller of Johnnie Walker and other consumer brands; and, most recently, newspaper empire Gannett.
Finally, Buffett bought three New England shoe manufacturers for about $600 million—a little-known but huge addition to Berkshire’s portfolio. H. H. Brown and Dexter Shoe, the two bigger companies, had resisted the onslaught of imports by adhering to Rose Blumkin work habits and by developing specific product niches, such as work shoes and outdoor shoes. Both were well-managed, family-style companies up Buffett’s alley.
Mrs. B herself made a détente with her grandsons and admitted publicly that she had made a mistake. Remarkably, she sold her new store to Berkshire for $5 million and returned to the fold.2 At ninety-nine, she continued to work at the new locale, in charge of her own carpet business, seven days a week. “I am delighted that Mrs. B has again linked up with us,” Buffett reported happily. “Her business story has no parallel.”3
Among Buffett’s other holdings, Gillette soared to 52⅛ and Coca-Cola climbed to 74¼, a quadrupling and near-septupling, each in six years’ time.† Gannett quickly surged 25 percent and Buffett cashed out Champion at a profit.
American Express fired Jimmy Robinson. True to form, Buffett ploughed another billion dollars into this old favorite. By the end of 1995, his investment was up 47 percent.
USAir’s total losses following Buffett’s investment mounted to $3 billion. In 1994, it suspended its preferred dividend to Berkshire. After an upturn the following year, Buffett decided to cut his losses and bail out.
None of these stocks moved as dramatically as Berkshire itself. In June 1992, when Buffett stepped down from Salomon, Berkshire was at $9,100. In November, it broke $10,000. Late in the year, Buffett redeemed Berkshire’s zero-coupon bonds—a signal that he thought the stock was cheap. During 1993, it was as if traded by the gods. By Valentine’s Day, Berkshire had risen to $12,400. It soared, like a messenger to Olympus, through spring and summer, whence it reached a peak of $17,800. Then it gave some ground and closed at $16,325.
The young man who had once put pinball machines in barbershops was proclaimed by Forbes to be the richest fellow in the land.4 In 1994, Buffett relinquished the crown to the young Bill Gates. However, he did not exactly lose ground. Berkshire rose 25 percent (in a year in which the Standard & Poor’s 500 inched up 1 percent.) Then, during the euphoric bull market of 1995, Berkshire rose a phenomenal 57 percent. The stock, which Buffett had begun buying at precisely $7.60 a share, finished at the astonishing figure of $32,100. At that price, Buffett was worth $15.2 billion, surpassing Gates.
Over thirty-one years, his stock has appreciated at a rate of 27.68 percent a year, compounded. Over the same span, the Dow Jones Industrial Average, including dividends, has a growth rate of 10.31 percent a year, and the Standard & Poor’s 500 of 10.7 percent.5 Put differently, if in 1965 one had put $10,000 into Berkshire and like amounts into the S&P 500 and crude oil, the Berkshire at year-end 1995 would have been worth $17.8 million, the S&P portfolio $224,000, and the crude oil $72,000.
If one tacks on the record of Buffett Partnership, Buffett has been doing it for four decades, without much leverage, without speculating or taking undue risks, and without suffering a single down year.6 Although nay-sayers continue to greet his each new investment with a chorus that “this time” Buffett has finally blown it, no one else has a record over a similar span that compares. Arguably, no one is close.
Among history’s great capitalists, Buffett stands out for his sheer skill at evaluating businesses. What John D. Rockefeller, the oil cartelist, Andrew Carnegie, the philanthropic steel baron, Sam Walton, the humble retailer, and Bill Gates, the software nerd, have in common is that each owes his fortune to a single product or innovation. Buffett made his money as a pure investor: picking diverse businesses and stocks.
When he took over Berkshire, in 1965, the once-great yarn mill was fading. He redeployed its capital into insurance, candy, department stores (a mistake), banking, and media. These were followed by tobacco, soft drinks, razor blades, airlines (another mistake), and various whole businesses from encyclopedias to shoes. In sum, he built an industrial empire now worth $38 billion entirely from what miserable trickle of cash he could wrest from a dying textile mill, before that mill was sold for scrap. Though still run by a corporate staff of twelve, Berkshire, ranked by market value, is now the nineteenth-largest company in the United States, worth more than household names such as American Express, Citicorp, Dow Chemical, Eastman Kodak, General Mills, Sears Roebuck, Texaco, and Xerox.7
Investors counting on Buffett to stay in orbit should keep in mind his perennial complaint about the burden of size. So far, it has not affected him. Over the last decade, Berkshire’s rate of appreciation has been a whisker better than Buffett’s overall rate of 29.2 percent. But the depressing truth is that allocating capital will get tougher as Buffett’s assets grow.
Also, the themes that have provided his biggest winners—consumer franchises and newspapers and television—could be getting long in the tooth. The societal trend toward discount, private-label shopping poses a real challenge to brand names. In 1994, Buffett discovered that Guinnesse’s well-known drinks were not so impervious to competition as he had figured—and he abruptly sold the stock, taking an estimated 15 to 20 percent loss. In the not-too-distant future, it is not unthi
nkable that Coca-Cola and Gillette, in which Buffett has much bigger investments, will face serious threats to their profit margins.
Similarly, if the futurologists are even partly right, newspapers and networks will have to contend with a proliferation of new outlets, and even with new forms, of news and entertainment. Though it is far too early to single out winners and losers, it is a good bet that once-safe media companies will find their “toll bridges” under attack.
Perhaps that helped to explain Buffett’s quick response to Michael Eisner, chairman of Walt Disney, in summer 1995. Buffett and Eisner were guests at investment banker Herb Allen’s annual retreat for entertainment moguls and family members in Sun Valley, Idaho. Eisner was packed and ready to leave the pristine resort, but on his way to the parking lot he bumped into Buffett and blurted out, “What do you think about selling ABC for cash?”
Buffett had sworn never to abandon Tom Murphy, his friend and the Cap Cities/ABC chairman. But Buffett’s instincts told him that Murphy, who had resisted such overtures in the past, might be ready, particularly if Eisner could be persuaded to pay in stock. And Buffett himself thought the company was ripe. Though still Cap Cities’ biggest shareholder, he had recently sold some of his stock at $63 a share.‡ By the time he saw Eisner in Sun Valley, the stock, benefiting from a cyclical upturn in advertising, had vaulted to $102.
“Sounds good to me,” Buffett shot back. “Why don’t we talk to Murph?” Coincidentally, Buffett was on his way to play golf with Murphy and also with Bill Gates, and suggested that Eisner come along.
Murphy seemed unsure. But at the right price, the prospect of combining ABC’s network with Disney’s famous brand name and product line was irresistible. After the retreat, Eisner and Murphy, counseled as usual by Buffett, began to negotiate in earnest. Murphy’s main concern was that his own shareholders get a chance to participate going forward—what he called a “ticket on the horse race.”
Incredibly, they cut a deal in only two weeks. Disney would acquire Cap Cities/ABC for $19.5 billion—the second biggest deal in history, trailing only RJR Nabisco. Cap Cities shareholders—Berkshire included, of course—got $127 a share, seven times Buffett’s going-in price of 17¼. (As Murphy and Eisner had compromised and made it a part-stock, part-cash acquisition, Berkshire became a big investor in Disney, one of the best of Buffett’s early stocks in the 1960s.) Buffett’s total profit from investing with Murphy, long his favorite CEO, was just over $2.5 billion.
And Buffett had a big idea for what to do with his profit—to finally close the loop with GEICO, the investment that had bewitched him literally from the start of his career, in Ben Graham’s investment class. As a salesman starting out in his father’s brokerage, he had bought the stock for himself and touted it to customers. In 1951, the Commercial and Financial Chronicle had published Buffett’s write-up of GEICO next to a mug shot of the buttoned-down, cherubic twenty-one-year-old under the apt title “The Security I Like Best.”8 By the 1980s, Berkshire owned half of GEICO.
Buffett had occasionally given thought to buying the rest, which traded publicly. But in the 1990s, GEICO had been a disappointment. Its success had been based on direct marketing to low-risk automobile drivers, but it had stumbled by going into new areas such as finance, home insurance, and aviation insurance. And William Snyder, the CEO who succeeded Jack Byrne, had bought a couple of insurance companies that weren’t direct marketers. Its profit slumped, due partly to Hurricane Andrew; worse, GEICO seemed to have lost its focus.
Buffett, plainly unhappy, aired his concern with two influential GEICO directors, Samuel Butler and Lou Simpson.9 Buffett even said he was thinking of selling his stock—a comment certain to alarm them. Butler and Simpson, who had been worried about GEICO even before, now decided that Snyder should be eased out as CEO a year ahead of his planned retirement. Buffett backed them and Snyder did step aside. Buffett’s silent coup complete, GEICO began to reform itself to Buffett’s liking. It quickly moved to dump its unsuccessful and distracting sidelines and to put more capital into its core auto lines.
By 1994, Buffett was sufficiently pleased that he opened merger talks with Butler and Simpson. A year later—just after the Disney deal—Buffett struck again, agreeing that Berkshire would acquire the rest of GEICO for $2.3 billion. Superficially, it was a rich price, but given Buffett’s time horizon and GEICO’s renewed growth prospects, it was not so rich as it seemed. And Buffett now owned all of the security he had “liked best” for forty-four years. Jack Byrne said it was “predestined.”
Even before the GEICO deal, Buffett had been sending signals of his renewed enthusiasm for insurance—the game of odds that so suits him. In particular, Berkshire’s in-house insurance operation, which will be increasingly important to Berkshire’s future, has for some time been writing special reinsurance policies, known as “super-cats,” which is Buffett-speak for super-catastrophics.
Insurance companies buy super-cats for protection against a mega-disaster that would require them to pay claims on a great number of policies. Berkshire got into the business in 1989, after the twin calamities of Hurricane Hugo and the World Series-shattering earthquake in San Francisco. With insurers devastated and premiums soaring, Buffett sensed the sort of bad news-cum-opportunity that has always aroused his interest.
Since then, Berkshire’s super-cat business has grown to be enormous. In most years, it is extremely profitable. But in an unusually bad year, one with a series of big disasters or a single blow such as a Hurricane Andrew, Berkshire could be stuck with gigantic losses, possibly as much as $600 million.10 (Few insurers write super-cats, because the stakes are so big.)
Buffett and Ajit Jain, the Indian-born, Harvard-educated star of Berkshire’s super-cat business, who works in Connecticut, frequently chat about the odds of a major earthquake in New Zealand, a flood in the Midwest, or a radical change in long-term climatic patterns.11 But super-cats occur too infrequently for the odds to be figured with precision, so Buffett and Jain must rely on judgment and on an informed reading of history.
Who would have guessed, Buffett recently wrote, that the United States’ most serious quake would occur in New Madrid, Missouri? It did, in 1812—an estimated 8.7 on the Richter scale. “Now you know why I suffer eyestrain: from watching The Weather Channel.”12
Thanks largely to super-cats, Berkshire’s insurance float has multiplied tenfold over a decade. In 1995, the float was $3.6 billion, a figure which will nearly double with the addition of GEICO. This money may be thought of as a low-interest loan, which is Buffett’s to play with until claims are made. In recent years, Buffett has had the use of this immense sum at an effective cost that is lower than the rate on long-term government bonds. This gives Buffett a huge advantage.
Though normally reluctant to talk up the future, Buffett has been predicting a rosy one for his insurance operation. He has said that he and Munger expect it to be their “main source of earnings for decades to come,” and has hinted that he thinks its value is enormous.13 But as Buffett freely admits, it will be hard to evaluate his bet on super-cats until decades of loss experience can be toted up.
Given this embarrassment of riches—from Disney to GEICO to super-cats—it is small surprise that the public’s expectations for Berkshire were becoming inflated. By early 1996, its share price was swelling toward $40,000. Buffett was worried that the shares were becoming bait for speculators, and he was highly agitated by the plans of a couple of promoters to take advantage of Berkshire’s unusual share price by peddling low-priced “clones.” (The promoters intended to create investment trusts that would purchase shares of Berkshire and then sell low-priced units to the public.) Obsessed, as usual, with controlling every aspect of Berkshire, Buffett decided to beat these promoters to the punch with a baby Berkshire of his own.
In a sort of do-it-yourself stock split, Buffett devised a new issue of Berkshire—Class B common stock—worth 1/30 of the old shares and expected to trade at 1/30 the price. Shareholders coul
d hang on to the ordinary common, now known as Class A, or (at any time) convert—one A share for thirty B shares. (Buffett would keep the high-priced variety.) Of course, in value terms they were identical: the same pizza cut in thirty slices.
But given that small investors attracted to his celebrity might be especially tempted to hop aboard the “cheaper” B stock, Buffett did what virtually no chief executive has ever done—he warned that the price of his stock (then $36,000) was more than he would pay for it. Berkshire’s intrinsic value had continued to grow at an impressive rate, but its stock, in recent years, had overperformed it, Buffett warned in his latest annual report. “Inevitably, there will be periods of underperformance as well.” In short, investors who pay too much for Berkshire—or any stock—implicitly are betting on its high performance to continue, perhaps for many years into the future.
Discussion of such an extended time period makes Buffett’s shareholders uncomfortable. It reminds them of the one “super-cat” they fear the most. As one shareholder and longtime friend admitted bluntly, “All of us have a vested interest in Warren’s good health.”14
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