The Snowball

by Alice Schroeder

  So one hot Midwestern day that July, Dodge had stopped in Omaha on his way to a vacation out west, a blue canoe strapped to the roof of his woody wagon. “He talked to me for a while and said, ‘Would you handle my money?’ And I set up a separate partnership for him.”

  Dodge gave him $120,000 to manage in the Buffett Fund, Ltd., on September 1, 1956.18 That was more money than the original Buffett Associates partnership—an enormous step*19 that made Warren a professional money manager, not just a former stockbroker running a little money for his family and friends. Now he had invested for someone recommended by Ben Graham.19

  “Later in the year, a friend of mine, John Cleary, who used to be my dad’s secretary in Congress, saw in a legal notice that I’d formed this partnership and asked me what it was. I told him about it, and he said, ‘Well, how about doing it with me?’ So we formed something called B-C, Ltd. That was the third partnership. He put in fifty-five thousand dollars.”20

  With the formation of the B-C partnership on October 1, 1956, Warren was now managing more than half a million dollars, including his own money, which was not in any of the partnerships. He operated out of a tiny study at home that could be entered only by passing through the bedroom. He worked odd hours, a night owl like Susie, reading annual reports in his pajamas, drinking Pepsi-Cola and eating Kitty Clover potato chips, enjoying the freedom and solitude. He pored over the Moody’s Manuals looking for ideas, absorbing statistics on company after company. During the day, he went to the library and read newspapers and industry trade magazines. As with his boyhood paper route, he took care to handle everything of value personally, a pleasure in and of itself. He typed his own letters on an IBM typewriter, carefully lining up his letterhead sheet on the carriage. To make copies he slid sheets of blue carbon paper and tissue-thin onionskin behind the first page. He did all his own filing. He did the bookkeeping himself and prepared his own tax returns. With its numbers, accuracy, and the measuring of results, the recordkeeping aspect of the job pleased him.

  Every stock certificate was delivered directly to him, made out in the partnerships’ names, rather than left on deposit with a broker as was the usual practice. When they arrived, he carried them—smooth cream-colored diplomas in investing, engraved with finely etched drawings of railroads and bald eagles, sea beasts and toga-clad women—down to the Omaha National Bank in his own hands and placed them in a safety deposit box. Whenever he sold a stock, he went to the bank, riffled through the collection of certificates, and mailed off the correct ones from the post office on 38th Street. The bank would call to let him know when a dividend check came in to be deposited, and he would go there, examine the check, and endorse it personally.

  He tied up the family’s single telephone line with his daily calls to the handful of brokers he used. His expenses were as close to zero as he could get. He listed them by hand on a lined sheet of yellow paper: 31¢ for postage, $15.32 for a Moody’s Manual, $4.00 for the Oil & Gas Journal, $3.08 for telephone calls.21 Except for more meticulous accounting and a great deal more thought, he ran the business much as though he were just anybody trading stocks through a broker for a personal account.

  At the end of 1956, Warren wrote a letter to the partners outlining the partnership’s results at year-end. He reported that it had earned a total income of slightly more than $4,500, beating the market by about four percent.22 By then, Dan Monen, his lawyer, had withdrawn from the first partnership, with Doc Thompson buying out his share. Monen had joined Warren on a personal side project that he had been pursuing for some time: buying the stock of an Omaha-based insurer, National American Fire Insurance. This company’s worthless stock had been sold to farmers all over Nebraska in 1919 by unscrupulous promoters in exchange for the Liberty Bonds issued during World War I.23 Since then, its certificates had lain crumbling in drawers, while their owners gradually lost hope of ever seeing their money again.

  Warren had discovered National American while working at Buffett-Falk, flipping through the Moody’s Manual.24 The company was headquartered only a block away from his father’s office. William Ahmanson, a prominent Omaha insurance agent, had originally been sucked into it unawares, set up as a local front man for what had started out as a fraud. But the Ahmanson family had gradually turned it into a legitimate company. Now, Howard Ahmanson, William’s son, was feeding top-drawer insurance business into National American through Home Savings of America, a company he had founded in California, which was becoming one of the largest and most successful savings-and-loan companies in the United States.25

  The defrauded farmers had no idea that their moldering paper was now worth something. Howard had been quietly buying the stock back from them on the cheap for years through his younger brother Hayden, who ran National American. By now the Ahmansons owned seventy percent of the company.

  Warren admired Howard Ahmanson. “Nobody else was quite as audacious at managing capital as Howard Ahmanson. He was very shrewd in a lot of ways. Formerly, a lot of people came in to Home Savings and paid their mortgages in person. Howard put the mortgage at the farthest branch away from where you lived so that you paid by mail and didn’t spend half an hour of one of his guys’ time telling them about your kids. Everybody else had been to see It’s a Wonderful Life and felt that you should do this Jimmy Stewart stuff, but Howard didn’t want to see his customers. His operating costs were way under anybody else’s.”

  National American was earning $29 per share, and Howard’s brother Hayden was buying its stock for around $30 per share. Thus, as with the rarest and most attractive of the cheap stocks that Warren stalked, the Ahmansons could pay virtually the entire cost of buying a share of stock out of one year’s profits from that single share. National American was the cheapest stock Warren had ever seen—except for Western Insurance. And it was a nice little company, too, not a soggy cigar butt.

  “I tried to buy the stock for a long time. But none of it was getting to me, because there was a security dealer in town and Hayden had given this guy the shareholders list. This stockbroker—he regarded me as a punk kid. But he had the list. And I didn’t have the list. So he was buying the stock at thirty for Hayden’s account.”

  Cash on the barrel from Hayden Ahmanson sounded good to some of the farmers compared to their worthless certificates. Though they had paid around $100 per share many years before and were only receiving $30, many of them had gradually convinced themselves that they were better off without the stock.

  Warren was determined. “I looked it up in some insurance book or something. If you went back to the twenties you could see who were the directors. They made some of these bigger stockholders the directors from the towns they worked the hardest for sales. There was a town called Ewing, Nebraska, which has got no population at all. But somebody sold a lot of stock out there. And that’s how they probably got the local banker on the board thirty-five years earlier.”

  So Dan Monen, Warren’s partner and proxy, went off to the countryside carrying wads of Warren’s money and some of his own. He cruised around the state in a red-and-white Chevrolet, showing up in rural county courthouses and banks, casually asking who might own shares of National American.26 He sat on front porches, drinking iced tea, eating pie with farmers and their wives, and offering cash for their stock certificates.27

  “I didn’t want Howard to know because I was topping his price. He had been picking it off at thirty bucks, and I’d had to raise the price some. The shareholders had been listening for probably ten years at thirty bucks, so it was the first time the price moved.”

  The first year Warren paid $35 each for five shares of the stock. The farmers’ ears pricked up. Now they realized that buyers were competing for the stock; they began to think maybe they weren’t better off without it. The price had to keep moving up. “Finally, toward the end, I paid a hundred. That was the magic number, because it was what they’d paid in the first place. A hundred bucks, I knew, would bring out all the stock. And sure enough, one guy came in
when Dan Monen was doing this and he said, ‘We bought this like sheep, and we’re selling it like sheep.’”28

  That they were. Many had sold at less than three times the $29 a year the company was earning. Monen eventually accumulated two thousand shares, ten percent of National American’s stock. Warren kept it in the original shareholders’ names, with a power of attorney attached that gave him control, rather than transferring it into his name. “That would have tipped Howard off to the fact that I was out there competing with him. He didn’t know. Or, if he did, he had insufficient information. I just kept collecting shares. Then, the day I walked into Hayden’s office, I plopped them all down and said I wanted to transfer them to my name. And he said, ‘My brother’s going to kill me.’ But in the end, he transferred the stock.”29

  The brainstorm behind Warren’s National American coup had been more than just the price. He had learned the value of gathering as much as possible of something scarce. From license plates to nuns’ fingerprints to coins and stamps, to the Union Street Railway, and National American, he had always thought this way, a born collector.30

  Alas, this voracious instinct could steer him awry on occasion. Tom Knapp, who had gone to work for a small broker, Tweedy, Browne and Reilly, after helping Jerry Newman close down the remnants of Graham-Newman, came out to visit Warren and to go hear Ben Graham give a speech in Beloit, Wisconsin. Driving through the Iowa cornfields on the way, Knapp mentioned that the U.S. government was about to take the four-cent Blue Eagle stamp out of circulation. The cash register dinged! in Warren’s head. “Let’s stop at a few post offices and see if they have any four-cent stamps,” he said on the way back. Knapp went into the first post office and returned to say that it had twenty-eight stamps. “Go buy them,” said Buffett. They talked about it some more and decided to write to post offices after they returned home, to offer to buy their stamp inventory. The stamps started coming in a few thousand at a time. Then Denver replied and said they had twenty pads. A pad is a hundred sheets of a hundred stamps. That meant Denver had two hundred thousand stamps.

  “We might as well control the issue,” Warren said. They spent $8,000 and bought the pads.

  “And that was our mistake,” says Knapp. “We should have let the Denver post office send them back to Washington to reduce the supply.”

  Through expending enormous effort to become virtual post offices themselves—with most of the work done by Knapp—they gathered more than six hundred thousand Blue Eagle stamps, collectively spending roughly $25,000. For Warren that was a lot, considering his attitude about money and his net worth. They stored the piles of stamps in their basements. And then they realized what they had done. They had laboriously acquired basements full of stamps that would never be worth more than four cents apiece. “When you have so many stamps,” Knapp explains, “there are not many collectors.”

  So the next task became disposing of the stamps. Warren expertly delegated the problem of getting rid of $25,000 worth of four-cent stamps to Tom. Then he simply put it out of his mind, except for the funny story, and instead turned back to what was actually important: raising money for the partnerships. In June 1957, another one of the original partners, Elizabeth Peterson, Chuck’s mother, asked Warren to set up a fourth partnership, to be called Underwood, investing another $85,000.31

  A few months later, in the summer of 1957, “I got a call from Mrs. Edwin Davis. They used to be customers of the Buffett grocery store. Her husband, Dr. Davis, was a very prominent urologist in town. They lived just a few blocks from here. She said, ‘I understand you manage money. Would you come down and explain it to us?’”

  Dr. Edwin Davis was nationally known. One of his patients, Arthur Wiesenberger of New York City, was one of the most famous money managers of the era. He had at some point come to Omaha to be treated for prostate problems, and Davis became his client.

  Wiesenberger published Investment Companies, an annual “bible” on closed-end investment funds. These were like publicly traded mutual funds, except that they did not accept new investors. They nearly always sold at a discount to the value of their assets, which made Wiesenberger a proponent of buying them.32 In short, they were like mutual-fund cigar butts. The summer before graduate school, Warren had sat in a chair at Buffett-Falk’s office, reading Wiesenberger’s bible while Howard worked. “Before I went to Columbia,” he says, “I used to spend hours and hours reading that book from cover to cover, religiously.” He bought two of Wiesenberger’s cigar butts, United States & International Securities and Selected Industries, which in 1950 had made up more than two-thirds of his assets.33 While at Graham-Newman, he also managed to meet Wiesenberger and had impressed him, “even though I wasn’t very impressive in those days.”

  In 1957, Wiesenberger called Dr. Davis out of the blue and explained that, although it was not necessarily in his own interest to do so, he was recommending a young man to him. “I tried to hire him myself,” said Wiesenberger, “but he was forming a partnership and so I couldn’t.”34 He urged Davis to consider investing with Buffett.

  Shortly afterward, Warren scheduled a meeting with the Davis family on a Sunday afternoon. “I went down to their place and sat in their living room and talked to them for about an hour. I said, ‘Here’s how I manage money and the arrangement I have.’ I was probably twenty-six. I looked about twenty years old at the time.” Actually, he looked more like eighteen, according to Eddie Davis: “His collar was open; his coat was too big. He talked so very fast.” At the time, Warren went around Omaha wearing a mangy sweater—which one person observed probably should have been given to Goodwill—an old pair of pants, and scuffed shoes. “I acted immature for my age,” Buffett recalls. “The kind of things I talked about were what you would expect from a much younger person.” In fact, there was still more than a trace of the hand-drumming, “Mammy”-singing boy from Penn. “You had to overlook a lot back then.”

  Yet not when he was talking about the partnerships. Warren was not there to sell the Davises. He laid out his ground rules. He wanted absolute control over the money and would tell his partners nothing about how it was invested. That was the sticking point. Not for him was Ben Graham’s handicap of people riding on his coattails. And his solution to the problem of people being disappointed was that he wasn’t going to give them the score after every hole, only once a year after playing eighteen holes. They would get an annual summary of his performance, and they could put money in or withdraw it only on December 31. The rest of the year, their money would be locked into the partnership.

  “All the while, Eddie paid no attention to me. Dorothy Davis listened very intently, asking good questions. Eddie was over in the corner doing nothing. He seemed like a very old guy to me, but he was not yet seventy. When we got all the way through, Dorothy turned to Eddie and said, ‘What do you think?’ Eddie said, ‘Let’s give him a hundred thousand dollars.’ In a much more polite way, I said, ‘Dr. Davis, you know, I’m delighted to get this money. But you weren’t really paying a lot of attention to me while I was talking. How come you’re doing it?’

  “And he said, ‘Well, you remind me of Charlie Munger.’35

  “I said, ‘Well, I don’t know who Charlie Munger is, but I really like him.’”

  But the other reason the Davises were so willing to invest with Warren was because, to their surprise, he “knew more about Arthur Wiesenberger than they did.”36 They also liked the way he laid out his terms—clear and transparent, so they knew whose side he was on. He would win or lose along with them. As Dorothy Davis put it, “He’s smart, he’s bright, and I can tell he’s honest. I like everything about this young man.” On August 5, 1957, the money from the Davises and their three children seeded the fifth partnership with $100,000. It was called Dacee.37

  With Dacee, Warren’s business jumped another leg upward. He could now land bigger positions in larger stocks. In his personal portfolio, he still played with things like the “penny” uranium stocks that had been in vogue a
few years earlier when the government was buying uranium. These were now fantastically cheap.38 Warren bought companies like Hidden Splendor, Stanrock, Northspan. “There were some attractive issues—it was shooting fish in a barrel. They weren’t huge fish, but you were shooting them in a barrel. You knew you were going to make good money. It was minor. The bigger stuff I was putting in the partnerships.”

  Having new partners meant more money, of course, but it also meant that the number of stock certificates and amount of paperwork managing the five partnerships plus Buffett & Buffett increased substantially. He had to hustle, but it felt good. The shortfall, as always, was money—he never seemed to have enough. The kind of companies he was researching often had market values of one to ten million dollars, so he wanted as much as $100,000 to get a significant position in their stocks. Getting more money to manage was key.

  By this time Dan Monen was ready to get back into the partnership, and he and his wife, Mary Ellen, formed the nucleus of Warren’s sixth partnership, Mo-Buff, on May 5, 1958. Thanks mostly to National American, the Monens, who had had only $5,000 to invest two years earlier, were now able to put in $70,000.39

  At the time, Warren Buffett probably understood the potential of money management to beget more money better than anyone on Wall Street. Every dollar added to a partnership would net him a share of what he earned for his partners.40 Each of those dollars, reinvested, would generate earnings of its own.41 Those earnings, reinvested, would beget still more earnings. The better his performance, the more he would earn, and the larger his share of the partnerships would grow, enabling him to earn even more. His talent for investing could exploit that potential of managing money to the hilt. And despite Warren’s apparent awkwardness, he was indisputably successful at merchandising himself. Even though he was nearly invisible in the investing world, the snowball was starting to roll.