The Snowball

by Alice Schroeder

  To each of the Grahamites coming to La Jolla, Warren sent out instructions. “Please do not bring anything more current than a 1934 edition of Security Analysis along with you,” he wrote.7 Whatever their age, wives, too, would remain at home.

  In his letter, Buffett reminded them that they were there to listen to Graham, the Great Man, not one another. Several in the group—Munger, Anderson, Ruane—were inclined to be loquacious. When it came to investing, of course, no one had more of this tendency than Buffett himself. At age thirty-seven, he had finally attained peerage and was able to call his former teacher “Ben,” but sometimes he still slipped and said “Mr. Graham.” So he must have been at least partly reminding himself not to try to take over as the best student in the class.

  Thus instructed, the dozen Graham-worshippers convened at the Hotel del Coronado, across the bay from San Diego. Warren had wanted to meet at a much cheaper venue such as a Holiday Inn; he made sure the group knew that the extravagance of this pink-and-white Victorian confection of a resort was Graham’s idea.

  By the time the dozen arrived in San Diego, a huge storm with lashing rain and churning seas had hit, but no one cared; they were there to talk about stocks. Buffett was bursting with pride at having engineered a tribute to his teacher and a chance to show off the wisdom of Ben Graham to his new friends. Graham arrived at the Coronado late. Ever the teacher, as soon as he got there, he immediately gave them an exam.

  Graham was almost painful to listen to under any circumstances. Every sentence was complex and larded with classical allusions. The exam he gave them was much the same. “They were not terribly complicated questions, although they were a little—you know, some were French history, or something like that. But you thought you knew some of the answers,” says Buffett.

  They didn’t. Only Roy Tolles got more than half. By answering everything “true” except a couple that he knew for certain were not, he scored eleven out of twenty. The “little exam” turned out to be one of Graham’s teaching tricks, designed to show that even an easy-looking game can be rigged. Buffett would later have a saying: Knowing that a clever guy is stacking the deck is not necessarily protection.

  During the rest of the meeting, Graham tolerated the discussions of stock promotion, manufactured performance, phony accounting, institutional speculation, and the “chain-letter acquisition syndrome” with bemusement.8 But he was no longer engaged; instead, he wanted to tell riddles and joined with enthusiasm in brainteasers and word and numbers games.

  Buffett, however, was as much engaged as ever, notwithstanding the tenor of his letter to his partners in October 1967, when he wrote that from now on he would limit himself to activities that were “easy, safe, profitable, and pleasant.” When he returned to Omaha from San Diego he focused intensely on the problems of the partnership. He needed to let the partners know that all was not well at some of the businesses they owned and in his next two letters dropped subtle hints. After having described the travails of textiles eloquently in 1967, he made no further mention of the business in 1968, although the prospects and results of the Berkshire mills had not improved. Earnings at DRC were falling because of Hochschild-Kohn.9 Still, Buffett did not take the logical next step, which would have been to sell Berkshire Hathaway and Hochschild-Kohn.

  Here, his commercial instincts chafed against some of his other traits: the urge to collect, the need to be liked, the preoccupation with avoiding confrontation after the Dempster windmill war. In an intricate minuet of rationalization, he explained his thinking in his January 1968 letter to the partners: “When I am dealing with people I like in businesses I find stimulating (what business isn’t?), and achieving worthwhile overall returns on capital employed (say, ten to twelve percent), it seems foolish to rush from situation to situation to earn a few more percentage points. It also does not seem sensible to me to trade known pleasant personal relationships with high-grade people, at a decent rate of return, for possible irritation, aggravation, or worse at potentially higher returns.”10

  Some of the growing crowd of Buffett-watchers may have read these words with surprise. Measuring by “overall” returns allowed for some businesses to do considerably worse than the average. To witness Buffett—who squeezed the last tenth of a percentage point from a buck like a miser gripping a toothpaste tube—dismissively waving away “a few more percentage points” was astonishing.

  Yet his performance stopped complaints, for even as he lowered expectations, he continued to surpass himself. Despite the deadweights, the partnership had averaged more than a thirty-one percent return over the dozen years of its existence, while the Dow had produced nine percent. The margin of safety Buffett always insisted on had skewed the odds sharply in his favor.11 Along with his talent for investing, its cumulative impact on his batting average meant that $1,000 put in the Dow was now worth $2,857, whereas he had turned it into nearly ten times that, $27,106. Buffett’s partners by now trusted him to always deliver more than he promised. He manifested predictability and certainty in 1968, the tumultuous year in which students would take over and close Columbia University, flower-child demonstrations would turn militant, and activists would nominate a pig for President.12

  But by mid-1968, Buffett had made a decision to try to jettison the intractable Berkshire Hathaway—a business that was neither easy, safe, profitable, nor pleasant—and its unlucky textile workers. He offered to sell the company to Munger and Gottesman. They came to Omaha to visit and talk. After three days of discussion, however, neither man wanted to buy something that Buffett thought he was better off without. He was stuck with Berkshire Hathaway.

  Because the Apparel and Box Loom divisions were not self-sustaining and it would take gobs of cash to keep them running, Buffett was now forced to act. Deploying capital with no hope of a return was a cardinal sin to him. He told Ken Chace what to do. Chace was upset, but, in typically stoic fashion, he followed orders and shut the two divisions down.13 Still, Buffett could not bring himself to put a spike through the whole thing and bury it.

  What he was left with, therefore, was a partnership that owned two businesses, one thriving—National Indemnity—and one failing—Berkshire Hathaway—plus eighty percent of DRC, the retail holding company, and, of course, shares in a wide range of other companies. As 1968 waned, stocks on the fringes of the market began to slide; investors concentrated on the biggest, safest names. Indeed, Buffett himself started buying the blandest, most popular stocks that remained reasonably priced: $18 million of AT&T, $9.6 million of BF Goodrich, $8.4 million of AMK Corp. (later United Brands), $8.7 million of Jones & Laughlin Steel. But above all, he kept accumulating more Berkshire Hathaway—despite his restriction against buying any more bad businesses and even though the textile business was sinking into the mud. Only a short while ago, he had tried to sell it to Munger and Gottesman, but now that he could not sell it, he seemed to want as much of the stock as he could get.

  He and Munger had also discovered another company they saw as promising and were buying as much stock of it as they could. This was Blue Chip Stamps, a trading-stamp company. They would buy it separately and together, and over the course of time Blue Chip would dramatically reshape the course of both men’s careers.

  The trading stamp was a marketing giveaway. Retailers handed stamps to their customers with their change. Customers dumped them in a drawer, then pasted them into little booklets. When redeemed, enough of the booklets bought them anything from a toaster oven to a fishing rod or a tetherball set. The small thrill of saving stamps fit neatly into a disappearing world: a world of thrift, a world that feared debt, that viewed these “free gifts” as the reward for taking the trouble to collect and save those stamps and for never wasting anything.14

  But the stamps were not really free.15 The stores paid for them and marked up the merchandise accordingly. The national leader in trading stamps was Sperry & Hutchinson, except in California. There, a group of chains had shut out the S&H Green Stamp by starting their own t
rading stamp, Blue Chip, and selling it to themselves at a discount.16 Blue Chip had a classic monopoly.

  “When you had all the major oil companies and grocers giving out a single stamp, it became like money. People would leave their change behind and take the stamps. Morticians gave out stamps. Prostitutes gave them. I always thought the funniest thing would be if the madam would call in one of the girls and say, ‘From now on, I think you better double-stamp, honey.’ It was ubiquitous. Everybody had them. People even counterfeited them.”

  In 1963, the Department of Justice had filed suit against Blue Chip for restraint of trade and monopolizing the trading-stamp business in California.17 S&H also sued it. With the stock in a slump, Rick Guerin, who had founded his own partnership, Pacific Partners, noticed Blue Chip and took it to Munger. Buffett had noticed it too. “Blue Chip did not have an immaculate conception,” Charlie Munger concedes, but they all decided to make a calculated bet that Blue Chip could work its way out of its woes—the S&H lawsuit being the most threatening.

  They wanted it because Blue Chip had something called “float.” The stamps were paid for in advance; the prizes got redeemed later. In between, Blue Chip had use of the money, sometimes for years. Buffett had first encountered this tantalizing concept with GEICO, and it was part of why he had wanted to own National Indemnity. Insurers, too, got paid premiums before the claims came in. That meant they could invest this steadily growing stream of “float.” To someone like Buffett, who was supremely confident in his investing ability, such a business was catnip.

  All kinds of businesses had float. Deposits in banks were also float. Customers often thought of banks as doing them a kind of favor by holding their cash in a safe place. But the bank invested the deposits in loans at the highest interest rates they could charge. They made a profit. That was “float.”

  Buffett, Munger, and Guerin understood how to invert every financial situation. If someone offered them trading stamps, they upended the situation and thought, “Hmm, it’s probably better to own the trading-stamp company,” then figured out why. They would no more spend time saving trading stamps to get a hibachi or a croquet set than they would wear their great-aunt Betsy’s petticoats to the office. Even Buffett—a boyhood stamp collector who still dreamed occasionally about counting stamps, and had a sentimental stash of Blue Eagle stamps in his basement—would rather own Blue Chip stock than collect Blue Chip stamps.

  In 1968, Blue Chip began settling the lawsuits filed against it by competitors.18 It entered into a “consent decree” with the Justice Department, under which the grocery chains that owned it would sell forty-five percent of the company to the retailers who gave away the stamps.19 To remove even more control from the grocers who had given Blue Chip its less-than-immaculate conception, the Justice Department required the company to find another buyer for one-third of its stamp business. Still, it looked as though Blue Chip had survived this part of the legal fight.20

  Munger’s partnership had bought 20,000 shares, and Guerin bought a similar amount. In the process, Munger developed the proprietary attitude about Blue Chip that Buffett displayed about Berkshire Hathaway. He warned others away from it. “We don’t want anyone buying Blue Chip,” he told people. “We don’t want anyone buying this.”21

  As the market rose, Buffett increased the partnership’s temporary cash position to the tens of millions, even though he was still buying stocks in huge chunks. His partnership also took over large blocks of Blue Chip stock from Lucky Stores, Market Basket, and shares owned by Alexander’s Markets, however, and would continue to buy for the next few months until the partnership had acquired more than 70,000 shares. For National Indemnity and Diversified, he also bought five percent of the stock of Thriftimart Stores, one of Blue Chip’s largest shareholders. Buffett figured he could eventually get Thriftimart to swap the Blue Chip it owned for its own stock. Fortunately they were betting mainly on the S&H lawsuit settling—otherwise, the timing would have been awful.

  Just as he and Munger and Guerin were making large commitments to Blue Chip, its steadily growing sales apexed. Women had started to lose interest in sitting at home, sticking trading stamps in a book. The burgeoning women’s liberation movement meant that they had better things to do with their time, more money, and with that a sense of entitlement that meant that if they wanted an electric blender or a fondue set, they went out and bought it, rather than fussing over books of stamps to trade in for it. Social roles and conventions had gone topsy-turvy, the Establishment culture so reviled that young people said categorically, “Don’t trust anyone over thirty.” Buffett, at thirty-eight, did not feel old personally—he would never feel old personally—but “I am in the geriatric ward, philosophically,” he wrote to the partners.22 He was out of step with modern culture and finance.

  In 1968, the prospect of Vietnam peace talks in Paris set off another boisterous rally in the market. Though proud of having husbanded, tended, and compounded his partnership, with minimal risk, from seven investors and $105,000 to more than three hundred people and $105 million, Buffett had become an elder of the market, seemingly eclipsed by young barnstormers who could flash a couple of years’ worth of showy numbers and joy-ride new investors into giving them $500 million nearly overnight.

  He seemed especially—and comfortably—antiquated when it came to all the new technology companies that were forming. At Grinnell College, he showed up for a meeting to find his fellow trustee Bob Noyce itching to leave Fairchild Semiconductor. Noyce, Gordon Moore (its research director), and its assistant director of research and development, Andy Grove, had decided to start a nameless new company in Mountain View, California, based on a vague plan to extend the technology of circuits to “higher levels of integration.”23 Joe Rosenfield and the college endowment fund each said they would put in $100,000, joining dozens who were helping to raise $2.5 million for the new company—which was soon to be named Intel, for Integrated Electronics.

  Buffett had a long-standing bias against technology investments, which he felt had no margin of safety. Years ago, in 1957, Katie Buffett, wife of his uncle Fred Buffett, had arrived at Warren’s back door one day with a question. Should she and Fred invest in her brother Bill’s new company? Bill Norris was leaving Remington Rand’s*26 UNIVAC computer division to start a company called Control Data Corporation to compete with IBM.

  Warren was horrified. “Bill thought that Remington Rand was falling behind IBM. I thought he was out of his mind. When he left Remington Rand he had six kids and no money to speak of. I don’t think Bill left to get rich. I think he left because he just felt frustrated. Everything had to go to New York to get approved and come back. And Aunt Katie and Uncle Fred wanted to put a few bucks in Control Data there right at the start. Bill didn’t have any money. Nobody had any money, in a sense.” Well, except Warren and Susie. “I could have financed half the thing if I’d wanted. I was very negative on it. I told them, ‘It doesn’t sound like much to me. Who needs another computer company?’”24

  But since Bill was Katie’s brother, for once she and Fred had ignored Warren’s advice and invested $400 anyway, buying the stock at sixteen cents a share.25

  That Control Data had geysered investors with money hadn’t changed Buffett’s opinion about technology. Many of the other technology companies that had started at the same time had failed. As much out of regard for Rosenfield as for any other reason, however, Buffett signed off on a technology investment for Grinnell.26 “We were betting on the jockey, not the horse,” as he saw it.27 But, more important, Rosenfield provided the margin of safety by guaranteeing the college’s investment. And as much as Buffett admired Noyce, he did not buy Intel for the partnership, thus passing on one of the greatest investing opportunities of his life. While he had lowered his investing standards in difficult environments—and would do so again—one compromise he would never make was to give up his margin of safety. This particular quality—to pass up possible riches if he couldn’t limit his risk—was w
hat made him Warren Buffett.

  Now the whole market was starting to look like Intel to him, however. His 1968 year-end letter assessed it soberingly, saying that investing ideas were at an all-time low.28 “Nostalgia just isn’t what it used to be,” he concluded.

  As he later explained: “It was a multi-trillion-dollar market, and yet I couldn’t find a way to invest $105 million intelligently. I knew I didn’t want to manage other people’s money anymore in an environment where I didn’t think I could do well, and yet where I’d feel obliged to do well.”

  That attitude was remarkably different from 1962, when the market was similarly soaring. Both times he bemoaned it. But then he had raised money with an energy that belied his inability to put it to work.

  The partners were dumbfounded by the contrast between his dour words and the wing-walk way he seemed to be earning money for them. Some began to impart an almost supernatural level of confidence to him. The more he surpassed his own gloomy predictions, the more the legend seemed to grow. But he knew it wasn’t going to last.

  33

  The Unwinding

  Omaha • 1969

  In the outer office on Kiewit Plaza’s eighth floor, Gladys Kaiser sat guarding Warren Buffett’s doorway. Rail-thin, perfectly made up, chain-smoke drifting through her platinum hair, Gladys dispatched paperwork, phone calls, bills, and nonsense with brisk efficiency.1 She kept Buffett off limits to everyone—including his family at times. It made Susie seethe, but with Gladys guarding the door there was nothing she could do.

  Susie blamed Gladys. And, of course, Warren would never give Gladys an actual order to keep Susie out. But everyone at his office knew how to interpret what he wanted from his subtle way of saying something without directly stating it. Nobody would so much as cough if they thought he would disapprove. People had to follow hints and signals as if they were stated rules simply to work at the Buffett Partnership. Beetled brows and “hmmmf” meant “Don’t even consider it.” “Really?” meant “I disagree but won’t say so directly.” An averted head, crinkled eyes, and backpedaling meant “Help me, I can’t.” Gladys brooked no nonsense in following these unarticulated requests and orders, and sometimes people’s feelings got hurt. But her job was to protect her boss, and that meant doing things he couldn’t bring himself to do. She had to be tough enough to take the blame.