The Snowball

by Alice Schroeder

  “I had such a good time that I hate to think it’s over,” Susie said afterward.39

  PART FOUR

  Susie Sings

  34

  Candy Harry

  Omaha • 1970–Spring 1972

  Two months after the Stage Door Deli party, as Buffett took the formal steps to unwind the partnership, the Dow broke 800 on the downside. A month later, in January 1970, his friend Carol Loomis highlighted his spectacular performance over the course of the partnership’s history—and his dour view of the prospects for stocks—in an article on hedge funds in Fortune.1 Shortly before the article appeared, as the market started to snowplow downhill, he sent the partners a letter explaining what they owned.

  • Berkshire Hathaway, which he said was worth about $45 per share.2 Of this, about $16 was tied up in textiles, a business that he said was not satisfactory and had an even smaller chance of being so in the future. But even though that was one-third of the value, he would not liquidate it to free the cash. “I like the textile-operating people,” he wrote. “They have worked hard to improve the business under difficult conditions—and, despite the poor return, we expect to continue the textile operation as long as it produces near-current levels.” Berkshire Hathaway also owned the much more profitable insurer, National Indemnity.

  • Diversified Retailing, which he valued at $11.50 to $12 per share. DRC consisted of only the scroungy Associated Cotton Shops and cash and notes from the sale of Hochschild-Kohn, which he planned to use “for reinvestment in other operating businesses.” He did not specify what these might be, implicitly requiring the departing partners to trust his judgment, just as they had when they joined the partnership.

  • Blue Chip Stamps, revealed for the first time. Buffett told the partners he would probably cash them out of this investment because the company was planning a sale of stock around the end of the year.

  • Illinois National Bank & Trust Company of Rockford, Illinois, also owned by Berkshire Hathaway.

  • Sun Newspapers, which he described as “not financially significant.”3

  The departing partners were floored to find that through their ownership of Berkshire Hathaway, they owned a trading-stamp company, a bank, and an insignificant newspaper.4 Now they had to decide whether to hold these cards or trade them, because they could have all cash instead.

  “He would cut the pie and you would be able to get the first choice on the pieces,” says John Harding. This was a brilliant move on Buffett’s part. He, of course, wanted them to choose the cash, leaving the Berkshire Hathaway and Diversified Retailing stocks for himself. Nevertheless, he was honest with them. In a letter of October 9, 1969, he made a market forecast, which he had previously declined to do. With the market at such heights, “…[f]or the first time in my professional life,” he wrote, “I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds”5—although he did allow as how the very best money managers might be able to squeeze out a few percentage points over the earnings of bonds. Nonetheless, the departing partners shouldn’t have high hopes for what they could do with the cash.

  Two months later, on December 5, he gave a prediction about how these two stocks would do, along with telling the partners what he was going to do himself. “My personal opinion is that the intrinsic value of DRC and B-H will grow substantially over the years…. I would be disappointed if such growth wasn’t at a rate of approximately ten percent per annum.” That was an important statement. He was telling them that Berkshire and Diversified would not only do better than bonds, but better than he had said in October the partners could expect from even the very best money managers.

  “I think both securities should be very decent long-term holdings and I am happy to have a substantial portion of my net worth invested in them…. I think there is a very high probability that I will maintain my investment in DRC and B-H for a very long period.”6

  Separately, Buffett wrote the partners a dissertation on how to invest in bonds, again extending himself considerably more than a typical money manager would ever do. Even so, “I had four people panic when I closed down. All four were divorced women. They trusted me, and they didn’t trust anybody else. They had had bad experiences with men, and they didn’t feel they could make it again if they lost what money they’d gotten. They would call me in the middle of the night and say, ‘You’ve got to keep earning me money,’ and all this sort of thing.”7

  But he refused to act as what he considered to be a fiduciary if he could not perform to his high standards. “Basically, if I’m the guarantor, I just can’t do it, knowing how hard it was on me once,” he says, harkening back to what he had felt at age eleven when Cities Service Preferred had disappointed his sister.

  He continued working on the partnership dissolution over Christmas in Laguna Beach. He had bought his Christmas gifts with his usual efficiency. As with most things, he had a system: He went to Topps, the best dress shop in Omaha, and gave them a list of the different sizes for all the women in his life.

  “I would go over, and they’d wheel out the dresses. I’d make a variety of decisions and buy presents for my sisters, Susie, Gladys, and so forth. I kind of enjoyed it. Bertie’s more conservative, so I’d move her up a notch in style, and she’d accept it from me but nobody else.

  “You know, clothing holds its value better than jewelry.”

  On December 26, after the exchange of Christmas gifts, he sent the partners another long letter, going out of his way to answer at length a number of their questions.8 A few of the partners had been challenging him. They were deciding whether to hold the Berkshire stock. If it was such a lousy business, why not get rid of the Berkshire Hathaway textile mill?

  “I have no desire to trade severe human dislocations for a few percentage points additional return per annum,” he wrote, echoing what he had said to them in his letter of January 1969. But since the whole point of his business was to eke out a few additional percentage points per annum, this kind of rationalization would have been unthinkable earlier in his career.

  What is Sun Newspapers? they asked. It’s worth a buck a share, he replied, kind of skipping the rest of the economics. Then he added some famous last words. “We have no particular plans to expand in the communication field,” he wrote.9

  Why didn’t you register the Berkshire Hathaway and Diversified stock so that it could be freely traded? Berkshire was so closely held that it traded “by appointment”—which made it hard for anyone to know what the stock was actually worth. Diversified did not trade at all.

  A long, complicated explanation followed, in which Buffett argued that a freely traded and liquid public market for these stocks would be less efficient and less fair and “the more sophisticated partners might have an important edge over the less sophisticated partners.” And it was certainly true that the more naive of his departing partners would be kept from the clutches of the manic-depressive Mr. Market, who might at times have valued the stock at a severely discounted price. It lowered the odds that a pack of brokers would talk them into selling just to buy IBM or AT&T. But it also meant that Buffett was limiting his partners’ options—making it harder for them to buy and harder for them to sell—and, if they did sell, making it more likely that they would sell to him.

  As general partner of the partnership, he was used to having total control of these two companies. Letting go and giving up control to the anonymous Mr. Market—he just couldn’t do it. Moreover, as soon as he handed these stocks to his departing partners, for the first time his own self-interest and theirs might be at odds. This complicated rationale to justify keeping the stocks unregistered danced a little do-si-do around the fact that Buffett was the most sophisticated partner of all. It was he who would have the most important edge over his former partners. No matter how honest his intentions, the decision widened the potential conflict between his interests and theirs. The painfully earnest tone of Buffett�
�s letter sounds like someone who has had to talk himself into thinking that he is doing the right thing. But the conflict was guaranteed to cause hard feelings. Anyone who sold to him and was later sorry could look back with hindsight and think: He had an edge on me.

  Still, the Howard in Warren demanded that he present their options with scrupulous honesty. The way he answered the next question told the departing partners exactly what to expect.

  Should I hold my stock? they asked.

  Buffett gave as clear and direct advice as he would ever give in public about a stock.

  “All I can say is that I’m going to do so,” he said, “and I plan to buy more.”10

  The departing partners were also going to have a third stock to deal with. In this same letter of December 26, Buffett told them that the Blue Chip stock sale had fallen through.11 The stock had plunged in a short time from a high of $25 to $13 a share because Safeway Stores had dropped Blue Chip stamps, its customer base was eroding, and no buyer was in sight for the one-third of the business that the Justice Department had mandated it sell. Two new lawsuits had been filed against it in the U.S. District Court in Los Angeles, one by Douglas Oil Company and the other by a group of filling stations, who said Blue Chip had broken the antitrust laws—that it was a monopoly—and asked for treble damages and attorneys’ fees.12

  Yet even as Blue Chip’s problems multiplied and the price fell, Buffett had been buying the stock instead of selling. He had bought it for Diversified Retailing and for National Indemnity. He had bought it for Cornhusker Casualty and National Fire & Marine, two little insurance companies that Berkshire had acquired. He had also bought it for himself and for Susie.

  Now the partners knew that Buffett wouldn’t sell, and indeed planned to hoover up more of all these stocks. They would get whichever they wanted—stock or cash. If they took the money, he would get the stock. If they kept their stock, they would still be his partners, in a sense.

  In his anxiety over whether people accepted and liked him, Buffett valued loyalty more than almost anything. He looked for loyalty in all of his relationships. The dissolution of the partnership had elements of a loyalty test, as his behavior afterward would make clear.

  When the partnership unwound, Buffett had more money to buy even more stock, for even while holding on to his shares—he personally owned eighteen percent of Berkshire Hathaway, twenty percent of Diversified, and two percent of Blue Chip Stamps13—he and Susie had hauled home roughly $16 million in cash by the end of 1969. During the ensuing year, the shares of Berkshire and Diversified quickly began to change hands, as though a giant were shuffling a deck of cards. As he had promised—but on a scale that might have staggered his partners, had they known—Buffett used the cash he got from the partnership to buy still more Berkshire and Diversified for his own account. He used Berkshire’s cash to buy its own stock, and for DRC, offered to buy the company’s stock from some people in exchange for a DRC note that paid interest at nine percent.14 He bought from people ranging from his former brother-in-law Truman Wood to his first investor, Homer Dodge, and his son Norton.15 Those who rejected these offers had to be willing to ride along and let Buffett reinvest the earnings without ever paying out a dime—a show of trust that was important to him.16

  Forever after, he would feel a loyalty to those who kept the stock—a loyalty of such depth and strength that the standard-model modern CEO would find it completely incomprehensible. Berkshire, he would later reflect, is still “like a partnership. You basically have the closest thing to a private business with shareholders who identify with you and who like to come to Omaha.” He thought of partners as people who had come together out of a complex set of shared values and interests, not out of short-term economic convenience. He often said that he tried to treat his partners the way he would his family. His partners were people who trusted him, people to whom he owed a special duty. In return, he expected loyalty from them.

  Yet people made their decisions for all sorts of reasons. Some needed money. Others simply invested in the Sequoia Fund after listening to Bill Ruane. Many people’s brokers urged them to sell the stock of a money-gobbling textile mill. Some listened, some didn’t. Some professional investors had other options and thought they were better off without these humdrum stocks. When Warren went to the West Coast in person and offered the DRC note, Estey Graham’s sister Betty sold her stock; Estey didn’t. Rhoda Sarnat, Ben Graham’s cousin, and her husband, Bernie, decided not to sell, telling themselves, Warren’s buying, and if it’s good enough for him, it’s good enough for us.17 When he offered the note to his sister Doris, she refused it, thinking, If he’s buying, why would I sell?

  A few partners quizzed Buffett more closely in person for his opinion of how the stocks would do. He said, carefully, that he thought they would do well, but it could take a long time. People like Jack Alexander and Marshall Weinberg parsed those words, considered the fact that they were good investors themselves, and sold him part of their stock.

  Munger would later call Buffett an “implacable acquirer,” like John D. Rockefeller in the early days of assembling his empire, who let nobody and nothing get in his way.18 With hindsight, some people felt hard done by, enticed, or even misled. Others said to themselves, in effect, Well, that’s just Warren. I should have known.

  By the end of 1970, many of the former partners had cashed out while Warren continued buying more stock. His and Susie’s ownership of Berkshire had shot from eighteen percent to almost thirty-six percent. Their ownership of DRC had nearly doubled, to thirty-nine percent. As a practical matter, Buffett now controlled both.19 He had also bought more Blue Chip, taking him from two percent to over thirteen percent ownership of its stock.

  But it was clear to Susie Buffett that Warren’s gyrations to get control of Diversified and Berkshire Hathaway meant that her husband’s second “retirement” would be similar to his first. One reason was that Blue Chip was in the same sort of trouble as Berkshire Hathaway.20 The business was no longer just shrinking, it was dying, so he and Munger would have to buy something new to springboard its capital.

  In late 1971, after President Nixon abandoned the gold standard, the price of oil skyrocketed and half the country’s oil companies suddenly stopped issuing trading stamps. With prices of everything leapfrogging day by day because of inflation, the classic retailing method of enticing customers into a store through a panoply of services and giveaways was thrown overboard. People wanted the lowest price, and retailers headed to a discount model.21 Any chance that housewives would plan their shopping to collect enough books of trading stamps to get an electric frying pan evaporated.

  Then one day Buffett got a call from Bill Ramsey, Blue Chip’s president, saying that a local Los Angeles company, See’s Candies, was for sale. Buffett had carved out a tiny subspecialty of studying candy companies, keeping a file on Fanny Farmer22 and looking into the company that made Necco Wafers. But candy companies were expensive. So far, he had never bitten. “Call Charlie,” he said.23 Munger was in charge of Blue Chip, their West Coast business.

  See’s, founded in 1921 by a Canadian candy salesman, competed by using the finest quality butter, cream, chocolate, fruits, and nuts, painstakingly prepared to “See’s Quality,” which was better than “top quality.” During World War II, rather than dilute its recipes to stretch rationed ingredients, See’s had put signs in its distinctive black-and-white stores: “Sold out. Buy war bonds for Christmas.”24 The company became a California institution.

  “See’s has a name that nobody can get near in California,” Munger told him. “We can get it at a reasonable price. It’s impossible to compete with that brand without spending all kinds of money.” Ed Anderson thought it was expensive, but Munger was overflowing with enthusiasm. He and Buffett went through the plant, and Munger said, “What a fantastic business. And the manager, Chuck Huggins—boy, is he smart, and we can keep him on!”25

  See’s had a tentative deal on the table already and wanted $30
million for assets worth $5 million.26 The difference was See’s brand, reputation, and trademarks—and most of all, its customer goodwill. Susie Buffett, for example, was crazy about See’s, which she had discovered in California.

  They decided that See’s was like a bond—worth paying $25 million for. If the company had paid out its earnings as “interest,” the interest would average about nine percent. That was not enough—owning a business was riskier than owning a bond, and the “interest rate” was not guaranteed. But the earnings were growing, on average twelve percent a year. So See’s was like a bond whose interest payments grew.27 Furthermore: