Warren Buffett (Trades, Portfolio) is the world's greatest investor, yet I hadn’t previously read "Buffett: The Making of an American Capitalist"by Roger Lowenstein for two reasons. First, everyone knows that Buffett is from the Benjamin Graham school of investing. I had read Graham's "Intelligent Investor" whilst in university and had studied value investing during my security analysis and equity investment management classes, so I was familiar with Buffett's value investing style. It's worth reading Buffett's "The Superinvestors of Graham-and-Doddsville" if you are not already familiar with the arguments.
However, the second reason I had not picked up this book much earlier was that I had this feeling that while Buffett was surely a talented investor, he was also might just have been in the right place at the right time, i.e. America during the 20th century, and he had made common-sense, long-term investment decisions and let the power of compound interest do its thing. I had always thought Buffett's real genius was in using the GEICO float to leverage his portfolio and earn a decent carry. While I have always respected Buffett, I thought he was an above-average investor with discipline and a good sense in growing his business, but had a good tailwind for the majority of his career. I am not sure we will see another Buffett ever again. Maybe in China or India. Might we see a Buffett-like computer algorithm?
Anyway, I decided to read this book because I had read another book a few years back by its author, Lowenstein, titled "When Genius Failed," which was about the rise and fall of the mega hedge fund Long Term Capital Management. That book was extremely well researched and written. In short, out of my respect for Lowenstein, I decided to read his book on Buffett. Besides, with a bit more time on my hands, what harm is there to know more about the world's greatest investor?
"Buffett: The Making of an American Capitalist" is incredibly detailed about Buffett's life, from his time as a child through school and university to the start of his career, through working for a stockbroker to working for Graham to Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) and famous investments like Coca-Cola (KO, Financial).
What I learned was that Buffett was not just a smart investor. He was a canny trader too. When working for Graham, he spotted an opportunity to arbitrage cocoa beans thanks to an opportunity that arose where one of their holdings, a chocolate company, was offering to redeem its stock in exchange for cocoa beans at a price cheaper than that of cocoa trading on the exchange, so Buffett exchanged the stock, collected the beans and sold them on the exchange at a higher price, locking in a risk-free profit.
Later in his career, in 1969 to be precise, Buffett decided to liquidate his partnership. This was the era of the "Go-Go" years, and most everything was expensive in Buffett's eyes. While Wall Street was recommending stocks at any price, Buffett reminded his friends that "price is what you pay, value is what you get."
Berkshire Hathaway
The chapter titled "Berkshire Hathaway" is also interesting. Buffett didn't just acquire the company in the market; he had to carefully negotiate with the shareholders and the management to get the company at a good price. This chapter also demonstrates something I think is key to Buffett's success that I was not aware of before: management incentives. To quote from the book:
"Buffett opposed options for the same reason that most CEOs were enamoured of them. Options conferred potential - sometimes vast - rewards, but spared the recipients any risk, thus giving executives a free ride on the shareholders' capital.
More subtly, Buffett wanted managers whose personal interests were in line with those of the stockholders. A manager who owned options, as distinct from shares had nothing to lose, and those would be more inclined to gamble with the shareholders' capital."
I thought this was very interesting, so I looked up the reference. Put another way, Buffett said in his 1985 letter to shareholders:
"Ironically, the rhetoric about options frequently describes them as desirable because they put managers and owners in the same financial boat. In reality, the boats are far different. No owner has ever escaped the burden of capital costs, whereas a holder of a fixed-price option bears no capital costs at all. An owner must weigh upside potential against downside risk; an option holder has no downside. In fact, the business project in which you would wish to have an option frequently is a project in which you would reject ownership. (I'll be happy to accept a lottery ticket as a gift - but I'll never buy one.)"
Pieces of businesses
Buffett was all about owning "pieces of businesses" and knowing the intrinsic value of companies. He often admonished friends for trying to predict the short-term direction of the market. You could say that as well as the sporadic riskless arbitrage he engaged in, Buffett's main activity has been "time arbitrage," waiting for Mr. Market to correct his crazy antics. It's clear that Buffett hated speculation. In "Soros on Soros," George Soros (Trades, Portfolio) said, when asked about a comparison with Buffett, that you could not find two more different characters. That is very true. Soros, for the most part, was a pure speculator and Buffett a pure investor, but also Buffett is known to admire Adam Smith's "Wealth of Nations," while Soros is against the principle of the Invisible Hand.
The book is a very good read, although it must be stressed it is a biography. What I mean is that it provides good examples of how the rules of value investing have been demonstrated by the world's most famous value investor. Readers wanting a more technical investment book should opt for Graham's "Intelligent Investor," Seth Klarman (Trades, Portfolio)’s "Margin of Safety" or "The Aggressive Conservative Investor"by Martin Whitman and Martin Shubik.
Conclusion
Did my opinion about Buffett change much after reading this book? I have to say he is more impressive than I had assumed, given the extent of his negotiation and management skills as well as his corporate finance and security selection abilities. But I still believe Buffett had the wind at his back thanks to the great success of America during the 20th century. With America struggling somewhat, or at least with the old economy being overtaken by Silicon Valley, we see many investors outperforming Buffett these days. To get Buffett-like results with value investing in the 21st century, one might have to look outside the United States. I believe the post-Brexit United Kingdom, a market I cover, is one with a lot of potential.
In the 21st century with a more challenging environment, I think Soros is someone to seriously study thanks to his unique analysis of the world and top risk management and portfolio management skills. I also think James Anderson is also someone to study in our current era.
Regardless, there is much to be learned from both Buffett and Soros.
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