Originally published July 31, 2016
I have no idea how many books have been written about Warren Buffett, but sometimes I have the feeling that he is giving George Washington a run for his money. The latest addition to the literature is Yefei Lu's Inside the Investments of Warren Buffett: Twenty Cases (Columbia Business School Publishing, 2016).
Lu examines 20 investments Buffett made over the course of his career that, in Lu's opinion, "had the largest material impact on his trajectory." He puts himself in the shoes of imaginary investment analysts "studying the businesses at the same time … Buffett did." Why would an ordinary analyst either recommend or, as would often have been the case, argue against investing in a company to which Buffett eventually opted to commit funds?
The book is divided chronologically: five investments between 1957 and 1968 (the years of Buffett Partnership Limited), nine investments between 1968 and 1990, and six after 1990. I found the first section the most interesting, both because it was the period I knew the least about and because it shows Buffett's willingness to pursue a variety of analytical and risk management strategies, perhaps even some long-short pairs trades. Here I will limit myself to Buffett's activities when he was running BPL.
The five investments Lu chooses as illustrative of Buffett's investing during this period are Sanborn Map Company, Dempster Mill Manufacturing Company, Texas National Petroleum Company, American Express, and (of course) the ill-fated Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B).
Sanborn Maps produced maps primarily for fire insurance companies. Its maps "included details of not only streets and houses of a city but also such items as diameter of water mains underlying streets, number of windows, elevator shafts, the material of construction for buildings, and production lines for industrial facilities. The commercial product sold to its customers would typically be a large volume of maps that weighed approximately fifty or so pounds…." Sanborn was a successful company, with steady revenues, until the 1950s, when a new technology, "carding," threatened to undermine its existence. By 1958, when Buffett began investing in Sanborn, the company was struggling. Between 1950 and 1958 net income had declined approximately 10% per annum. Why, then, would Buffett have been interested in it? First, it had a securities portfolio worth more than the value of the entire company and, second, Buffett believed it could be turned around. Buffett was an activist investor in this instance. Over the course of three years he acquired a controlling interest and separated the company into two separate entities. Sanborn Maps exists to this day.
Dempster Mill, a Nebraska-based company, sold windmills and assorted agricultural equipment such as seed drills and fertilizer applicators. In the 1950s windmills were anything but a growing business. Buffett wrote that Dempster Mill's "operations for the past decade have been characterized by static sales, low inventory turnover and virtually no profits in relation to invested capital." But Buffett could buy the company's stock at a significant discount (on average 63%) to book value, the bulk of its assets could be readily sold and turned into cash, and with better management it could be revitalized. Once again, Buffett played the role of activist investor, a role it turned out he didn't enjoy and came to abandon.
The next two investments were different. Texas National Petroleum was a special situation. It had an offer to be acquired but had not yet accepted the offer. American Express (NYSE:AXP), a growing business then best known for its travelers cheques, was reeling from the "salad oil swindle" and faced "unknown and potentially enormous liabilities." Judging the ramifications of the scandal to be temporary, Buffett was willing to forgo the "cigar butt" strategy and pay a fair price for a really good business. As for Berkshire Hathaway, although it is often viewed as a mistake, "the shrinking business actually provided the capital with which Buffett would invest in many other businesses starting in 1967 with the purchase of National Indemnity." And so, Lu concludes, "it likely did not actually lose money for Buffett in absolute terms." And it provided Buffett with an iconic name.