"So why do smart people do things that interfere with getting the output they’re entitled to? It gets into the habits and character and temperament, and behaving in a rational manner. Not getting in your own way. As I said, everybody here has the ability absolutely to do anything I do and much beyond. Some of you will, and some of you won’t. For the ones who won’t, it will be because you get in your own way, not because the world doesn’t allow you." — Warren Buffett
There are two responses that come to mind.
We’re human. The world we live in today hasn’t been around long enough for our brains to have evolved into the rational, unbiased and disciplined investors he suggests we can be. For most of us, it’s a fight with our wiring.
Markets are human (mostly). The markets are aggregations of irrational, biased and undisciplined investors so there are always investment opportunities.
While Simons, Munger and Dalio had different personalities, they shared the same obsession with principles, models and discipline that Buffett is referring to, even if you don’t quite buy into the self-effacing comments. I don’t. He’s not like us. None of these great investors are just like us, but we can still learn from them.
Warren Buffett first caught my attention during the Salomon scandal in 1991. In the late 1980’s the investment houses were looking to shore up their balance sheets from bad bets made in the junk bond market. Warren invested $700 million in Salomon thinking there was a ” margin of safety” assuming Salomon had avoided the junk bond fiasco. That turned out to be a mistake and Salomon was caught in a bond trading scandal that almost forced the firm into bankruptcy. Warren had to transition from passive investor to CEO and Chairman. It was his solid character and integrity that saved Salomon and made a big impression on me.
“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently”.
This trait seems to be dominant in all the great successful investors I’ve been profiling. From Graham to Dalio these men had it. Not only were they smart and innovative but of solid character with integrity. That helped guide their investment decisions and sustained them during tough situations. Given that there are many persons of character that aren’t successful investors I need to look deeper but it was the consistent and solid track records and strength of character that has motivated me to learn more.
Principles Forged in Omaha
Born in Omaha Nebraska in 1930, the second of three children and the only son of Congressman Howard Buffett and his wife Leila, Buffett began his education at Rose Hill Elementary School. As a child, he “loved numbers since childhood; he’s been constantly calculating everything around him as long as he can remember.” In 1942, his father was elected to the first of four terms in the United States Congress, and moved with his family to Washington, D.C.. Warren finished his public education and graduated from Woodrow Wilson High School in 1947 at the age of 16. His senior yearbook picture reads, "likes math; a future stockbroker."
Before graduating high school, Warren had a variety of investing and business ventures. At 11, he bought three shares of Cities Service Preferred for himself, and three for his sister Doris Buffett at $38 per share. While he sold it at $40, he missed the move to $212 and cites this as a critical lesson in patience.
At the age of 15, Warren made more than $175 monthly delivering Washington Post newspaper. His first income tax return in 1944 showed a $35 deduction for the use of his bicycle and a watch on his paper route. In 1945, as a high school sophomore, Buffett and a friend spent $25 to purchase a used pinball machine, which they placed in the local barber shop. Within months, they owned several machines in three different barber shops across Omaha. The business was sold later in the year for $1,200. With this successful start, Buffett wanted to skip college to go directly into business, but was overruled by his father.
He entered the Wharton School of the University of Pennsylvania in 1947. Warren studied there for two years and then transferred to the University of Nebraska–Lincoln where at 19, he graduated with a Bachelor of Science in Business Administration. After being rejected by the Harvard Business School, Buffett enrolled at the Columbia Business School after learning that Benjamin Graham taught there. He earned a Master of Science in Economics from Columbia in 1951. After graduating, Buffett attended the New York Institute of Finance.
After Columbia Buffett returned to Omaha and started selling securities. He was constantly sending Graham securities ideas, he finally received a reply telling him to come and see Graham in NYC. Graham offered him a job which he politely turned down. Later, returning to Omaha, he started the Buffett Partnership in 1956, operated seven partnerships by 1960 and in 1962 made the infamous investment in textile manufacturer Berkshire Hathaway, ultimately taking control and building it into the huge firm it is today. I loved his first investor pitch according to Forbes,
“But these ground rules are the philosophy. If you are in tune with me, then let’s go. If you aren’t, I understand. I’m not going to tell you what we own or anything like that. I want to get bouquets when I deserve bouquets, and I want to get soft fruit thrown at me when I deserve it. But I don’t want fruit thrown at me if I’m down 5 percent, and the market’s down 15 percent—I’m going to think I deserve a bouquet for that.”
Can you imagine getting that pitch today?
Buffett’s success came from buying undervalued, illiquid securities. He had what he called his “generals” - stocks he felt were undervalued, and a separate portfolio for what he called special situations. These were spinoffs, arbitrage situations and other securities where a value-realization process was underway. All of his investment decisions were heavily influenced on the fundamentals he learned from Benjamin Graham. One of the key principles guiding his investments is the Margin of Safety Principle.
“Margin of safety is a principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. In other words, when market price is significantly below your estimation of the intrinsic value, the difference is the margin of safety. This difference allows an investment to be made with minimal downside risk.”
Not a Big Fan of Wall Street
While he became the world’s most successful and famous investor, he was always from Omaha and not part of Wall Street. In one of his letters to shareholders, he said that "when trillions of dollars are managed by Wall Streeter’s charging high fees, it will usually be the managers who reap outsized profits, not the clients." To prove his point in 2007, Buffett made a bet with numerous managers that a simple S&P 500 index fund will outperform hedge funds that charge exorbitant fees. By 2017, the index fund was outperforming every hedge fund that had made the bet against Buffett by a significant margin. Of course, today one of the dominant trends on Wall Street is the flow of money out of active and into passive funds or ETFs.
In most books by or about Buffett, his position against corporate charitable donations would leave you to believe he’s only interested in his own wealth but this isn’t true. His position was that companies should distribute that money to its shareholders and let them donate it, not give it away for them. As for his personal position, he joined Bill Gates to sign what is known as the "Gates-Buffett Giving Pledge", in which they promise to donate to charity at least half of their wealth. They challenged others to join them and the result has been an enormous amount of funding for some of the world’s greatest challenges. While trying to match Buffett’s success as investors, his leadership in this area may be his greatest lesson.
Principles for Investing
In contrast to Dalio or Simons (and the trend to quant funds and AI), Buffett does not talk about algorithms, big data or sophisticated models. He expresses straightforward principles for investors and I’m sure, retains some very good (Munger) models in his head, developed through a lifetime of avid reading and studying mountains of annual reports. Not sure it’s possible to get those models out of his head, so I’ll leave you with some of his best known “rules”.
"Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
"If The Business Does Well, The Stock Eventually Follows."
"It's Far Better To Buy A Wonderful Company At A Fair Price Than A Fair Company At A Wonderful Price."
"Our Favorite Holding Period Is Forever."
This man is a genius and throughout time has prevailed by sticking to his principles. There is no better way to close out this post than to watch this great HBO documentary, Becoming Warren Buffett and appreciate the man behind this success.
Profitable investing decade after decade requires a lifetime dedicated to continuous learning, a sense of history and big trends, and above all disciplined execution within your own core competence while maintaining intellectual humility. This applies whether you are using the latest in artificial intelligence managing a funds, investing in ETFs or picking stocks.