If you have a spare $3.5 million, you could spend it on lunch with Warren Buffett. Now, you might baulk at the cost, but every year, Mr. Buffett, the most successful investor in history auctions off a lunch date with himself, with proceeds going to the Glide Foundation, a San Francisco charity for the homeless. Warren Buffett, who is known as “The Sage of Omaha”, is currently worth $53bn. Maybe some of his magic will rub off on you and the meal will be a bargain. Buffett is the chairman and CEO of Berkshire Hathaway, a multinational conglomerate holding company based in Omaha, Nebraska. In his 2012 letter to the shareholders, Buffett pointed out the company’s per-share book value has grown by an average of nearly 20% each year since 1965. That sounds awfully high to me, in Madoff territory. But, as far as we know, Buffett is not running a Ponzi scheme. To put all this in perspective, if you had taken $5,000 in 1965 and achieved with it the same annual rate of return as Berkshire Hathaway, today it would be worth $29.3 million. I don’t have an intuitive feel for all these numbers. As Einstein said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” Despite all this wealth, Warren Buffett retains a modest lifestyle, living in the same house that he purchased in 1958 for $31,500. Who is this man and how was he able to become one of the richest men in the world?
Warren Edward Buffett was born in 1930 in Omaha, Nebraska, one of U.S. Representative Howard Buffett’s three children, the only son. He has had a somewhat unconventional personal life. He married Susan Thompson in 1952 and they had three children, Susie, Howard and Peter. However, the couple began living separately in 1977, when Susan moved to San Francisco to pursue a musical career. Before she left Susan had arranged for Buffett to meet Latvian-born Astrid Menks and the two began living together with the blessing of Susan. All three were said to be close and Christmas cards to friends were signed “Warren, Susie and Astrid.” Warren and Susan remained married until she passed away in 2004. Buffett then married Astrid, who was by then 60 years old.
Warren Buffett demonstrated a knack for business from childhood, buying his first stock at the age of eleven, three shares of City Service at $38 per share. After buying the stock, its value fell to $27 per share. However, Buffett held on to the shares until they recovered to $40. He then quickly sold the shares, which then proceeded to reach about $200 per share. This experience would be an important lesson for the young Warren. While still in high school, he was able to earn money by delivering newspapers, selling golf balls and stamps, among other activities. When he filed his first income tax return in 1944, Buffett claimed a $35 deduction for the use of his bicycle and watch on his paper round. In 1945, in his second year of high school, Buffett and a friend bought a used pinball machine for $25. They put it in a local barber shop. They later reinvested the profits from this machine to purchase two more. Within a year, they sold all three to a war veteran for $1,200.
In 1947 Buffett began studying in business administration at the Wharton School of the University of Pennsylvania. However in 1950 he transferred to the University of Nebraska–Lincoln where at the age of nineteen, he graduated. He then enrolled at the Columbia Business School because Benjamin Graham, an investor he greatly admired, was teaching there.
Then it was out in to the world of work. By 1962, Buffett had become a millionaire. He invested in and eventually took control of a textile manufacturing firm, Berkshire Hathaway. He initially maintained the core business of textiles, but by 1967, he had begun to move into the insurance industry and other investments. In the late 1970s, Berkshire Hathaway acquired an equity stake in the Government Employees Insurance Company (GEICO), which still forms the core of its insurance operations today and is a major cash cow that helps the conglomerate finance its other investments. In 1985, the last textile operations were finally shut down. Buffett now argues that purchasing Berkshire Hathaway was the biggest investment mistake he has ever made. If he had invested that money directly in insurance businesses, he would have made compounded investment returns of about $200 billion over the previous five decades. As well as wholly owning GEICO and Fruit of the Loom, and half of Heinz, they have significant minority holdings in American Express, Coca-Cola, Mars, Procter & Gamble, Tesco, Wal-Mart. Buffett became a billionaire in 1990 and in 2008 the richest person in the world. He is currently fourth on the Forbes Rich List, behind Carlos Slim, Bill Gates, and Amancio Ortega.
Warren Buffett engages in what is known as value investing. Value investors look for securities with prices that are unjustifiably low based on the company’s fundamentals. The value investor searches for stocks that he or she believes are undervalued by the market, stocks that are valuable but not recognized as such by the majority of other buyers. Buffett, however, isn’t concerned with the beauty contest that is the stock market. He is not your common or garden speculator – he prefers to choose stock exclusively on their overall potential as a company he believes in investing for the long run – “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” If the price goes down, he will simply invest more because he believes in their prospects for the future. He is looking for ownership in quality companies that will be capable of generating earnings. He is interested in the profit margins, whether the company is saddled with excess debt and how long the company has been public – he prefers companies which have been listed for at least ten years. He does not suffer from neomania, favouring instead companies that have stood the test of time. Therefore, he avoids buying stock in new social media companies like Facebook and Google because he finds it hard to estimate future value. He is also wary of initial public offerings (IPOs) of stock, which he believes are almost always bad investments. Ultimately he likes a distinctive brand, something that sets the company apart from the competition.
Whether you agree with Buffett’s strategy or not, it has proved remarkably successful. He is one of the richest people in the world, with a net worth of more than $53 billion according Forbes in 2013. The proof is in the pudding. Or is it? There is a cognitive bias known as survivorship bias, “the logical error of concentrating on the people or things that “survived” some process and inadvertently overlooking those that did not because of their lack of visibility.” In Fooled by Randomness Naseem Nicolas Taleb put it like this:
“I am not saying that Warren Buffett is not skilled; only that a large population of random investors will almost necessarily produce someone with his track records just by luck.”
People look at the winners and discover the similarities with others who are successful. However, if you ever visit the graveyard of failed individuals and companies, you will find that many of those there possessed many of the same traits of the winners. Taleb imagines an eccentric (and bored) tycoon offering $10 million to the winner a game of Russian roulette:
“The problem is that only one of the histories is observed in reality; and the winner of $10 million would elicit the admiration and praise of some fatuous journalist (the very same ones who unconditionally admire the Forbes 500 billionaires).“
Taleb does not appear to be a big fan of Buffett. I think we can safely say that Taleb will not be getting an invitation to Omaha this Christmas:
“I have no large desire to sacrifice much of my personal habits, intellectual pleasures, and personal standards in order to become a billionaire like Warren Buffett, and I certainly do not see the point of becoming one if I were to adopt Spartan (even miserly) habits and live in my starter house. Something about the praise lavished upon him for living in austerity while being so rich escapes me; if austerity is the end, he should become a monk or a social worker—we should remember that becoming rich is a purely selfish act, not a social one. The virtue of capitalism is that society can take advantage of people’s greed rather than their benevolence, but there is no need to, in addition, extol such greed as a moral (or intellectual) accomplishment (the reader can easily see that, aside from very few exceptions like George Soros, I am not impressed by people with money).“
The other question is which came first, chicken or egg? His numerous followers hang on his every word. So, when Buffett invests in a company, is he seeing value that others are incapable of seeing, or does his interest mean that millions of others follow him blindly? I think it would be interesting if he deliberately invested his stock in some company with bleak prospects for the future, one which makes typewriters or a video rental company. Would the millions follow the messiah thus raising its value?
In the end though, I take a more positive view of Buffett than Taleb does. I do not go in for adulation, but after what we have seen in the last few years, it is nice to see someone who takes a long-term view. He represents everything that Wall Street is not. I don’t know how much is skill and how much is luck, but he does seem like a smart guy. What’s more he has other appealing traits. His philanthropy is legendary. In June 2006, he announced a plan to give away his fortune to charity, with 83% of it going to the Bill & Melinda Gates Foundation, the largest charitable donation in history. He is also one of that rare breed of billionaires who thinks they should pay more taxes. Warren Edward Buffett has become the acceptable face of capitalism.