Notes – Horizon Kinetics 2015 Compendium (@HorizonKinetics, #investing, #diversification, #indexing, #EMH)

For the last two years, Murray Stahl and Steve Bregman of Horizon Kinetics have published a “Compendium Compilation” of their various research pieces and market commentariesthroughout the year. I recently requested copies of the 2014 and 2015 compendiums and just completed reading through the 2015 compendium. What follows are “stitched together” quotes from several of the essays.

The Indexation Experience

An active manager always can be found to be deficient if underperformance relative to an appropriate index is discovered. In fact, a manager can be found to be deficient if a return generated is equivalent to the appropriate index… one could always purchase the index as the less expensive investment alternative.

How does one judge an index to be deficient?

Since short-term interest rates approach zero in most regions of the world, the valuation environment is very benign… most governments during this period have embarked upon grand fiscal stimulus efforts that are now becoming unsustainable.

When one measures a manager relative to an index, is one measuring investment acumen or marketing ability?

The manager… will purchase a security until the expected excess rate of return is zero. The index… is marketed until the marginal revenue from a product is zero, which is an entirely different concept.

The index is not constrained by valuation.

Most indexes, in the fullness of time, do not earn impressive rates of return.

Problems With Indexation

When indexation excludes the so-called marginal securities, two things happen. The marginal securities are the stocks where the volatility really resides, which means the index is going to lose its volatility. Second, the marginal securities are an important contributor to what would have been the return… their negative impact gets captured on the way down– but the positive return impact does not get captured on the way up.

It is the nature of a market capitalization weighted index that it is always un-diversifying.

Diversification

 

The problem with such an approach [wide diversification] is that it is quite impossible for any individual, or even a team of individuals, to have a good working knowledge of the individual investments at a security level. The portfolio can only be understood in terms of its statistical attributes… CalPERS… has about 20,349 individual investments.

If a team of 10 analysts were to work eight hours a day for three months, which is 22 business days per month, with no interruptions, the team would have at its disposal 10 x 8 x 3 x 22 man-hours to read 20,349 quarterly reports. This amounts to 5,280 man-hours available to read 20,349 quarterly reports, which equates to slightly more than 15 minutes per quarterly report… It should be obvious that success or failure in this endeavor must depend upon whether the statistical attributes of the portfolio provide the data necessary to make intelligent asset allocation decisions… it is impossible to devise a simple list of fundamental statistics to be used to comprehend a portfolio… because of differences in corporate expenditure practices, depreciation policies, tax laws in various jurisdictions, and GAAP vs. IFRS accounting.

The many diversified funds that purchase the most liquid securities must by definition generally own the same securities, since there is only one set of liquid securities. If the diversified institutions, therefore, own the same securities, when studying the price behavior of those securities, those institutions are, in reality, studying themselves.

If one believes in the Efficient Markets Hypothesis, then securities prices must reflect the beliefs of the holders of the securities. Yet, as shown above, the holders of securities do not study the securities. In fact, given diversification practices, it is not possible to study the securities. It is only possible that the investors study one another. Thus, one is confronted with a feedback loop or a huge self-reference paradox, as one may see in the paintings of M.C. Escher, such as Waterfall or Drawing Hands.

Another interesting case is the Singapore Index… returned 3.2% per annum. The mere fact that the economy of Singapore grew at over 6% per annum for more than 18 years does not correlate well with the stock market reutnr for the simple reason that the Singaporean companies in the index are global companies. These results reflect many factors apart from the economy of Singapore.

Similarly, the Swedish index does not necessarily reflect the economy of Sweden. And the UK index does not necessarily reflect the economy of the UK.

The thrust of these facts is to question, if not actually reject, the geographical form of classification as an asset allocation building block. That calls into question the entire international method of investing. The characteristics of equities have little to do with the legal place of domicile of a given firm. However, on a weekly basis the Investment Company Institute records $3 billion to $4 billion withdrawn from domestic equity funds and deposited into internaitonal equity funds in search of diversification and risk control atrributes that simply do not exist. As has been the case with many widely held investment beliefs without foundation, this will not have a good outcome.

Inefficient Markets

[Fischer Black] said that there are people who are highly knowledgeable about certain companies– the information traders– and when they trade, they are very well informed. Most others, however, are not so well informed; they are the noise traders.

[Fischer Black’s concept of] efficient markets was that if the bulk of investors were in an index that, as he defined it, would include every stock out there– everything– the noise traders would go there. That would eliminate the bulk of the noise traders from the active marketplace, so only the information traders would be trading. They would not go into the index, becuase they are highly informed, and the market would be much more efficient in the sense that it would reflect the judgments of informed participants.

If one reflects upon this matter [Carl Icahn’s letter to Apple], one will see that Mr. Icahn has posed an exceedingly profound question to all investors, and especially academics. Apple is the largest company in the world. It is arguably the most ubiquitous company in the world. Billions of people use Apple products daily and are very familiar with those products. If there is any equity in the world that should be priced efficiently, it should be Apple.

Yet, Apple has a lower P/E than companies such as Exxon, Coca-cola, and even Philip Morris International. One might debate the future prospects for Apple, but surely these are more robust than those of Philip Morris International. Does anyone assert that demand for cigarettes will increase?

The money manager industry is not populated by Homo Economicus, carefully and rationally evaluating different investment opportunities. The money manager can only survive by attracting assets to manage for a fee.

Modern financial theory cannot explain momentum because, if the stock market is efficient, there should be no serial correlation observed in securities… momentum investing is not a new innovation. It is a concept virtually as old as the idea of a stock market, although it has not always been called “momentum.” Technical analysis is essentially a search for securities with momentum.

It is now possible to raise substantial sums for almost any index if the rate of return is sufficiently high. It is nearly impossible to raise money for any index if the rate of return is insufficiently high, let alone if that return happens to be negative. This is not the asset allocation process. This is the momentum process. The industry makes use of a substantial marketing budget, It clearly influences the valuations not only of individual securities but of entire sectors, and it dominates, for the time being, the investment process.

 

Other Remarks

  • Is modern risk control methodology actually serving to reduce risk or is it merely convincing professional investors to accept, perhaps unwittingly, another type of risk?
  • It should be noted that the real was not always the currency of Brazil. There were cruzeiros, there were cruzadoes, and now we have the real. That in itself should tell the reader something about the stability of the currency.
  • Historically, that is what emerging market debt was: questionable claims against governments.
  • Bonds should be thought of in the following way: they offer risk with no possibility of reward, especially if you are a taxable investor.

 

Notes – Best Practices in Deal Flow Origination (#investing, @dteten)

These notes are from an article entitled “Where Are The Deals?” by David Teten. He also has resources on adding value to portfolio companies which are worth browsing. For notes on a related topic, check out the “Notes – Stanford Graduate School of Business Search Fund Primer” post.

  • the median investor in private companies had to review 80 companies in order to close one transaction
  • investments sourced through personal and professional networks have been shown to yield better results
  • in order to train your relationships, it is important that you provide them with simple, clear investing criteria, not lengthy checklists; provide them a narrowly defined niche of interest (“Retail brands with $50M in annual revenues”)
  • on average it can take 1-2 years between the first meeting with a target CEO sourced through a network and the close of the deal
  • market mapping, identifying key macro and micro drivers of an industry and creating a database of all key companies; identify those with greatest growth potential or competitive white space
  • specialization enhances deal origination through deeper knowledge base, ability to add value through enhanced network and likelihood of being top of mind to key deal sources
  •  monitor target sector for cyclical opportunities and structure shifts; M&A creates orphan divisions and downturns cause strategy refocuses; 30-46% of PE returns over last 30 years driven by EBIT arbitrage (market timing)
  • other valuable sources of deal flow:
    • regional surveys
    • “fastest growing company” lists
    • trade association membership lists
    • commercial vendors
      • Amadeus
      • Capital IQ
      • Dun & Bradstreet
      • Hoover’s
      • InfoUSA
      • Lexis-Nexis
      • Thomson-Reuters
      • OneSource
  • set up alerts in a blog reader based on key words important to your target or industry focus
  • “A large portion of my deal flow comes from people I have rejected in the past.” be kind to everyone, even those you don’t do a deal with
  • consider having a dedicated, SEO-optimized website and blog for your acquisition fund/team that explains what you’re looking for, why, what you bring to the table, etc.; many VCs and most PE investors are not using basic internet marketing techniques (competitive advantage opportunity)
  • Accel Partners and Khosla Ventures post detailed analyses of their target investment sectors; blogging and posting of internal analyses is the “VC freemium model”
  • PE investing is a relationship business and the most important relationships are with LPs, entrepreneurs, executives and intermediaries which are relatively few in number
  • blogging is the best tool for VC investing according to one experienced observer; helps investor gain information, credibility and relationships through improved visibility
  • look for access to secondary interests through directly approaching funds (particularly distressed), markets for secondary interests (SecondMarket, NYPPEX, PORTAL Alliance) and approaching ibanks specializing in secondary interests (Cogent Partners, Probitas, Triago, UBS)
  • service providers such as accountants, lawyers, etc., are typically not good sources of deal flow because they require too much education and often have a fiduciary responsibility to their client; on the other hand, connecting with service providers in a specialized domain that is being targeted can be a good source of insight
  • trawl the Q&A portion of sites such as LinkedIn to identify domain experts for further outreach
  • measure your deal origination efforts with activity measures, deal flow by source, pipeline analytics and industry benchmarking measures
  • many professional services firms do not use a global CRM system such as Salesforce.com, Act, Saleslogix, Microsoft Access or Angelsoft (angel/VC network)
  • Key data sources for CRM systems include employee networks (ContactNet Enterprise Relationship Management), business cards (Cardscan, IRIS, Neat, Presto), data from email and files (eGrabber, Gwabbit, Grab-Text, Broadlook), the “cloud” (LinkedIn, Spoke, Plaxo) and direct from target companies’ websites, media, etc.

Key attributes of top originators in order of importance

  1. persistence (every no gets you closer to a yes)
  2. personality (people do business with those they like)
  3. business and financial judgment
  4. adequate financial sophistication
  5. seniority and appropriate title (decision-maker)
  6. internal authority to get transaction executed
  7. creativity

Important deal signals when identifying targets (utilize commercial databases, social media, data mining and targeted phone research to uncover)

  • Status of the major equity owner
    • PE funds motivated to sell due to fully invested, raising next fund or current fund has aged beyond 5-7 years
    • Large corp raising cash by selling subsidiaries
    • Time limited tax incentives
    • Family in midst of succession battle
    • Death, disease and divorce (“three Ds”)
  • Status of CEO
    • retirement
    • age
    • acknowledgement of limited competence
  • Corporate performance
    • growth too rapid for self-funding
    • underperforming/distressed
  • Industry/economic trends
    • industry consolidation
      • competitive pressure
      • seeing competitors liquidating equity for large gains
    • competitors raising capital; pressure to maintain parity
    • growth sector

Top considerations for deal intermediaries in directing deal flow

  1. Possibility of future revenue
  2. Integrity
  3. Timely responses
  4. “Fair” treatment of sellers
  5. Experience with the industry or owner type
  6. High certainty to close
  7. Friendship
  8. Feedback and referrals
  9. Maintaining a single point of contact

Most valued aspects of acquiring companies by the acquired

  1. Added operational value
  2. No extra costs
  3. Fair treatment of employees post-transaction
  4. Brand
  5. Long holding periods (no buy-to-flip)

Leading databases of institutional investors (use principles of SEO to optimize your profile here)

  • Galante’s
  • Grey House
  • VentureXpert
  • PE funds
    • Eurekahedge
    • Pitchbook
  • VC funds
    • Angelsoft
    • CrunchBase
    • PWC MoneyTree
    • TheFunded
    • VentureDeal

Market Mapping steps

  1. choose industries and geographies of initial interest
  2. define your proprietary point of view
  3. translate into investment theme (industries/geographies of interest)
  4. list major players in target industry/geography
  5. improve market map with feedback from industry contacts and investment targets
  6. determine which activities offer the highest return and outsource the rest
  7. identify areas of future growth
  8. asses fit with your overall strategy
  9. regularly update the market map with additional feedback and lessons

10 Simple Steps to Improve Your Origination

  1. Analyze your network
  2. Use market mapping to develop deep, proprietary insights about your target
  3. Monitor target ecosystem for cyclical/structural opportunities
  4. Align internal interests
  5. Divide and conquer
  6. Centralize data and become an information sponge
  7. Develop a network with limited overlap
  8. Take control of your virtual presence (marketing)
  9. Join the in-person and virtual communities of your target market
  10. Take a leadership role; find a way to stand out and attract others to you

Notes – Edward Tufte’s “Presenting Data and Information” (@EdwardTufte, #display, #data, #visualization, #design, #statistics)

Edward Tufte is a Yale-connected academic who conducts several private seminars around the country each year promoting his view of visual design for the display of quantitative information and statistics. He has published multiple books through his own publishing mark such as The Visual Display of Quantitative Information, Beautiful Evidence, Envisioning Information and Visual Explanations. His personal website which contains articles, research papers, examples of his work and principles and other information is at EdwardTufte.com. A friend who is a fan has blogged some notes about the man and his seminar courses.

If I were to summarize Tufte’s philosophy of information design into a single sentence, which is certainly a crude way to approach the nuanced and thoughtful lifework of a person, I’d say this– beautiful design means creating the highest density information display the resolution of your medium will allow. This stands in stark contrast to the reigning paradigm of “less is more” and sacrificing much of the available real estate of an information display for white/empty space, navigational or UI elements and “inference assists” (my term) such as arrows, boxes and non-data lines which are supposed to draw the viewer’s attention to what’s important or where to focus their eyes.

In Tufte’s own words, he summarized the philosophy with the pithy, “The information is the interface; maximize content reasoning time; minimize design decoding time.” [Note: on my hand-written notes written in a darkened room early in the morning at the start of his seminar, I think I mistakenly wrote “maximize design decoding time” but meant to write “minimize”.] Even more pithy, and in Tufte’s own words:

The purpose of information display is to assist thinking about its content.

I attended his seminar in San Diego, CA in February. Below I am posting my notes which may or may not be useful to a person unfamiliar with his work or the content of the seminar. Tufte, who introduces himself as “ET”, likes to circulate amongst his audience before, during and after the session and introduce himself– clearly he enjoys what he does and appreciates the people who have taken an interest in his work which is a good professional example for others to follow.

  • The information is the interface.
  • Idea: maximize content reasoning time; minimize [maximize? see above] design decoding time
    • design decode effort/time is wasteful as the pattern for design is often not repeated in the future
  • Graphics are only useful when there is a lot of data, not a little bit of data
  • Design should encourage scanning, scrolling and choosing
  • Increases in resolution allows for spatial adjacency [note: this is the idea of putting lots of information side-by-side versus having to change mediums, windows, displays, repeatedly to compare and contrast blocks of information]
  • Digital display screen resolution is finally approaching “P.A.P.E.R. technology” (paper) resolution
  • Simple, clear conventional design with rich, complex data is preferable to complicated design devoid of content; many designers invest too much effort in display relative to content quality
  • NYT, WSJ are highly trafficked websites high in information density (many links, many pieces of data and text) which demonstrate this approach is desirable for design of corporate sites
  • Names have reputations, put your name on your work
  • Reasoning on a flat surface means all viewers can go at their own pace; a slideshow makes most people wait; think “documents” not “decks”
  • Listing sources for data provides credibility and reasons to believe
  • Look at sources, start points, end points, rates of change, to examine whether a chart establishes a relationship between evidence and conclusion
  • Annotations help explain all data by providing specific information about one data point captured in the graphic
  • Look at “excellence in the wild” to contrast your own efforts against the pros
    • Use Word, not PowerPoint
    • Be web-based
  • Order data tables by performance, not by alphabet; performance often tells a story
  • ESPN.com demonstrates that even complex data can be appreciated by lesser intellects (!)
  • Dashboards are idiotic and no way to operate a business or institution
  • How to Make A Presentation, some tips:
    • show up early (head off problems, ensure equipment works, room not double-booked, etc.)
    • talk to people
    • give them a document for discussion; don’t give it in advance of the meeting, no homework
    • begin meetings with study hall, people can read faster than you talk
    • the document addresses the principles of individualism and personalization as people can take what information from it they deem important
    • PPT disappears as you go higher up an org chart, the top execs have no time for the “long and winding road” (Steve Ballmer anecdote); submit ideas to discuss as written documents
    • provide intellectual leadership about content, stop discussing production methodology
    • finish early, your audience will thank you
    • Remember “Problem, Relevance, Solution”, three necessary components of any good presentation
  • How does Jeff Bezos run a meeting? Read the Forbes article or watch this Charlie Rose interview:
  • Applied presentation tip– provide notes/documents of medical concerns for a doctor to read during your doctor visit; this is what they’re trained to do and they’ll pay more attention to the information if you give them something to read
  • Check out The Public Library of Science and its templates for ideas on content rich documents
  • You can copy the source code from EdwardTufte.com and use the CSS to apply style ideas to your own blog or website
  • Real reading entails looting and hacking the valuable materials useful for later efforts, liberating them from the text; always read with an awareness for context (what came before this, what comes after, why did the author write it?); this echoes the idea of “making the work your own” of Mortimer Adler
  • Refer to “Beautiful Evidence”, pg. 78-79, using diagram trees appropriately (annotated linking lines)
    • links need to convey causality and action
    • replace generic lines with words and numbers– annotate!
  • Turn fundamental principles of analytical thinking into design decisions
  • The purpose of information display is to assist thinking about its content
  • Don’t pre-specify a data display method, use whatever method the job requires
  • Look at Google Maps and ask IT why you can’t achieve similar design capabilities; their maps are rich, colorful, multi-dimensional, varied fonts and orientation of information, etc.
  • Refer to “Visual Explanations”, pg. 90-91
  • Refer to “Beautiful Evidence”, pgs. 82-83, 114-115; exploring words, numbers and images together
  • Today’s computer interfaces separate and segregate information based on the method of production
  • Statistical graphics can be anywhere a number or letter can be
  • Statistical graphics can have the same resolution as topography
  • Refer to “Beautiful Evidence”, pg. 46-47, “sparklines” method for creating text-sized data graphics, embedded within text (inspired by Galileo’s revelation of Saturn)
  • “Nature” magazine has some of the best data-driven graphical displays, good place to look for examples of the possible
  • Why aren’t all data displays excellent? Tufte suggests there is a profit-driven bias and the dominance of Microsoft combined with the lack of scientific rigor of many data designers results in a failure of the “public spirit” principle; color me skeptical about profit and “public spirit” being at odds!
  • Excel, Google Analytics can both produce sparklines
  • Refer to “Beautiful Evidence”, pg. 58, for the famed Swiss mountain maps, or see this video (YouTube):
  • The human eye-brain optic system operates at 20mb/s in 16-bit color, digital displays don’t come close to this much data and resolution
  • Content and credibility are the keys to presenting and spectatorship
    • have the sources been credible in the past?
    • demonstrate your understanding of detail and mastery of verbs, not nouns (not who is who, but who does what to whom?)
    • threats to credibility: lying, cherry-picking (evidence vs. evidence selection), over-polished, hidden or absent sources (“proprietary”, “legal liability”, “violate federal law”, etc.)
  • Know your content, not your audience; maintain respect for your audience
    • “know your audience” leads to pandering
    • use presentations as a teaching moment to inform people of your content
  • Scan lots of material and drill down where you see discrepancies for superior economization on large volumes of data to achieve relevance
  • Investigate how data was measured; go out, walk around, see the process producing the data
    • people can not keep their own score; the metric is gamed as soon as it becomes important
    • eg, Google words are gamed by SEO, so use Google Images to search
  • Refer to “Beautiful Evidence”, pg. 32-33 for “small multiples” concept; use the need to learn a repetitious format to get people to focus on the content
  • Universality and “forever ideas”; Galileo was the supreme data designer; why should the “best thing ever” have occurred recently versus long ago?
  • Personal curiosity– why are US internet pipelines significantly slower than other developed nations?
  • Spatial adjacency versus temporal stacking (hi-res vs. low-res)
  • Different modes of display are not competitors, they are co-operators in communicating information; no one display is optimal

     

Notes – The 2014 Rothbard Graduate Seminar (#economics, #gradstudies, @mises)

In 2014 I attended the Rothbard Graduate Seminar at the Ludwig von Mises Institute in Auburn, AL as an observer. The following are notes I typed while listening to lectures and discussions between faculty and graduate students. They have been edited for clarity, organization and in some cases privacy.
Lecture 1, Praxeology, David Gordon
  • Praxeology is the science of human action, uses deductive methodology, begins with axiom of man acting, deduced with supplementary postulates (Rothbard uses action axiom, Mises never refers to “Man acts”, he refers to the concept of action)
  • Supplementary postulates: leisure is desired over work, there are a variety of economic resources
  • Economics is the best-developed branch of praxeology: Crusoe economics (isolated human action), catallactics (economics of exchange) including barter and money
  • The study of violent intervention in the market, socialism and interventionism, are also part of praxeological analysis, as well as “games”, but these have not been well-developed (no systematic treatises?)
  • Examples of praxeological reasoning— every action uses means to achieve an end; every action is a choice between alternatives; the actor always chooses his highest valued alternative
  • Methodological individualism— only individuals act, not groups or societies or nations or classes, however this doesn’t imply that nations and classes don’t exist
  • On Austrian Methodology” by Robert Nozick, an interesting article
  • Methodological Individualism has been used to deflate various ideologies such as nationalism, statism, etc.
  • Why should we do economics this way (praxeology)?
    • Popular objection: principles of praxeology are supposed to be synthetic (truth about the world) and a priori (knowable by simply thinking about them), but you can’t learn about the world just by thinking about it, the meaning of concepts is conventional, people just decide to use words a certain way, you can’t make something true about the world just by defining words, other a priori truths are logical and tautological that say nothing new about the world
    • Rothbard’s answer: concepts come from experience, action isn’t an arbitrary construction but rather an abstraction from experience, if we get the concept from experience we know action exists, then anything we deduce from that applies to the world, deduction transmits truth from premises to the conclusion, if the premises are true the conclusion is true
    • Tautology objection: rests on an equivocation
    • Rothbard’s objections to the mainstream: they construct mathematical models and then test predictions derived from the models; math substitutes functional relations for causation, also introduces the false assumption of continuity but human action occurs in discrete steps, he objects to the testing because there is no way to perform controlled experiments as all phenomena are occurring simultaneously, and there are no quantitative laws of human action, human action is the product of choice
Questions:
1.) In property rights theory, how can joint ownership (or government ownership) of a resource be explained if “only individuals act”?
2.) How do we know the experience of action is true? Don’t we need a prior theory to interpret the empirical experience of action as action?
3.) Can Austrian economics be translated into math? If not, does this suggest it is not rigorous or coherent?
4.) Why is the Austrian ERE a useful abstract tool for studying elements of reality in isolation, but the “equilibrium” economy of mainstream thought is not?
Discussion session:
Rothbard’s book (Economic Controversies) had great depth, not just covering epistemology and economic theory but historical commentary, etc., this book is also digestible, repetitive so you get the same concept dissected from different angles, straight to the point, challenges the mainstream orthodoxy, accessible to the layperson, Rothbard starts with realistic premises and deduces from there which makes this approach even more empirical (econometric models falsify the real world), his criticisms are very thorough and you want to smile after you read them which is unique in reading academic papers. Rothbard isn’t ashamed to say there is meaning and truth.
Methodological individualism applies only to the concept of action, it does not exclude the idea of something like a “cosmic consciousness”, there is a difference between ontological and methodological claims; praxeology is not a metaphysical system, it simply takes the world as we find it
Mathematical annotation is more precise than verbal logic, but one problem is how do you convert initial premises into mathematical annotation (and back when a conclusion is reached)?
“Academic choice”, public choice analysis applied to the incentive structure of academia and how this influences their search for truth
Lecture 2, Methodological Debates, Jeff Herbner
  • Every academic discipline is defined by its method and scope (boundaries).
  • Rothbard— Each subject matter has a proper method; neoclassical approach— there is only one scientific method.
  • Praxeology’s divisions:
    • Theory of Isolated Person (autistic exchange)
    • Theory of Voluntary Exchange
      •  barter
      • medium of exchange (catallactics)
        • unhampered market
        • violent intervention
        • violent abolition of market
    • Theory of Games
    • Theory of War
    • Unknown
  • Neoclassical divisions:
    • Rational choice model
      • Market participants
      • Political participants
      • Social participants
    • Behavioral economics
  • Categories of the social sciences
    • Economics— voluntary associations w/ economic calculation (UME, HME)
    • Sociology— voluntary associations w/o economic calculation (family, church)
    • History— contingent, concrete conditions of action blended w/ theory
    • Ethics— personal action, interpersonal action, voluntary and involuntary
    • Politics— involuntary associations (gangs, states)
  • Praxeology— logic of action, economizing, underneath all 5
  • Praxeology and Ethics— public policy (economic science is value free, but economic policy is value laden and requires assumptions or principles about ethics and what is desirable to make conclusions), critique of ethics, political philosophy, welfare economics
  • Misesian Economics— a.) economic theory b.) economic history (understanding economic action in the past) c.) applied economics (predicting economic effect in the future based on proposed economic cause, i.e., policy)
  • Neoclassical Economics— economic model and empirical testing
Questions:
1.) Is the division in economics between calculating and non-calculating, or financial calculation and non-financial calculation? How are non-calculating actors choosing if not by some form of calculus?
2.) Who has best developed Games and War theories of praxeology?
3.) Why aren’t Austrians trying to develop comprehensive treatises in these fields?
4.) What is the application of game theory?
5.) How do you know when a circumstance is new and requires an extension of the existing theory, or when it is “unoriginal” and can be explained by the previous body of theory? How do we know when existing theory can’t explain a new phenomenon or historical incident? How is this explanation different from the pragmatist argument about a lack of common principles?
6.) Who, if anyone, is worth reading right now outside of the Austrian tradition, and why?
7.) How can “proportionality” be administered in a judicial punishment setting without treading into utilitarianism or other non-subjectivist value systems?
Lecture 3, Austrian Microeconomics, Peter Klein
  • Price theory, production theory, the theory of the firm, some parts of capital theory, etc., constitute “Austrian micro”
  • It is not mainstream micro minus calculus and some graphs plus “spontaneous order” and “radical subjectivism”, etc.; this is a misconception of the contribution of Austrian econ
  • Mengerian economics— focused on mundane topics, not esoterica; shares subjective utility and marginal analysis of Walras and Jevons; not simply verbal version of neoclassicism, emphasized cause and effect real market behaviors and thus “causal-realist”
  • Fundamentals of Austrian micro— economics as the analysis of action (praxeology); teleology, means and ends; economic goods which are concrete (real prices of real goods, not abstract prices of conceptual entities) and are limited and desirable, split into consumer and producer goods (direct and indirect serving of human needs); time, implied by action, itself a scare means and the notion of time preference; production is rearrangement, not creation ex nihilo, takes time and uses stages
  • General insights on valuation include emphasis on discrete, marginal units, not abstract categories, as well as attention to demonstrated preference
  • Menger’s utility theory— the value of particular means, marginal utility being the value of the highest-ranked end that cannot be achieved if a unit is lost, law of diminishing marginal utility (not a psychological concept, a logical concept focused on individual use of each unit not the benefit)
  • Contrasts with neoclassical utility theory— consumers in NCM are choosing among heterogeneous bundles, choosing between total utility of each bundle; marginal rate of substitution is rate at which consumer substitutes unit of good X for unit of good Y (slope of indifference curve) vs. causal-realist where substitution occurs at the margin and demonstrates that the marginal utility of X is greater than the marginal utility of Y w/ no separate income or substitution effects; indifference can not be demonstrated in action and is therefore not a scientific concept (focus is on explaining actions, not states of being)
  • Price determination— analysis of the marginal pairs (see Greaves, paper by Egger) states that prices are set by pairs of buyers and sellers; characteristics of the equilibrium price, determined exclusively by individuals’ subjective valuations, subjective valuations of buyers and sellers matter, not set unilaterally by sellers, the real prices actually paid in market transactions
  • Prices and knowledge— buyer and seller valuations can include speculative demands (they don’t need to know in advance what equilibrium price will be), prices as signals (Hayek)
  • Factor pricing— Austrian theory of imputation, rental prices imputed backwards to the ???
  • Applications and extensions— no distinction between production and “distribution” (Piketty), wealth is “distributed” in the act of production, it is not produced and then arbitrarily distributed by capitalists, government, etc.; rent = unit price of services of any good (Fetter); production functions, but no cost curves; firm as an organization, not a productive unit
Discussion section:
Kirzner and Schumpeter restrict entrepreneur to nothing but alertness, the Misesian approach is more expansive and includes everyone in some capacity acting as an entrepreneur
Mises in Human Action talks about the entrepreneur as a leader, who is far-seeing, comes from Weiser, who also mentored Schumpeter; Mises was uncharacteristically fuzzy and unclear on his writings on the entrepreneur, occasionally he refers to the “promoter” (ideal type) involving leadership, having a quicker eye than the crowd, etc., but typically he refers to the function of entrepreneurship
Kirzner is talking about alertness to opportunities for profit, but entrepreneurs create goods, capital, companies, etc., not “opportunities for profit”, opportunity implies objective configurations of resources that allow for a decision or action or take place, but is this analogous in the business world? Or is “opportunity” a metaphor? Do we need the construct of “opportunity” to explain what entrepreneurs do?
Kirzner’s equilibrium is the condition under which no unfound profit opportunities exist
Mises vs. Knight on judgement— Mises never refers to Knight in this context, judgement is more of a black box for Mises than for Knight
Questions:
1.) If Austrian econ is not distinct, why do mainstream thinkers argue so violently with Austrians?
2.) Did the anglo-American Austrians, etc., self-consciously identify with the “Austrian school” or did we lump them in post hoc? If so, what did they refer to themselves as?
3.) When challenging Keynesianians and other mainstream opponents, Austrian critics often accuse them of “not understanding economic calculation”. Is this criticism accurate? Why or why not?
4.) Would it be better to distinguish between “offers” and “prices”, where “offers” are ratios of exchange advertised but not consummated, hypothetical, whereas “prices” represent historical data of consummated exchanges between buyers and sellers?
5.) Is Kirzner’s “capital-less entrepreneur” really a description of professional managers, and if it is, is it a legitimate analysis or does it still lack connection to reality?
6.) Is “public choice” an analysis of entrepreneurship in socialism, or in privatization within socialism?
Lecture 4, Taxation and Public Finance, Mark Thornton
  • Rothbard’s approach: nature of taxation; technical corrections to mainstream analysis; theories of “just” taxation; neutrality of taxation; approaches to tax reform
  • Interventionism: autistic (ruler tells the ruled what to do); binary (e.g., taxation, transfer of property from owner to intervener); triangular (ruler tells two ruled how they can interact with each other, e.g., prohibitions and regulations)
  • Impoverishment caused by taxation is in proportion to the amount of taxation, not the form the taxes take
  • Taxes can not be passed on to consumers because of competitive pricing of supply and demand
  • Taxation distorts market outcomes in two ways: the withdrawing of resources from the economy, and the redistribution of those resources across the economy
  • “Benefit principle”— pay taxes in accord with the benefits you receive
  • “Ability to pay principle”— pay taxes in accord with your relative wealth
  • There are no scientifically valid principles of taxation, there is no conceptually possible neutral tax
Discussion section:
How to explain countries where majority of taxes are paid by a minority of people, as Calhoun’s analysis suggests the majority bear the costs for a small minority to benefit from? The answer could be additional implicit subsidies such as protections from the State in terms of liability or regulation that they see taxation as payment for
Can the State make investments? Rothbard is writing against the idea of “social investment” such as infrastructure spending, and he is writing in terms of capital structure— they’re not integrated into economic calculation, they’re not part of the capital structure; counter-example, State-owned oil production
Questions:
1.) Why doesn’t taxation create business cycles due to mass misallocation of resources?
2.) When taxes are “shifted backward” to suppliers through lowered net revenue, aren’t consumers STILL paying the tax due to lower supply and lower quality of remaining supply versus free market outcome?
3.) Why can employers shift taxes to employees if businesses can’t shift taxes to consumers?
4.) In the marketplace, how is price discrimination explained in reference to the benefit principle?
5.) Does the lack of scientificness of taxation principles imply the irrationality and injustice of government in general?
6.) “Over” and “under” exploitation of a government owned resource… relative to what? How do we know how much the free market would exploit it?
Lecture 5, Monetary Theory, Joe Salerno 
  • Money as a medium of exchange— trade requires barter in the absence of money, creating high search costs due to the double coincidence of wants
  • Money as unit of account— used to express prices and record debts, simplifies relative price comparisons
  • The value of money— measured as the inverse of the price level measured against an arbitrary basket of goods (i.e., 1/P), what does one unit of money buy?
  • The (neo-)classical dichotomy— the theoretical separation of nominal and real variables; Hume and classical economists suggested monetary developments affect nominal variables but not real variables; if money supply doubles, for example, all nominal variables, such as prices, will double; in the short run, supply and demand determine the value of money, in the long run cost of production determines the value of money
  • The neutrality of money— proposition that changes in the money supply do not affect real variables
  • Purchasing Power Parity (PPP)— relies on the “law of one price” which establishes that arbitrage opportunities eliminate differences in value of common goods in different markets; exchange rates are supposed to be ratios of price levels between two economies
Discussion section:
What Has Government Done To Our Money?” is Rothbard’s explanation of how an economy “progresses” from commodity to fiat money, because Mises said that a true fiat money is a historical question given that every episode in the past has been a form of “credit money” based on expectations about an eventual return to a commodity money that predated it
Questions:
1.) For a relative price to be a useful data, wouldn’t it have to be collected from a real exchange (i.e., barter exchange)?
2.) Do mainstream models explaining fiat money violate Occam’s Razor?
3.) If velocity of money is increasing, isn’t the “velocity of hoarding” increasing at the same rate because all money balances must be held by somebody at some time?
4.) If IEOR policy is causing banks to “hoard” bank balances and this is non-expansive, is this money “neutral” to the economy or what effect is it having? What role does it serve? (Compare to Jingjing’s question on corrupt Chinese official cash balances)
Lecture 6, Professional Strategies, Career Advice and Current Research Topics, Peter Klein
 [I did not take any notes during this discussion.]
Discussion section:
[I did not take any notes during this discussion.]
Questions:
1.) What about pursuing a career as a “private lecturer” by establishing yourself as an authority on Austrian economics with a crisp website?
2.) How can Austrian economist career hopefuls improve their career by thinking in terms of their “personal brand”?
Lecture 7, Monetary Policy, Jeff Herbener
  • Monetarists— micro efficiency, but macro instability caused by monetary regime; optimal monetary regime would create stability in the price level; requires an elastic money supply to offset forces causing price inflation or deflation to keep price level roughly stable; avoid trade imbalances w/ flexible exchange rates
  • Monetary Disequilibrium Theory (MDT)— micro efficiency, macro inefficiency; means of payment must accommodate changes in money demand; avoid price deflation from excess demand for money; separate unit of account from general medium of exchange, supplant general medium of exchange with means of payment; competitive issue of means of payment adjust to accommodate changes in money demand;
  • Banking school FB— micro efficiency, macro inefficiency; money stock and credit supply must accommodate the needs of trade; avoid price deflation from excess demand for money; competitive issue of fiduciary media adjust to accommodate changes in money demand
  • Currency school FB— micro efficiency, macro efficiency; production of money and money substitutes should be integrated into the social economizing process of economic calculation by entrepreneurs
  • “Free banking” in Scotland— Rothbard suggests using Vera Smith’s schema of 4 groups (free vs. central banking Banking School, free vs. central banking Currency School) rather than Larry White’s 3 groups; there was no Banking School free banking in Scotland, and the system didn’t work well, numerous bailouts, pyramiding credit on top of Bank of England notes;
  • Free Market Monetary reform— separate money from the State; abolish fFed, dollar redeemable in gold, legal enforcement of 100 percent reserve on money substitutes;
  • Ancillary roles for the State— Hayek (Sennholz), abolish all legal disabilities on private enterprise production of money and money substitutes; Yeagar (Timberlake), state defines the unit of account in terms of market-basket of goods, the general medium of exchange is eliminated, private enterprise provides means of payment
  • Central role for the State— Fisher, state defines a market-basekt of goods for the unit of base money, currency is redemption claim for base money, supply of currency managed to keep price level stable; Friedman, Fed conducts non-discretionary monetary policy to keep the price level stable
Discussion section:
 [I did not take any notes during this discussion.]
Questions:
1.) What “problem” did the MDT respond to? Similarly, did the Monetarist framework develop in response to existing statist monetary regimes or was it to address perceived problems with a theoretical free market monetary regime?
2.) Does the existence of taxation in general complicate or prevent the possibility of private production of the money supply?
3.) Is “balance of payments” thinking by mainstream economists an anachronistic way of thinking in a non-commodity standard money world?
4.) Why do socialist countries have money? How does money function in these economies?
5.) How can the crash and then explosion in the price of gold since ~2000 be explained in Austrian monetary theory?
Lecture 8, Mark Thornton, Comparative Economic Systems
  • Hoppe’s A Theory of Socialism and Capitalism (1988)— systematic, offers a theory of comparative economic systems, based on the concept of private party
  • Capitalism— based on property rights; property is the result of scarcity; provides non-violent mechanism for resource allocation; Garden of Eden, property right to your body; original appropriation; contractual exchanges; wealth; absence of systematic aggression; no unemployment (idle resources) problems
  • Russian-style socialism— socialism par excellence; State owns the means of production; equality vs. anarchy of production; aggression and democracy; less investment, appropriation (black market); calculate the structure of production = waste; Mises (1920) complete vs. relative; East vs. West Germany
  • Social democratic socialism— “reform”, taking steps at the ballot box; “commanding heights” (the sectors deemed essential by socialist planners for control such as education, utilities, transportation networks, etc.); owners remain caretakers with partial ownership; property owners taxes for redistribution; dominant form in Europe; Sweden
  • SDS vs. Russian-Style and Capitalism— solves the calculation problem; compared to Russian, less impoverishment, less over utilization of resources, more leisure, more incentive to work, save and invest; but it’s still poor compared to capitalism; both reduce production of talent and skills, increase the production of aggressive and political skills, both increase barter and black market activities
  • Conservative-style socialism— supports status quo, old order; private property, commanding heights; sin taxes, not income taxes; price controls, unions, prohibitions, not redistribution; regulations and cartels; Nazi Germany, Fascist Italy, Imperial Japan (Prussian social monarchy?)
  • Similarities between conservative and social-democratic socialism— both have private property and commanding heights; both infringe on private property; both have negative effects on labor, savings, investment, innovation; SDS stresses egalitarianism, CS stresses nationalism; both underperform capitalism
  • Socialism of social engineering— American pragmatism, technocracy; positivism and empiricism; reality must be verifiable or falsifiable by experience, “socialism might work”; however, empiricists must implicitly assume the existence of non-empirical as knowledge of reality, i.e., logic, math, geometry
  • Empiricism— must assume some sort of existence of cause and effect; must presume the constancy principle in order to proceed in its investigation, but the constancy principle (there are relationships to be found empirically) is not established, confirmed or falsified empirically, it is a given a priori; life proceeds on the basis of cause and effect; social engineering via empiricism is a giant contradiction
Discussion section:
Crony capitalism is the modern day equivalent of mercantilism
Old wine in new bottles, people can intellectually reject an idea like mercantilism as an historical phenomenon but if it is repackaged in a new brand they might adopt it as sensible
Are many of the distinctions of totalitarian regimes explained by the path to power? IE, Hitler came to power through the ballot box, Mao led a peasant rebellion, Lenin was elected by the army
Democracy is one of the most stable forms of the State; democracy involves participation of the population, and has a process for slowly implementing policies vs. unitary or limited participation and the ability to make drastic, sudden changes via emperor or dictatorship; democracy tends to hand out favors to large groups of people so it is hard to create an opposition coalition to overturn it
Mises’s three pre-conditions of the division of labor and economic specialization: private property in the means of production, free exchange (for price formation) and ???
Questions:
1.) There seem to be an endless variety of “socialisms” reflecting the unique cultural and historical factors of each society that has suffered them; what are some UNIVERSAL elements of socialism that must be or always are present to be declared a socialist system?
2.) Does technological innovation and economic “evolution” allow for political change or does it work in the opposite order?
Lecture 9, Property Rights and the Public Sector, David Gordon
  • Ethics and economists— one of Rothbard’s most original contributions is his criticism of the way mainstream economists deal with normative issues; economists want economics to be value free, economics is a science, normative judgments are mere subjective preferences; Rothbard agrees that economics is value free, but he doesn’t think that ethical judgments are mere subjective preferences; mainstream economists are caught in a dilemma, they want to make normative judgments that do more than express their preferences, how can they do so?
  • Concealed value judgments— some economists think that they can escape the dilemma by endorsing a value-free statement that still leads to normative recommendations; if everybody prefers something, then it should be done (strong Pareto criterion), if at least one person favors something and it makes no one worse off, it should be done (weak Pareto criterion), these principles still involve value judgments; what if everyone has wrong views about what is desirable, or the starting point involves violating someone’s rights?
  • Unanimity principle— Rothbard thinks that the unanimity principle has had bad results in practice; because unanimous agreement can’t in practice be reached, Buchanan and Tullock settle for less than full unanimity
  • Rothbard on the State— it is a fundamental mistake to view the state as a voluntary organization; it is a parasitic, predatory gang that seizes resources from the productive; Rothbard follows Oppenheimer and Nock
  • Public sector— if the State is predatory, then the productivity of the public sector is problematic; the State takes resources by force, thus, its activities cannot be considered productive; government expenditures should be subtracted from, not added to, production statistics; Rothbard’s definition of productivity is intertwined with an understanding of demonstrated consumer preference on the market
  • Statistics— Rothbard is suspicious of statistics collection; they are not value neutral but are essential to government control
  • Utilitarianism and property rights— many economists take some version of utilitarianism for granted; it’s argued that recognition of property rights makes nearly everybody better off; this isn’t a value-free claim, but it’s defended as non-controversial; Rothbard objects that this position doesn’t consider the justice of property rights, any stable system of property rights is accepted;
  • Escape from the dilemma— Rothbard believes the dilemma of the economists can be escaped by developing an objective ethics based on natural law; self-ownership, Rothbard defends the concept by rejecting alternatives, slavery and a system where everyone owns part of everyone else; if you own yourself, then by mixing your labor with unowned resources you own them as well; once you own something you can exchange it and give it to anyone you want, including the right of bequest;
  • Externalities
Discussion section:
[I did not take any notes during this section.]
Questions:
1.) Can any philosophical principle be established simply by rejecting alternatives? (Last man standing philosophy?)
2.) What criteria are sufficient for “mixing labor” and taking ownership? If mixing labor with factors of production, why doesn’t this mean workers own them? What makes “mixing labor” effective in one circumstance and not effective in another?
3.) Walter Block claims that it’s okay for libertarians to take from the State, but no one else. Is there any logic to this?
4.) Maybe there is a Coaseian solution for the dismantling of the State— it doesn’t really matter HOW it is privatized, it just matters that it IS privatized?
5.) When your money is taxed, it is stolen, and your money is fungible and spent, so what legitimate claim do you have to fungible, disposed assets that can not be traced?
6.) What about when government functionaries in “marketable” positions are part of unions or agitate for State privilege?
Lecture 10, Current Debates and Critiques, Joe Salerno
[I did not take any notes during this section.]
Discussion section:
Is the term “Austrian” valuable as a marketing concept? “Capital Based Macro”, “Causal Realism”
You don’t want to be the kid at camp who picked their own nickname, names come from the outside
Is there rhetorical value in labeling opponents in sensational ways (“Friedman is a socialist”) or does that hurt your cause more than it communicates information?
Questions:
1.) What might have happened to the Austrian school’s influence if WW2 had never occurred?
2.) What critical lessons have we learned (as a “movement”) from the Salerno/Hulsmann theory of the decline and rebirth of Austrian economics?
3.) Why aren’t there more applied economic works in the Austrian tradition? What would be some priority applications?
4.) What is “Austrian economics in a nutshell” or the Austrian elevator pitch? Why Austrian?

Notes – The Snowball, By Alice Schroeder: Part V, Chap. 43-52 (#investing, #books, #Buffettology)

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder (buy on Amazon.com). This post covers Part V: The King of Wall Street, Chap. 43-52

The modern Buffett

In Part V of the Snowball, we see Buffett’s transformation from the early, cigar butt-picking, Grahamian value-minded Buffett, through the filter of his Fisherite partner, Charlie Munger, into the mega cap conglomerator and franchise-buyer Buffett who is popularly known to investors and the public the world round.

It is in this part that we also see Buffett make one of his biggest missteps, a stumble which almost turns into a fall and which either way appears to shock and humble the maturing Buffett. It is in this era of his investing life that we see Buffett make some of his biggest rationalizations, become entangled in numerous scandals he never would’ve tolerated in his past and dive ever deeper into the world of “elephant bumping” and gross philanthropy, partly under the tutelage of his new best friend and Microsoft-founder, Bill Gates.

The lesson

Buffett made a series of poor investments but ultimately survived them all because of MoS. There will be challenges, struggles, and stress. But after the storm, comes the calm.

The keys to the fortress

From the late seventies until the late nineties, despite numerous economic and financial cycles Buffett’s fortune grew relentlessly under a seemingly unstoppable torrent of new capital:

Much of the money used for Buffett’s late seventies spending spree came from a bonanza of float from insurance and trading stamps

This “float” (negative working capital which was paid to Buffett’s companies in advance of services rendered, which he was able to invest at a profit in the meantime) was market agnostic, meaning that its volume was not much affected by the financial market booming or crashing. For example, if you owe premiums on your homeowner’s insurance, you don’t get to suspend payment on your coverage just because the Dow Jones has sold off or the economy is officially in a recession.

The growth in Buffett’s fortune, the wilting of his family

Between 1978 and the end of 1983, the Buffetts’ net worth had increased by a stunning amount, from $89 million to $680 million

Meanwhile Buffett proves he’s ever the worthless parent:

he handed the kids their Berkshire stock without stressing how important it might be to them someday, explaining compounding, or mentioning that they could borrow against the stock without selling it

Buffett had once written to a friend when his children were toddlers that he wanted to see “what the tree has produced” before deciding what to do about giving them money

(he didn’t actively parent though)

Buffett’s private equity shop

Another tool in Buffett’s investment arsenal was to purchase small private companies with dominant franchises and little need for capital reinvestment whose excess earnings could be siphoned off and used to make other investments in the public financial markets.

Continuing on with his success in acquiring the See’s Candy company, Buffett’s next private equity-style buyout involved the Nebraska Furniture Mart, run by a devoted Russian immigrant named Rose Blumkin and her family. And, much like the department store chain he once bought for a song from an emotionally-motivated seller, Buffett beat out a German group offering Rose Blumkin over $90M for her company, instead settling with Buffett on $55M for 90% of the company, quite a discount for a “fair valuation” of practically an entire business in the private market, especially considering the competing bid.

An audit of the company after purchase showed that the store was worth $85M. According to Rose Blumkin, the store earned $15M a year, meaning Buffett got it for 4x earnings. But Rose had buyers remorse and she eventually opened up a competing shop across the street from the one she had sold, waging war on the NFM until Buffett offered to buy her out for $5M, including the use of her name and her lease.

One secret to Buffett’s success in the private equity field? Personality:

“She really liked and trusted me. She would make up her mind about people and that was that.”

Buffett’s special priveleges

On hiding Rose Blumkin’s financial privacy: Buffet had no worries about getting a waiver from the SEC

Buffett got special dispensation from the SEC to not disclose his trades until the end of the year “to avoid moving markets”

The gorilla escapes its cage

Another theme of Buffett’s investing in the late 1980s and 1990s was his continual role as a “gorilla” investor who could protect potential LBO-targets from hostile takeover bids. The first of these was his $517M investment for 15% of Tom Murphy-controlled Cap Cities/ABC, a media conglomerate. Buffett left the board of the Washington Post to join the board of his latest investment.

Another white knight scenario involved Buffett’s investment in Ohio conglomerate Scott Fetzer, which Berkshire purchased for $410M.

Then Buffett got into Salomon Brothers, a Wall Street arbitrage shop that was being hunted by private equity boss Ron Perelman. Buffett bought $700M of preferred stock w/ a 9% coupon that was convertible into common stock at $38/share, for a total return potential of about 15%. It even came with a put option to return it to Salomon and get his money back.

But Buffett had stepped outside of his circle of competence:

He seemed to understand little of the details of how the business was run, and adjusting to a business that wasn’t literally made of bricks-and-mortar or run like an assembly line was not easy for him… he had made the investment in Salomon purely because of Gutfreund

Buffett’s disgusting ignorance and hypocrisy

Buffett:

I would force you to give back a huge chunk to society, so that hospitals get built and kids get educated too

Buffett decides to sell the assets of Berkshire’s textile mills– on the books for $50M, he gets $163,122 at the auction. He refused to face his workers and then had the gall to say

“The market isn’t perfect. You can’t rely on the market to give every single person a decent living.”

Buffett on John Gutfreund:

an outstanding, honorable man of integrity

Assorted quotes

Peter Kiewit, a wealthy businessman from Omaha, on reputation:

A reputation is like fine china: expensive to acquire, and easily broken… If you’re not sure if something is right or wrong, consider whether you’d want it reported in the morning paper

Buffett on Wall St:

Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway

Review – Dressing The Man (#sartorialism, #style, #masculinity, @ArticlesOfStyle, #review, #books)

Dressing The Man: Mastering The Art Of Permanent Fashion

by Alan Flusser, published 2002

Why do some men look debonair while others look disheveled or worse? What role do clothes play in making a handsome man look plain, and a plain man handsome? According to Alan Flusser, the secret lies in the man’s face itself– do his clothes direct the eye confidently and purposefully to the face, or do they beg the viewer to stare anywhere but there?

Dressing well rests on two pillars– color and proportion… Fashion should be accountable to a specific set of physical trademarks.

For Flusser, successful sartorial pursuits play within known boundaries of taste, structure and purpose, but within those broad confines the greatest spoils go to the most individual:

The best dressed men consistently demonstrate the greatest degree of self-knowledge… a superior understanding of their physical manner and appearance.

This self-aware approach to menswear starts and ends with a man’s face.

The face is the destination to which one’s attire should escort the beholder’s attention… the colors of any given ensemble should exhibit the same degree of contrast as that manifested by one’s skin and hair tones, a person’s two primary color signposts… highlighting each face by repeating one or more of its natural pigments in the colors worn below.

While there is infinite variance to men’s faces, all men happily fit into one of two primary categories of complexion:

If your hair is dark and your skin light, you have a contrast complexion. If your hair and skin tone are similar, your complexion would be considered muted, or tonal.

For example, Southern Europeans and Slavs, as well as Africans and Asians, are clear contrast-type complexions. Northern Europeans, Scandinavians, the Irish and other “norse” blooded peoples are classic muted/tonal complexions. Of special note is the “light, bright and blond”, for whom “at least one item in each ensemble reflects his gold toned complexion.”

For contrast complexions, contrasting colors help to brighten the face and draw attention to it. Conversely, tonal complexions are best shown against complementary, typically warm, colors as their complexion can be easily over-powered by a surfeit of dark tones. The idea is to find combinations that help the face to “pop”, almost as if one is walking around with a low-powered spotlight directing attention to one’s face.

If the man can master this one element of permanent style, he has accomplished at least 80% of the job. The rest of the book involves classic style recommendations on how to wear and match the different elements of mens’ formal clothing such as the suit, jacket, slacks, dress shirt (including collars and cuffs), ties, hosiery, shoes and accessories, as well as how to think about patterns and colors. As I found these sections immensely helpful, I am recreating the most essential advice in list form below:

Navigating the body

While style must be matched to the individual characteristics of each man to succeed, Flusser cautions against simply making up the rules.

Genuine innovation has always taken place with an awareness, rather than an ignorance, of restraints.

The primary restraints beyond complexion are the “five major intersections” of menswear: the neck, shoulder, waist, wrist and ankle. Each provides an opportunity to choose complementary lines, angles and colors which can either greatly enhance or greatly diminish the effect of drawing the viewer’s eye toward the man’s face.

The suit jacket

  • Since the jacket’s shoulders frame the head, if they are too narrow, the head will appear larger than actual size; conversely, if cut too wide, the head will appear disproportionately small
  • Length: long enough to cover the curvature of the buttocks while giving the leg as long a line as possible (relative to torso, divide in half the distance from the collar’s seam to the floor)
  • Bottom line: should line up with the thumb knuckle
  • Waist button: when fastened, should divide the body so that the torso and legs appear at maximum length; should be placed 1/2 inch below the natural waist (place your hands around the smallest part of your torso and then press down at the sides into the hollow above the hipbone)
  • Lapels: width should harmonize with the necktie; single-breasted should cover between 2/5 and 3/5 of the distance between the chest and shoulder line
  • Sleeve: full at the top and tapering down to the wrist bone; the converging lines should conform to the broad shoulder and narrowing waist of the jacket; the band of linen between the jacket sleeve and hand is yet another stylistic gesture associated with the well-turned out man
  • The sine qua non of tailoring sophisticiation is a suit that brackets the wearer’s head with gently sloped, natural-looking but defined shoulders
  • Side vents lead the observer’s eye up either side of the coat’s back, subliminally imbuing the wearer with an illusion of greater height
  • Four buttons (working!) on a suit jacket’s sleeve convery superior satorial breeding
  • The waistcoast adds gravitas to the single-breasted suit; it is a rememberance of things past and accessible only to those able to afford one custom-made

The suit trouser

  • Suit trousers should extend the line of the jacket; fuller-chested jackets require fuller-cut trousers, just as more fitted jackets mandate slimmer-fitting trousers
  • Trousers should be worn on the waist, not on the hip

The dress shirt

  • The choice of the dress shirt should be guided first and foremost by the appropriateness of its collar shape to that of the wearer’s face
  • If its collar is too small, the head will appear large; if the collar sits too low on the neck, it will make the neck look longer than it is; broadly spaced points of a spread collar will counterbalance a long and narrow face; long-pointed collars that are either pinned or buttoned down will help to countermand faces with angular features and strong lines
  • With top button closed, two fingers should be able to slide comfortably between the neck and collar of a new shirt; if it fits perfectly on first wear it may strangle after repeated washings
  • It should be cut full enough to allow the wearer to sit without concern for whether its front will gape open; lengthwise, it should be such that you can raise your arms without it pulling out of the trouser top; the collar’s points ought to be able to remain in touch with the shirt’s body
  • The shirt must fit snugly around the wrist so that the additional length required to keep the cuff from pulling back when the arm is extended does not force it down the hand; if the hand can slide through the cuff opening without first unfastening it, the cuff’s circumference is too large
  • A shirt’s formality begins at the collar, its most prominent and defining feature; stiffer collars are more formal; more open points are more dressy; the cuff also contributes to the overall effect; fabric is the next indicator of formality, smoother or more lustruous materials are dressier; finally, the amount of white in the design’s ground add to dressiness
  • While pure white has been the traditional color of choice, medium-blue flatters more men’s faces; at least half a dozen or so dress shirts in one’s wardrobe should ideally be in some shade of solid blue or in a predominantly blue pattern; the trick is to find the deepest shade of blue that highlights the face without distraction
  • A mane with strong contrast in his complexion can enjoy a larger range of colors; fair-haired men with muted complexions can balance their lighter tones with soft-hued blues such as end-on-ends, oxfords and mini-checks whose weaves use white to reduce the blue’s intensity
  • Gold is frequently used as an accent color in many patterned neckties, so if a man has flecks of blond hair, echoing it under the chin is an opportune way to illuminate the face
  • While the matching french cuff is always acceptable, a button cuff has no place at the end of a sleeve attached to a shirt with a contrasting white collar
  • To fully exploit the french cuff link’s decorative potential, each side shouldbear a design and connect with a chain or link
  • Sooner or later, every well-dressed man should acquire an antique set of studs

The necktie and neckwear

  • The necktie’s correct width has always been determined by the jacket’s lapel (not what is fashionable at the time!)
  • The knot should be compressed so that it dovetails high up into the inverted “V” of the collar’s converging sides; a dimple or inverted pleat should emerge from the middle of the knot
  • Because of the move toward business casual in the professional world, the appearance of a necktie will more than ever signify the wearer’s desire to embrace a dressier, more authoritative image
  • A necktie should be agreeable to the touch, silk is undeniably the fabric of choice
  • Some standard woven types: Macclesfield, Spitalsfield, regimental stripes (proper direction is high left to low right; these ties have a slimming effect), plaid, solid (a more sophisticated look), wool (best for cool-weather); should a man want to acquire a necktie with a reasonable probability of aesthetic longevity, the woven design tie would generally be the safer bet
  • Polka-dot ties enliven all kinds of menswear ensembles but they are on particularly friendly terms with stripes
  • Bow ties can be worn on both formal and informal occassions, day or evening, and are correct with either single- or double-breasted jackets; its width should not extend beyond the outer edge of a man’s face and definitely not beyond the breadth of his collar; the hand-tied bow’s moody loops and unpredictable swirls give you that subtle insouciance; bow ties work best for the over-fifty set
  • The manner in which a tie is knotted offers the only true means of imposing one’s individual stamp on it; over time this male rite should evolve into another manifestation of one’s personal style
  • The widest point just above the tip of the tie should coincide with the belt’s upper edge
  • The tie should arch out from the collar, the dimple extending downward, projecting a subliminal authority

The pocket handkerchief/square

  • No man can consider himself an elegante without knowing how to rig out the simple white pocket square; angle the hank outward toward the shoulder, with its point irregularly arranged
  • Without some form of pocket rigging, an outside breast pocket appears superfluous and the outfit incomplete; it is the quickest and least expensive way to lend a mediocre suit a more expensive look
  • Its deportment should appear unstudied, effortlessly contributing to the overall aplomb
  • Overtly coordinating, or worse, matching a tie and handkerchief is not only a sign of an unsure dresser but also a sure way to lead the eye across the body and away from the face; solid handkerchief with patterned necktie, and should not be of the same color as the ground shade of the necktie
  • A tie’s silken luster calls for a matte pocket square like linen or cotton; wool or linen neckties with a dulled surface requires the upbeat luster of a silk foulard
  • A solid pocket hank should echo a color in the necktie, shirt or jacket

The dress belt

  • The choice should be dictated first by the shoe’s color and then by the hue of the jacket and trouser
  • Should be an equal or darker shade than the suit; darker imparts a dressier look, the more contrast between the belt and trouser, the sportier the look
  • Long enough to finish through the trouser’s first belt loop without running past the second
  • Buckles should be simple in design, in either silver or gold, depending on the color of accompanying jewelry

The tailored ankle

  • The trouser bottom should cover about two-thirds of the shoe
  • The round or slightly-square-toed oxford, or blucher lace-up with a welt-constructed sole, ranks as the ideally proportioned shoe for suit-driven attire

Hosiery

  • By reiteraing at floor level a color or pattern found near the face, the silhouette’s upper and lower zones begin to network with each other
  • Should match the trouser rather than the shoe; when shoe and hosiery are perceived as a unit, they separate themselves from the trouser which is not desirable
  • Black hose should be avoided any time one is not engaged in formal wear or swathed head to toe in black
  • The more formal the ensemble, the finer or more sheer the hose
  • The bulkier the outfit, the more one must step up the sock’s thickness
  • After the necktie, the hose’s most frequent stage partner is none other than the dress shirt

Footwear

  • A well-made and properly looked after pair of leather dress shoes can provide several decades of fine service; uppers should be made from skins no more than twelve weeks old and have a fine grain that takes a high polish; the sole can be removed and repaired repeatedly with minimal damage to the shoe’s upper; it’s impossible to spend too much on a finely crafted, perfectly fitting pair of shoes which will improve with age
  • Top quality brown leather shoes invest all fabrices with an intangible richness
  • The plain cap-toe oxford lace-up is the basic shoe style for smart, though not strictly formal, town wear
  • The wing tip takes its name from its toe cap shaped like the spread wings of a bird, pointed in the center and eztending toward the rear with heavily perforated side seams
  • The blucher is a step down in dressiness from the oxford
  • The monk-strp shoe has intermediate formality, registering somewhere between that of a slip-on and a lace-up shoe
  • The brown suede shoe happens to be suitable for all seasons
  • Crocodile leather in a dark honey tone affords versatility
  • The Weejun-style slip-on became the year-round workhorse of many men’s casual shoe wardrobe

Suit colors and patterns

  • When it comes to starter suits, the dark grey, two-piece charcoal gets the professional’s nod; it has the highest color and function versatility
  • More enriching than stark black, more ceremonial than charcoal, whether in twill or plain weave, 12 ounces or 8, a navy suit shows off the average man to best advantage
  • Of all men’s suitings, none has ever matched the glamour and popularity of the striped suit; it’s innate appeal derives from the vertical lines which lengthen the wearer
  • The window-pane is the anti-prole
  • The classic gray flannel suit remains a paragon of cool-weather stylishness
  • The brown suit provides special charisma to the chocolate-, blond-, red-, or sandy-haired man who are continually encouraged to consider brown as one of their staple wardrobe themes; the dark brown worsted jacket and the medium-blue dress shirt attract considerable acclaim
  • In medium blue, brown or gray and white oxford stripe, single- or double-breasted, worn with a necktie or polo shirt, the seersucker suit offers a heat-beater stylishness transcending both low and high fashion
  • For business casual, the easiest way to pull together unmatched separates is through the medium of color; when harmonizing three different seperates keep two pieces in the same color family
  • Accessorizing a suit in a monotone palette imbues it with instant sleekness and modernity
  • Psychologists consider black and white the most authoritarian of all color combinations
  • Darker trousers will make sport jackets appear dressier
  • For business casual, the buttons of most sport jackets often come in a complementary contrast shade, so it’s a fair guess that trousers chosen in the same tonality will match the jacket pretty well; if the jacket and trouser are in a similar hue, the shirt can be in a contrast or tonal relationship to both, dictated by complexion and personal taste; if the shirt is multi-colored, one of its colors should echo that of the jacket and trouser

Pattern matching

  • When combining two patterns of the same design, the size of each should be as different from the other as possible
  • When matching two checks, specifically, there should be a healthy dose of contrast between the scale of each player
  • When coordinating two different patterns, such as a striped suit and a check dress shirt, or a plaid jacket and a figured necktie, the patterns should be kept close in size; when in doubt, choose a larger rather than a smaller design; placing two smaller patterns near each other, whether similar or not, will wreak havoc on the eye of the beholder
  • When mixing three patterns where two are the same, separating the two like designs in size while selecting an unlike pattern that is visually compatible with both is the trick; the odd one out should take its cue from the more prominent of the similar partners; for neckties, the open-ground, large-spaced motif affords the greatest possibilities for textural harmony
  • When mixing three patterns of the same design, graduating in size from small out to large, beginning closest to the body and going up as clothing layers outward (ie, shirt smallest, jacket medium, tie or pocket square largest)
  • When mixing four patterns, the more imagination and taste one puts into his appearance, the more subtle the results should be

Conclusion

This book is an incredible resource and fun to read, to boot. It feels like having a conversation with a thoughtful but playful personal clotheshorse. The number of synonyms for different pieces of menswear and style are unbelievable and luckily there is a thorough glossary at the back of the book. There’s so much more here than what I chose to make notes about.

4/5

Notes – Stanford Graduate School of Business Search Fund Primer (#searchfund, #business, #investing)

Notes on “A Primer On Search Funds” produced by the Stanford Graduate School of Business

“The Search Fund”

  • Greater than 20% of search funds have not acquired a company
  • Stages of the Search Fund model:
  • Raise initial capital (2-6mos)
  • Search for acquisition (1-30mos)
  • Raise acquisition capital and close transaction (6mos)
  • Operation and value creation (4-7+ years)
  • Exit (6mos)
  • SFs target industries not subject to rapid tech change, easy to understand, fragmented geographic or product markets, growing
  • Highest quality deals are found outside broker network/open market due to lack of auction dynamics
  • Research shows that partnerships are more likely to complete an acquisition and have a successful outcome than solo searchers (71% yielded positive return, 15 of top 20 performing funds were partnerships)
  • Principals budget a salary of $80,000-120,000 per year w/ median amount raised per principal $300,000~
  • Majority of the economic benefit of SF comes through principal’s earned equity; entrepreneur/partners receive 15-30% equity stake in acquired company in three tranches
  • Investors typically receive preference over the SFer, ensuring investment is repaid, with return attached, before SFer receives equity value
  • Individual IRR from 2003-2011 median was not meaningful, heavily skewed toward 75th percentile where median was 26% in 2011; 57% of individual IRRs were not meaningful in 2011; the median fund destroyed capital in 2009 (0.5x) and 2011 (0.8x); 58% in 2011 broke even or lost money
  • Half of the funds that represent a total or partial loss were funds that did not acquire a company; biggest risk is in not acquiring a company at all
  • Median acquisition multiples: 1.1x revenues; 5.1x EBITDA
  • Median deal size, $8.5M

“Raising a Fund”

  • Search fund capital should come from investors with the ability and willingness to participate in the acquisition round of capital raising

“Search Fund Economics”

  • Search fund investors often participate at a stepped up rate of 150% of original investment in acquired company securities

“Setting Criteria and Evaluating Industries”

  • Desirable characteristics for a target industry: fragmented, growing, sizable in terms of revenues and number of companies, straightforward operations, early in industry lifecycle, high number of companies in target size range
  • Desirable characteristics for a target company: healthy and sustainable profit margins (>15% EBIT), competitive advantage, recurring revenue model, history of cash flow generation, motivated seller for non-business reasons, fits financial criteria ($10-30M in revs, >$1.5M EBITDA), multiple avenues for growth, solid middle management, available financing, reasonable valuation, realistic liquidity options in 3-6 years
  • Key challenge is “know when to take the train” lest a SF never leaves the station waiting for the perfect opportunity
  • Ideally, seller is ready to transition out of the business for retirement or personal circumstances or has something else they’d like to do professionally
  • Experience shows it is better to pay full price for a good company than a “bargain” for a bad one
  • Idea generation: SIC and NAICS codes, Yahoo! Finance, Thomson Financial industry listings, Inc. 5000 companies, public stock OTC and NASDAQ lists and even the Yellow Pages; generate a list of 75 potential industries to start
  • Target industries buoyed by a mega-trend
  • Can also target an industry in which the SFer has worked and possesses an established knowledge base and network
  • Some focus on 2-3 “super priority” industry criteria (eg, recurring revenues, ability to scale, min # of potential targets, etc.)
  • Objective is to pare down the industry target list to 5-10 most promising
  • Basic industry analysis (Porter’s five forces, etc.) is then used to narrow from 10 to 3; SFers use public equity research and annual reports for market size, growth, margin benchmarks; also Capital IQ, Hoover’s, Dun & Bradstreet and One Source
  • Industry insiders (business owners, trade association members, sales or business development professionals) and industry trade associations or affiliated ibanks and advisory firms are primary methods of research and often have general industry research or white papers available
  • Next step is to create a thesis to codify accumulated knowledge and compare opportunities across common metric set in order to make go/no-go decision
  • In order to become an industry insider, SFers typically attend tradeshows, meet with business owners, interview customers and suppliers and develop “River Guides”

“The Search”

  • Median # of months spent searching, 19
  • 54% spend less than 20 months searching, 25% spend 21-30 months, 21% spend 30+ months
  • Track acquisition targets with CRM software such as Salesforce, Zoho, Sugar CRM
  • Bring up financial criteria and valuation ranges as early as possible when speaking to potential acquisition targets to save everyone time
  • A company that is too large or too small as an acquisition target may still be worth talking to for information
  • You must immediately sound useful, credible or relevant to the owner; deep industry analysis should already have been performed at this stage
  • Tradeshows can be a critical source of dealflow
  • If a particular owner is not willing to sell, ask if he knows others who are
  • “River Guides” are typically compensated with a deal success fee, usually .5-1% of total deal size
  • Boutique investment banks, accounting firms and legal practices specializing in the industry in question are also a good source of deals
  • The business broker community itself is extremely large and fragmented; could be a good rollup target?
  • Often, brokered deals are only shown if a private equity investor with committed capital has already passed on the deal, presenting an adverse selection problem
  • Involve your financing sources (such as lenders and investors) early in the deal process to ensure their commitment and familiarity

“Evaluating Target Businesses”

  • Principles of time management: clarify goals of each stage of evaluation and structure work to meet those goals; recognize that perfect information is an unrealistic goal; keep a list of prioritized items impacting the go/no-go decision
  • Stages: first pass, valuation/LOI, comprehensive due diligence
  • It is in the best interest of the SFer to tackle core business issues personally during due diligence as it is the best way to learn the details of the business being taken over
  • Adding back the expenses of a failed product launch rewards the seller for a bad business decision; adding back growth expenses gives the seller the double benefit of capturing the growth without reflecting its true cost
  • Due diligence may also uncover deductions to EBITDA or unrealized expenses that reduce the “normalized” level of earnings (undermarket rents, inadequate insurance coverage, costs to upgrade existing systems, etc.)

“Transitioning Ownership and Management”

  • Create a detailed “Transition Services Agreement” with the seller, a legal contract where specific roles, responsibilities, defined time commitments and compensation are agreed prior to the transaction close
  • The first 100 days should be dedicated to learning the business
  • Businesses consist of people, and people need communication; great leaders are always great communicators
  • “Don’t listen to complaints about your predecessor, this can lead to a swamp and you don’t want to be mired there.”
  • The goal is to learn, not to make immediate changes
  • Outwork everyone; be the first person in and the last to leave
  • Many SFers insert themselves into the cash management process during the transition period by reviewing daily sales, invoices and receipts and signing every check/payment made by the company
  • The company’s board should be a mix of deep operational experience, specific industry or business model experience and financial expertise
  • The seeds of destruction for new senior leaders are often sown in the first 100 days

Notes – The Snowball, By Alice Schroeder: Part IV, Chap. 34-42

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part IV: Susie Sings, Chap. 34-42

Buffett unwinds, but does not relax

In 1970, Buffett decided to unwind his partnerships, partly because he seemed to have plenty of his own capital to manage at this point and no longer needed the headaches that came with fiduciary leverage, partly because the labyrinthine holdings of the partnership were becoming a regulatory compliance headache and partly, no doubt, because of Buffett’s ill mood toward future return potential offered by the market at that point in time.

In his 1969 letter Buffett made another of his unusual market forecasts which, as infrequently as they’ve appeared over the course of his career, nonetheless seem to mark intermediate tops and frothy market conditions. In it, Buffett said,

I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds

As his partners were left with the choice of holding onto their stock or selling, Buffett, the most sophisticated of the partners, left them with one clue as to what he recommended, announcing that he intended to continue buying the stock of Berkshire Hathaway and others which had become his investment holding vehicles.

The “implacable acquirer”

Buffett’s four main holdings at this time were Berkshire Hathaway, Blue Chip Stamps, National Indemnity (an insurance company) and Diversified Retail Holdings. But it was through these companies that Buffett would eventually come to own and control many others, using the earnings of each to buy even more of the next. The key in each situation was that the holdings were either capable of generating investable float, or else they were generating excellent free cash flows that could be redirected away from the core business into ownership of others.

Buffett learned this “Russian doll” strategy in part from a little-known investor named Gurdon W. Wattles, whose control company, American Manufacturing, was used to take controlling stakes in numerous other companies such as Mergenthaler Linotype, Crane Co., and Electric Auto-Lite, many of which Buffett gladly road the coattails on. Buffett claimed he followed the man for ten or fifteen years and that he saw himself as simply standing on the shoulders of a giant in emulating his acquisition approach.

The beauty of this investment technique is that the cash flows are largely market-agnostic– aside from the impact of a general business recession, they would keep generating new cash to be invested to matter what the larger market was doing, which was excellent because when the market was swooning under the weight of panicky investors, Buffett had ample resources to take deep dives on any number of absurdly cheap, high quality companies he might want.

Combined with the power of compounding, his reinvestable cash flows and float would continually increase over time.

Buffett and Mungers’ sweet teeth

One of Buffett and Mungers’ most famous coups of this era was their purchase of See’s Candies. Demanding $30M for assets worth $5M, the true value of See’s was captured in its goodwill with customers, built on its uncompromising quality standards. Buffett believed this goodwill meant the company had “uncapped pricing power”– with current earnings to acquisition price generating a 9% “yield” on investment, the deal was good, but on top of that earnings were growing 12% per year organically and Buffett was convinced that prices could be steadily raised each year to increase the rate of earnings growth beyond the rate of growth in unit volumes.

If the price increases could be met and earnings growth would continue, Buffett and Munger were looking at something that would earn not $4M on a $25M acquisition price, but $6-7M plus additional growth over time. Because the business required very little ongoing maintenance or growth capex, almost all of the earnings were investable free cash flow that Buffett and Munger could use to make additional investments and acquisitions.

Extra! Extra! Buffett buys the Washington Post and becomes board member for Kay Graham

Whether it was because of his early childhood experiences as a newspaper delivery boy or because of his belief in the pseudo-monopolistic economics of newspapers, Buffett found himself drawn to the Washington Post and other media enterprises as an investment. According to the author, newspapers were the perfect investment for Buffett because they allowed him to play all the roles he so enjoyed at once: relentless collector, preacher and cop.

Prior to his engagement, the WaPo was earning $4M per year on $85M in revenues. Run by a talented but psychologically troubled Kay Graham, Buffett was the beneficiary of temporary troubles at the paper which pushed its stock price from a high of $38/share to a low of $16. Buffett bought in big blocks whenever they were available and aimed all along at taking a seat on the board.

In the meantime, he was investing in other newspaper and media companies, breaking his no-IPO rule and buying stock in Affiliated Publications (publisher of the Boston Globe) at a negotiated discount, as well as Booth Newspapers, Scripps Howard and Harte-Hanks Communications.

By 1973 he had accumulated 5% of the shares of WaPo and he wrote a letter to Kay Graham announcing his ownership and advising her that he planned to increase it substantially, telling her that

Writing a check separates conviction from conversation

But Buffett faced challenges from other board members who were protective of Graham, untrustworthy of Buffett and bent on protecting their own turf, such as the great Lazard banker Andre Meyer. Despite controlling the voting stock A shares, even Graham herself became paranoid and defensive at one point and Buffett, to calm her nerves, agreed not to purchase anymore stock without her permission even though he’d already spent almost $10.7M to acquire 12% of the company.

He also made a play for the Buffalo Evening News, one of two newspapers in the Buffalo market. But this investment quickly became complicated as the BEN suffered not only numerous anti-competitive lawsuits from the other local paper, but massive labor disruptions as well. Buffett’s investment quickly turned into a loser whose cash-consumption multiplied rapidly with each passing year, creating a real moment of truth for Buffett and Munger who had, until this time, constructed a nearly flawless investment record.

In Buffett’s mind, the critical element in the equation was customer habit,

You’re gauging the likelihood of people changing their habits… the question is, at what point does it become more of a habit for them to buy the other paper?

Ultimately, their insight on customer habit was correct and their saving grace. Despite losing tens of millions initially on their investment of $35.5M, after surviving the labor disputes and the eventual bankruptcy of the local rival, Buffett’s Buffalo Evening News earned $19M pretax in 1983, more than all the previous losses combined.

Things get sticky with the SEC

In the mid-1970s, Buffett and Munger found themselves in a compromising position with the SEC. Supposedly tipped off by angry competitors and customers of Blue Chip Stamps, the SEC began a cursory investigation of claims about insider dealings between Buffett, Munger and Wesco Financial which eventually turned into a full-blown investigation of every single part of their combined business operations.

The details are complicated and irrelevant at this point, but at the time it was Buffett and Munger’s first real hair-raising legal experience and despite their good intentions and attempts at sweet-talking and playing innocent, they found the SEC investigators to be fairly ruthless in their inquiries and accusations.

The net result was Buffett and Munger’s decision to clean up their ownership structure and simplify it by merge more of their companies into the umbrella holding company of Berkshire Hathaway.

But one can’t help but wonder about the timing– just as Buffett was making his move on the Washington Post and beginning to enter the world of the Washington power elite, had someone decided to give Buffett a scare, to show him just how delicate his “conservative” investment empire really was, and to compel his obedience to the power elite agenda going forward?

More Buffett investments

Here is a running list of Buffett investments over the period of 1970-1983:

  • Berkshire Hathaway
  • Blue Chip Stamps
  • Diversified Retail Holdings
  • National Indemnity
  • Cornhusker Casualty
  • National Fire & Marine
  • The Washington Post
  • See’s Candies
  • Scripps Howard
  • Harte-Hanks Communications
  • Affiliated Publications
  • Booth Newspapers
  • San Jose Water Works
  • Source Capital
  • Wesco Financial
  • National Presto
  • Vornado Realty Trust
  • Interpublic
  • J. Walter Thompson
  • Oglivy & Mather
  • Studebaker-Worthington
  • Handy & Harman
  • Multimedia, Inc.
  • Coldwell Banker
  • Pinkerton’s, Inc.
  • Detroit International Bridge
  • Buffalo Evening News
  • The Illinois National Bank and Trust Company of Rockford
  • GEICO
  • Munsingwear
  • Data Documents (a private investment)

A collapsing personal life

With regards to Buffett’s personal life, Part IV is so far the saddest of all. It is in this stage of Buffett’s life and investment career that he really begins to lose touch with his children and his spouse, Susie. Though married in name, the couple are de facto separated and living their own independent lives, with Buffett traveling constantly and spending a lot of time “elephant bumping” with Kay Graham in Washington and Susie leaving her now empty nest in Omaha to take up her own apartment in racy San Francisco.

Buffett’s children are distant from him, physically and emotionally and the life choices and dysfunction of each seem to demonstrate quite clearly what an absentee father he was. Sadly, Susie turns to an affair (or two) in her search for companionship and even Buffett eventually caves and shacks up with his caretaker, Astrid Menks, a friend of Susie’s in Omaha.

Buffett expresses deep regret about this part of his life, realizing too late to salvage the situation what damage his indifference had caused.

If there’s a lesson here, it is that life always requires balance for it to be happy and worthwhile. What good is knowing you’re the world’s greatest (and soon to be wealthiest) investor, if it comes at the cost of agonizing sadness when your marriage falls apart and your children no longer seem to know much of you?

Other important investment ideas

In no particular order, below are a few more quotes on important investment ideas, as shared by Buffett and other investors, in Part IV.

Buffett on uncertainty:

The future is never clear, you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values

Buffett on reputation:

Over a lifetime, you’ll get a reputation for either bluffing or not bluffing. And therefore, I want it to be understood that I don’t do it [bluff]

Tom Murphy on the value of stock as a currency:

Warren never gave his stock away; neither did I if I could possibly avoid it. You don’t get rich that way. [Commentary by Alice Schroeder] Giving stock in exchange for TV Guide was saying, in a literal sense, that they thought it would earn more in the future than whatever share of Berkshire Buffett swapped for it. Paying with stock showed a sort of contempt for your own business versus whatever it was that you were buying– that is, unless you were paying with stock that had gotten wildly overpriced

Buffett’s advice to Graham on acquisitions, channeled through Alice Schroeder:

It was always a mistake to pay too much for something you wanted. Impatience was the enemy… [there was] immense value in buying their company’s own stock when it was cheap to reduce the shares outstanding

Bill Ruane on the investment business:

In this business you have the innovators, the imitators, and the swarming incompetents

Buffett on Wattles and coattailing:

There’s nothing wrong with standing on other people’s shoulders

Notes – The Snowball, By Alice Schroeder: Part III, Chap. 20-33

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part III: The Racetrack, Chap. 20-33

Racing On

The third part of The Snowball opens with Warren Buffett on the verge of starting his infamous partnerships, the precursor to his Berkshire Hathaway holding company conglomerate. On the way, he took a few short detours and learned lessons all over the place, some of them completely unrelated to the art of investing. For example, witnessing the implosion of his father’s political career and campaign, Warren realized:

  • allies are essential
  • commitments are so sacred that by nature they should be rare
  • grandstanding rarely gets anything done

And from his father-in-law, Doc Thompson, the young Buffett learned

always surround yourself with women. They’re more loyal and they work harder

Meanwhile, Buffett’s young wife and mother-to-be, Susie Thompson, was learning just how deep the rabbit hole went when it came to Warren’s insecurities:

Leila [Buffett’s emotionally unbalanced mother] convinced both Warren and Doris that deep down they were worthless… [Buffett] was riddled with self-doubt. He had never felt loved, and she saw that he did not feel lovable

The depth of Buffett’s personal insecurities not only explain a lot about his later behavior and public persona, but they also provide a couple of startling questions to ponder, namely:

  • how did a person with such fundamental self-confidence issues nevertheless summon the self-confidence necessary to trust his own investment thinking?
  • being as insecure as he appeared to be, how much better of an investor might Warren Buffett have been had he not been carrying around such a handicap?

Who is Charlie Munger?

In Part III, we begin to get a more detailed picture of Buffett’s soon-to-be-infamous partner, Charlie Munger, as well as the subtle but fundamental ways in which his own thinking about investing and business analysis came to influence and then dominate Buffett’s own style. A mathematics major at the University of Michigan at age 17, following the incident at Pearl Harbor, the young Munger enlisted in the military and found himself as an Army meteorologist in Nome, Alaska. He took up poker where he learned to bet big when he had the odds and fold fast when he did not. He later attended Harvard Law School where he claims he graduated “without learning anything.”

After law school, he was obsessed with the idea of achieving social prominence, choosing Los Angeles as a place that was growing and full of opportunity but not so big and developed that he’d never be noticed. Munger’s life, like Buffett’s, was not without personal tragedy. His first marriage fell apart right around the time his 8-year-old son came down with a terminal illness. Munger had to watch these two pillars of his life dissolve simultaneously.

He later became obsessed with children and raised eight of them with his second wife. Munger was a compulsive reader and thinker, known to his family as a “book with legs” and was constantly found reading books on science and the achievements of great figures. Munger was interested in making money early on. When he was a young lawyer and earning about $20/hr he realized his most valuable client was himself so, in the style of The Richest Man In Babylon, Munger decided to “sell himself an hour each day”, which he used to pursue real estate and construction projects as well as other investment opportunities. Munger had

a considerable passion to get rich, not because I wanted Ferraris– I wanted the independence

Buffett was patient with Munger. Even though Munger was his senior by several years, Munger pleadingly inquired about whether he could do what Buffett was doing in Los Angeles. Not only did Buffett tell him he could and should, he proceeded to build a relationship with him that involved hours of phone conversations everyday as the two came up with different business ideas together. As Munger described Buffett, and his fascination with him,

That is no ordinary human being

In other words, they seemed to be soulmates, a truly odd couple.

The Munger Effect

Charlie Munger entered Buffett’s life and investment world at a critical juncture in Buffett’s development as a capital allocator.

Until 1958, his straightforward route was to buy a stock and wait for the cigar butt to light. Then he usually sold the stock, sometimes with regret, to buy another he wanted more, his ambitions limited by his partnerships’ capital

But as his total AUM approached $1M with his partnerships and personal money, Buffett had a new scale that let him branch out into new styles of investing. His investments began to become concentrated, elaborate and time-consuming, such as the Sanborn Maps episode. Munger himself started his own partnership in 1962 with his poker buddy Jack Wheeler  who was a trader on the floor of the Pacific Stock Exchange and $300,000 in capital he had accumulated through real estate investments. He eventually gave up his law practice at age 41 and decided to pursue investing full-time. He also used Wheeler’s membership on the exchange to lever up (at a ratio of 95/100) when he felt sure about his investments, something Buffett was not willing to do early on.

Munger’s early investment style involved net-nets, arbitrage and even the acquisition of small businesses. But his real interest lay in buying “great businesses”, which he identified by:

  • strength of management
  • durability of brand
  • cost to compete/replicate the firm
  • did not require continual investment
  • created more cash than it consumed

To find these businesses, Munger asked everyone he met, “What is the greatest business you’ve ever heard of?”

As the market for net-nets dried up in the mid-60s and Buffett’s capital swelled, he found more and more he had to look at the kinds of great businesses that Charlie Munger favored, changing his focus from statistical cheapness (quantitative investing) to competitive advantage (qualitative investing).

With his capital ballooning, Buffett began looking at the acquisition of entire businesses as a more attractive option. In 1966, this twinkle in Buffett’s eye became Diversified Retailing Company, Inc., an 80/10/10-ownership holding company owned by Buffett, Munger and Sandy Gottesman, whose first acquistion was a $12M Baltimore department store called Hochschild-Kohn, financed 50% with bank borrowings, a “second-class department store” at a “third-class price”. However, the store had no competitive advantage, as the partners soon learned, and was continually caught up in a game of “standing tiptoe at a parade” as every innovation by a competitor had to be quickly imitated (at additional capital expense) lest customers shop elsewhere. It was here that Buffett and Munger learned that the essential skill of retailing was merchandising, not finance, and that retailing, like restaurants, is

a wearing marathon in which, every mile, fresh, aggressive competition could leap in and race ahead of you

Having learned their lesson, their next foray into Associated Cotton Shops, “a set of third-class stores for a fourth-class price” 80 in number led by Benjamin Rosner, a “true merchandiser” found them with a retail operation generating $44M in sales and approximately $2M/yr in earnings. Buffett made a deal to buy the stores for $6M, a sale which was ultimately made by Rosner in part to screw over his female business partner who drove him nuts, causing him to purposefully sell the business for less than it was worth just to get back at her. Buffett and Munger also insisted that Rosner stay on the manage the company for them.

In 1967, Buffett increased his control of the Buffett Partnerships while simultaneously weeding out 32,000 shares worth of investors who preferred a 7.5% debenture to Berkshire stock, ensuring that those who remained were in for growth and the risks that came with it.

Miscellany of the markets

As Buffett’s investment strategy changed over the 1950s and 1960s and his level of sophistication rose, he picked up a number of useful techniques for gaining informational edges in the market and making successful investments:

  • coat-tail riding – Buffett became a notorious borrower of good ideas and was not too proud to keep an eye on people who demonstrated deal-making intelligence in the past, such as Ben Graham and Jay Pritzker, assuming they’d continue to make good judgments in the future
  • detective-work/sleuthing – Buffett was the only person digging through the Moody’s Manuals at their company headquarters, or going to the shareholder meetings of small companies, or even meeting with executives of small companies to get an idea of who was running these companies
  • no self-imposed market cap restrictions – Buffett looked at EVERY company he came across, no matter how small, looking for opportunities others weren’t focused on; he was particularly fond of the “Pink Sheets” publications
  • consulting lists of registered shareholders – Buffett would buy blocks of companies he was interested in by hunting down individual shareholders and convincing them to unload the shares to him
  • collecting scarce things – Buffett’s National American Fire Insurance investment taught him “the value of gathering as much as possible of something scarce”, both undervalued stocks and information related to said stocks
  • proxy-investing – Buffett would often have his friends buy stocks he was interested in to hide his identity as the main buyer accumulating a position
  • benefit from sentiment – when the market hit a fever pitch in the 1960s, Buffett went into fundraising overdrive and raised as much capital as he could while people were eager to invest
  • use psychology to your advantage – as Buffett’s success unfolded, he forced would-be partners to ask him to allow them to invest with him, which put him psychologically in control
  • preservation of capital – Buffett would willingly forgo the chance of profit to avoid too much risk, viewing it as a “holy imperative”; his partner Munger believed unless you were already wealthy you could afford to take risk if the odds were right
  • haystack of gold – a concept imparted to him by friend Herb Wolf, the idea was if you’re looking for a gold needle in a haystack of gold it is not better to find the gold needle; obscurity was not virtue
  • expense control – Buffett only took on overhead as needed, and in ways that could be easily turned back off or were free to begin with; he made extensive use of “soft-dollars” in his brokerage commissions to buy research from his favorite sleuth brokers
  • profile visibility – when he was buying small companies early in his career, Buffett valued secrecy and anonymity, but as he began to target bigger companies he saw the value of a public profile and cultivated a relationship with Carol Loomis, a financial markets journalist

Buffett’s partnerships

Buffett had a total of 9 official partnerships that later became the infamous Berkshire Hathaway. However, he also set up an early partnership with his father, Howard, called Buffett & Buffett, which

formalized the way they had occassionally bought stocks together. Howard contributed some capital, and Warren’s contribution was a token amount of money, but mostly ideas and labor

Why was Buffett interested in managing money? Two reasons. One, Buffett had a strong aversion to working for others and he understood that

The overseer of capital was not an employee

Two, Buffett was obsessed with becoming a millionaire. Managing money for others and collecting a fee on profits generated would allow him to grow his own capital faster than if he were earning a return on just the money that was actually his. In other words, agreeing to manage money for others was a way to leverage his own investment returns.

Buffett started with 7 official partnerships, which were essentially all mini-hedge funds under his exclusive control, and which he viewed as “compounding machines”, meaning once the money went in it should not come out, which is why he managed most of his own wealth separately (as he would be living off his trading gains). And Buffett was so obsessed with compounding he decided to rent rather than own his own home, to free more capital for compounding.

The seven initial partnerships and several follow-on partnerships were as follows:

  1. May 1, 1956, Buffett Associates Ltd., starting capital of $105,100, seven partners: Doc Thompson, Doris Buffett, Truman Wood, Chuck Peterson, Elizabeth Peterson, Dan Monen and Warren Buffett; Buffett charged 50% performance fee on returns over 4% (4% returns being guaranteed as a minimum by Buffett); added $8,000 in capital in 1960 from Buffett’s aunt and uncle
  2. September 1, 1956, Buffett Fund, Ltd., starting capital of $120,000, partnered with Homer Dodge, a former Graham-Newman investor
  3. Late 1956, B-C, Ltd., starting capital of $55,000, partnered with John Cleary, Howard Buffett’s secretary in Congress
  4. June 1957, Underwood, starting capital of $85,000, partnered with Elizabeth Peterson; 1960, another $51,000 from connections of Chuck Peterson’s
  5. August 5, 1957, Dacee, starting capital of $100,000, partnered with the Davis Family
  6. May 5, 1958, Mo-Buff, starting capital of $70,000, partnered with Dan Monen (who had withdrawn his capital from partnership #1 to do a special investment with Buffett on National American), later joined by the Sarnats and Estey Graham with another $25,000 in capital
  7. February 1959, Glenoff, starting capital of $50,000, partnered with Casper Offutt, Jr., John Offutt and William Glenn
  8. August 15, 1960, Emdee, starting capital of $110,000, partnered with  11 local doctors
  9. 1960, Ann Investments, starting capital of ??, partnered with a prominent member of a local Omaha family
  10. 1960, Buffett-TD, starting capital of $250,000, partnered with Mattie Topp and two daughters plus son-in-law (MT owned the fanciest dress shop in town)
  11. May 16, 1961, Buffett-Holland, starting capital of ??, partnered with Dick and Mary Holland, friends he had met through his lawyer Dan Monen
  12. May 1, 1962, Buffett dissolves all partnerships into Buffett Partnership, Ltd. (BPL), beginning the year with $7.2M in net assets

His total starting capital across all of his partnerships was $580,000 and he

never deviated from the principles of Ben Graham. Everything he bought was extraordinarily cheap, cigar butts all, soggy stogies containing one free puff

Truly, one man’s junk is another man’s treasure.

Buffett’s investments

The “racetrack” period of Buffett’s life marked Buffett’s gradual transformation from a Grahamian “cigar butt” (Net-Net) investor to the well-known “growing franchise” investor of today. As Buffett’s assets under management (AUM) grew and the general market conditions of the era changed, so, too, did Buffett’s idea of a good investment. Below is a list of some of Buffett’s investments for his partnerships, as well as his personal and peripheral portfolios:

  • Greif Bros. Cooperage; originally purchased for the B&B partnership in the early 1950s
  • Western Insurance; purchased for Buffett’s personal portfolio in the early 1950s, Buffett actually sold his GEICO position to raise money to invest in this company earning $29/share and selling for $3/share, “He bought as much as he could”
  • Philadelphia and Reading Coal & Iron Company; controlled by Graham-Newman, Buffett has discovered it on his own and had invested $35,000 by the end of 1954; it was not worth much as a business but was throwing off a lot of excess cash; Buffett learned about the value of capital allocation with this company
  • Rockwood & Co.; controlled by Jay Pritzker, the company was offering to exchange $36 of chocolate beans for shares trading at $34, a classic arbitrage opportunity; unlike Graham, Buffett didn’t arbitrage but instead bought 222 shares and held them, figuring Pritzker had a reason he was buying the stock, “inverting” the scenario; the stock ended up being worth $85/share, earning Buffett $13,000 vs. the $444 he would’ve received from the arbitrage
  • Union Street Railway; a net-net he discovered through Ben Graham, had about $60/share in net current assets against a selling price of $30-35/share, Buffett ultimately made $20,000 on this investment through sleuthing and speaking to the CEO in person
  • Jeddo-Highland Coal Company (mentioned as an idea Buffett investigated on a road trip)
  • Kalamazoo Stove and Furnace Company (mentioned as an idea Buffett investigated on a road trip)
  • National American Fire Insurance, earning $29/share, selling for around $30/share, Buffett first bought five shares for $35/share, and later realized that paying $100/share would bring out the sellers because it would make them whole (financially and psychologically) after being sold the stock years earlier
  • Blue Eagle Stamps, a failed investment scheme between Buffett and Tom Knapp, they eventually spent $25,000 accumulating these “rare” stamps that weren’t worth more than their face value ultimately
  • Hidden Splendor, Stanrock, Northspan, uranium plays that Buffett described as “shooting fish in a barrel”
  • United States & International Securities and Selected Industries, two “cigar butt” mutual funds recommended to him by Arthur Wisenberger, a well known money manager of the era; in 1950, represented 2/3 of Buffett’s assets
  • Davenport Hosiery, Meadow River Coal & Land, Westpan Hydrocarbon, Maracaibo Oil Exploration, all stocks Buffett found through the Moody’s Manuals
  • Sanborn Maps, in 1958 represented 1/3 of his partnerships’ capital; the stock was trading at $45/share but had an investment portfolio worth $65/share; Buffett acquired control of the board in part through proxy leverage; ultimately he prevailed over management and had part of the investment portfolio exchanged for the 24,000 shares he controlled
  • Dempster Mill Manufacturing, sold for $18/share with growing BV of $72/share, Buffett’s strategy as with many net-nets was to buy the stock as long as it was below BV and sell anytime it rose above it and if it remained cheap, keep buying it until you owned enough to control it and then liquidate at a profit; he and his proxies gained control of 11% of the stock and got Warren on the board, then bought out the controlling Dempster family, creating a position worth 21% of the partnership’s assets; the business was sliding and at one point he was months away from losing $1M on the investment, but was ultimately rescued by Harry Bottle, a new manager brought in on Charlie Munger’s recommendation; the business eventually recovered through strict working capital controls and began producing cash, which Buffett augmented by borrowing about $20/share worth of additional money and used it to purchase an investment portfolio for the company; he later sold the company for a $2M profit
  • Merchants National Property, Vermont Marble, Genesee & Wyoming Railroad, all net-nets he later sold to Walter Schloss to free up capital
  • British Columbia Power, selling for $19/share and being taken over by the Canadian government at $22/share, this merger arb was recommended by Munger and Munger borrowed $3M to lever up his returns on this “sure thing”
  • American Express, one of Buffett’s first “great company at a good price” investments, the firm’s reputation was temporarily tarnished in the aftermath of the soybean oil scandal; Buffett did scuttlebutt research and realized the public still believed in American Express, and as trust was the value of its brand, the company still had value; Buffett eventually invested $3M in the company and it represented the largest investment in the partnership in 1964, 1/3 of the partnership by 1965 and a $13M position in 1966
  • Texas Gulf Producing, a net-net Buffett put $4.6M into in 1964
  • Pure Oil, a net-net Buffett put $3.5M into in 1964
  • Berkshire Hathaway, the company was selling at a discount to the value of its assets ($22M BV or $19.46/share) and Buffett’s original intent was to buy it and liquidate it, which he started accumulating 2000 shares for $7.50/share; the owner, Seabury Stanton had been tendering shares with the company’s cash flow, so Buffett tried to time his transactions, buying when it was cheap and tendering when it was dear; he continued purchasing stock assuming Seabury would buy him out via tender offers, the two eventually agreed to a $11.50 tender but Seabury reneged at the last moment, changing the bid to $11 and 3/8, sending Buffett into a rage and causing him to abandon his original strategy in favor of acquiring the entire company; he eventually bought out Otis Stanton’s two thousand shares and had acquired enough to gain control with 49% of Berkshire
  • Employers Reinsurance, F.W. Woolworth, First Lincoln Financial, undervalued stocks he found in Standard & Poor’s weekly reports
  • Disney, which he bought after meeting Walt Disney and being impressed by his singular focus, love of work and the priceless entertainment catalog
  • A portfolio of shorts to hedge against a potential market collapse in the mid 60s, totally $7M and consisting of Alcoa, Montgomery Ward, Travelers Insurance and Caterpiller Tractor
  • Near the end of 1968, as the market became more and more overvalued, Buffett relented and bought some of the “blandest, most popular stocks that remained reasonably priced” such as AT&T ($18M), BF Goodrich ($9.6M), United Brands ($8.4M) and Jones & Laughlin Steel ($8.7M)
  • Blue Chip Stamps, a “classic monopoly” Buffett and Munger discovered in 1968, the company was involved in a lawsuit that the pair thought would be resolved in the company’s favor, and it also possessed “float” which could be invested in more securities, Munger and his friend Guerin each purchased 20,000 shares while Buffett acquired 70,000 for the partnership, in part through share swaps with other companies that owned Blue Chip stock for their own stock; the lawsuit was eventually resolved and the $2M investment produced a $7M profit
  • Illinois National Bank & Trust, a highly profitable bank that still issued its own bank notes, it was managed by Eugene Abegg, an able steward of the company whose retainer was one condition for Buffett’s investment in the company
  • The Omaha Sun and other local newspapers, which Buffett figured he’d make an 8% yield on, his motivation for buying seemed to be primarily connected to his desire to be a newspaper publisher
  • The Washington Monthly, a startup newsmagazine that Buffett lost at least $50,000 on, again, as a vanity project

Buffett’s AUM

Below is a record of the growth of Buffett’s personal wealth, partnership AUM and performance fees accrued:

  • 1954, Buffett’s total personal capital stood at approximately $100,000
  • 1956, Buffett was 26 years old and had $174,000 of personal capital, growing his money by more than 61% per year for six years since he entered Columbia with $9,800 in capital
  • 1959, partnership returns beat the market by 6%
  • 1960, partnership assets stood at $1.9M and returns beat the market by 29%, and Buffett’s reinvested partnership fees had earned him $243,494 (13% of partnership assets belonged to him)
  • 1962, Buffett was a millionaire and his outside investments totalled over $500,000, which he added with the rest of his money into the BPL partnership; he had acquired more than a million dollars in six years and owned 14% of the partnership
  • 1964, $5M in new capital for the partnerships, and $3M in investment earnings, Buffett’s personal net worth was $1.8M and BPL had $17.5M in capital
  • 1965, ended the year with assets of $37M, including $3.5M in profit on American Express, Buffett had earned more than $2.5M in fees, bringing his total stake to $6.8M
  • 1966, $6.8M in additional capital investments in the partnerships, with total capital amounting to $44M, some of which was set aside as cash for the first time in Buffett’s career
  • 1967, Buffett’s personal net worth was $9M and he had generated $1.5M in fees in 1966
  • 1968, the partnership was worth $105M thanks to additional capital infusions and investment returns
  • 1969, Buffett’s net worth was $26M

The Desert Island Challenge

Buffett and his investor friends came up with the following challenge that is a helpful mental tool for thinking about the investment problem:

If you were stranded on a desert island for ten years, he asked, in what stock would you invest? The trick was to find a company with the strongest franchise, one least subject to the corroding forces of competition and time: Munger’s idea of a great business.

Notes – The Snowball, By Alice Schroeder: Part II, Chap. 5-19

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder. This post covers Part II: The Inner Scorecard, Chap. 5-19

The beginning of Buffett

In a letter to a family member from one of Warren Buffett’s ancestors, Zebulon, the elder Buffett counsels his grandson to

be content with moderate gains

almost as if some strain of value investing ethic permeated his lineage from before Buffett himself had even heard of The Intelligent Investor. Buffett’s family represents a long line of business minded people. Yet, despite this heritage,

Buffett always credited most of his success to luck

It’s an odd, likely guilt-laden existential belief to carry around with oneself! But it is maybe no surprise. Love doesn’t sound like it was given much attention in Buffett’s childhood home, and self-love is probably included, as we learn that:

Politics, money and philosophy were acceptable topics for dinner-table discussion at the Buffett house, but feelings were not. Nobody in the Buffett household said “I love you,” and nobody tucked the children into bed with a kiss.

Any guess as to where some of Buffett’s later self-hating charitable giving ideas might have come from?

[Buffett’s mother, Leila’s] favorite stories told of her and Howard’s sacrifices… anything for Howard. “She crucified herself”… But Leila’s attitude of duty and sacrifice had another, darker side: blame and shame.

If you guessed his psychotic, clinically depressed mother, you answered correctly!

It is Buffett’s relationship to his mother and his vulnerability to her rage as a child that we actually see Buffett in the most sympathetic light. We see as Warren recounts his relationship with his mother this grown, aged man “weeping helplessly”, and we also learn that despite the savage treatment from his mother, which his idolized father was aware of, Howard “didn’t intervene.”

The most vulnerable people in any society are children– they’re physically, intellectually AND emotionally unequipped to make sense of and thoughtfully respond to the irrationalities and volatilities of unstable and violent adults. It is actually quite touching imagining this young, budding genius, Warren Buffett, suffering at the hands of his psychologically diseased mother and developing a precarious existential belief system that leaves him feeling so guilty for the remainder of his life that after all he has (legitimately) achieved, he is still convinced it was mostly due to luck! What an absolute tragedy of human imagination! It would be nice to imagine the poor, hurting and timid child inside of Warren Buffett eventually being freed to go on his way and let Warren wrestle with these childhood demons no more.

What a different world it would be if Warren was a hero entrepreneur rather than a man so tormented by his past that he carries his fears and anxieties into his public persona and recommendations for society at large!

We also see in this information the source of Warren’s fascination with other people’s mothers (who he often developed crushes on), with motherly women in general and with his tendency to have a cadre of close female friends in both his personal and professional life, all while simultaneously having a troubled and distant relationship with his own wife and children later on. What a sad development for an otherwise triumphant individual.

The search for a system – Buffett the handicapper

One of the central themes of Part II is the young Warren Buffett’s search for a “system”: a predictable, confined process for predicting and handicapping the odds of various events in his life. Starting with his bathtub marble race, extending to the racing track (horses) and eventually culminating in his quest for an investment system (part of his initial attraction to Graham, who was especially formulaic, scientific and systematic in his approach to the investment question in general).

And a system, once found, is only valuable if it has a lot of information to process:

There were opportunities to calculate odds everywhere. The key was to collect information, as much information as you could find.

We also begin to see hints of the later, “original” Buffett, with his love of monopoly as a competitive advantage. The anecdotes of Buffett and his friend Russ collecting license plate information in the hopes of eventually providing it to the police to catch a bank robber are examples of Buffett’s early obsession with  the value of a monopoly. Similarly, while the young Warren was holed up in a hospital with an illness, he took to collecting the fingerprints of the nurses so that if one of them committed a crime,

he, Warren Buffett, would own the clues to the culprit’s identity

This is a pretty astounding conclusion for a young child to reach, even if it is innocently done. It appears Warren had something of an intuitive understanding of the value of a restricted supply granted by a monopoly on a particular resource.

He also was perplexed by the way so much valuable information (valuable to someone with a system in place for interpreting and analyzing it) went uncollected and unused. An early example is Buffett’s collecting of bottle caps nearby soda dispensers:

The numbers told him which soft drinks were most popular

Do you see the future investor in Coca-Cola beginning to formulate his understanding of the value of consumer habits and patterns?

In the 1940s, Buffett started visiting horse racing tracks where he learned

The art of handicapping is based on information. The key was having more information than the other guy

Buffett ended up reading HUNDREDS of books on horse handicapping before he eventually learned the Rules of the Racetrack:

  • Nobody ever goes home after the first race
  • You don’t have to make it back the way you lost it

Buffett later connected these experiences to his investing and understood

The market is a racetrack too. The less sophisticated the track, the better… the trick, of course, is to be in a group where practically no one is analytical and you have a lot of data

In this way, a handicapper or investor can develop informational asymmetries which grant him the all-important edge. Interestingly, Buffett earned a college scholarship in just this way, as he was the only person to show up to a scholarship committee session and thus earned the scholarship by default because he had no competition.

This is where the quote about Buffett sifting through the Moody’s Manuals company by company, page by page (all ten thousand) comes from, and the famous quote,

I actually looked at every business– although I didn’t look very hard at some

In a similar vein, Warren’s classmates at the Columbia Business School completely ignored the opportunity they had, right in front of them, to learn investing from the premier guru of their era, Benjamin Graham. Instead,

They were a remarkably homogeneous group of men, mostly headed to General Motors, IBM or U.S. Steel after they got their degrees

These young men were being trained to become managers. Meanwhile, Buffett was training to become an owner (and he would later own IBM, while the other two American stalwarts died slow, painful deaths). Or, as Buffett later put it,

U.S. Steel was a good business… it was a big business, but they weren’t thinking about what kind of train they were getting on

Buffett also learned the importance of “swinging at the right pitches”:

You’re not supposed to bet every race. I’d committed the worst sin, which is that you get behind and you think you’ve got to break even that day

Simultaneously, Buffett was realizing the importance of thinking for oneself and not being a mindless trend follower. Granted an opportunity to play “the echo” to another trumpeter in the school band, Buffett found himself in a confusing and embarrassing situation in which the lead player played the wrong note and Warren didn’t know what to do as his “echo”. The lesson?

It might seem easier to go through life as the echo– but only until the other guy plays a wrong note

He also became enamored with Dale Carnegie and his social system, one of the most important lessons of which he felt was “Don’t criticize, condemn or complain.”

In addition, Buffett studied the biographies of great businessmen such as:

  • Jay Cooke
  • Daniel Drew
  • Jim Fisk
  • Cornelius Vanderbilt
  • Jay Gould
  • John D. Rockefeller
  • Andrew Carnegie

looking for the keys to their “system”.

History repeats itself, or at least rhymes

In Part II we also get a glimpse into the way that early themes and experiences in Buffett’s life replayed themselves as important investments in his later life as the world’s best known and must successful investor. For example:

  • as a child, Buffett sold chewing gum door-to-door; he later successfully invested in Wrigley’s chewing gum
  • as a child, Buffett collected soda bottle caps; he later successfully invested in Coca-Cola
  • as a child, Buffett was obsessed with model trains and always dreamed of owning a train set; he later successfully invested in Burlington Northern railroads
  • as a child, Buffett met Sidney Weinberg, an important figure at Goldman Sachs, during a field trip to Wall St with his father; he later successfully invested in Goldman Sachs
  • as a child, Buffett had a paper route in which he distributed, amongst many other papers, the Washington Post; he later successfully invested in the Washington Post and other dailies

Warren catches the wealth-bug

It was on his trip to the Stock Exchange in New York City in 1940 with his father that Warren first understood the money-making potential of stock investing. Witnessing exchange members who had servants roll custom cigars, Warren realized

the Stock Exchange must pour forth streams of money… he worked with a passion for the future he saw ahead of him, right there in sight. He wanted money

Later, Warren came across a book entitled “One Thousand Ways to Make $1,000” or, in Warren’s mind, how to make a million dollars. This was it. He was going to be a millionaire. The book had hopeful, helpful and optimistic advice that we would all well consider and pay attention to in the event that we become similarly motivated:

the opportunities of yesterday are as nothing compared with the opportunities that await the courageous, resourceful man of today! You cannot possibly succeed until you start. The way to begin making money is to begin… Hundreds of thousands of people in this country who would like to make a lot of money are not making it because they are waiting for this, that or the other to happen

Buffett also learned around this time the power of compounding and decided

If a dollar today was going to be worth ten some years from now, then in his mind the two were the same

Early Buffett investments, and why he made them

Before he had even graduated from college, the young Warren Buffett had made a number of stock and private investments:

  • Cities Service Preferred; bought three shares at $114.75 for himself and his sister, the shares fell and then recovered; Buffett sold at $40/share for a $5 profit, only to watch the shares rise to $202, lessons learned:
    • Do not overly fixate on the price paid for a stock
    • Don’t rush unthinkingly to grab a small profit; it can take years to earn back the profit “lost” through opportunity cost
    • Buffett didn’t want to have responsibility for other people’s money unless he was sure he could succeed
  • Around age 15, Warren had invested in “Builders Supply Co.”, a hardware store owned and operated by his father and his father’s business partner, Carl Falk, in Omaha
  • Around age 15, Warren bought a 40-acre farm for $1,200 that he split the profits of with a tenant farmer; he sold it when he was in college (5 years later) for $2,400
  • Buffett invested “sweat equity” in a paper route which earned him $175/mo in an era when a grown man felt well-paid on $3,000/yr
  • Buffett started a used golf-ball retailing business with a friend, selling golf balls for $6/dozen, through a wholesaler in Chicago named Witek
  • Buffett bought a pinball machine for $25, placed it in a barbershop and recouped $4 in the first day; he went on to purchase 7-8 pinball machines for “Mr. Wilson’s pinball machine company”, learning the principle of capital,  money that works for its owner, as if it had a job of its own
  • 1949, Buffett shorts automaker Kaiser-Frazer, which went from producing 1/20 cars to 1/100 in the market; Buffett saw a trend in the statistics
  • Preparing to enter Columbia, Buffett invested in Parkersburg Rig & Reel, purchasing 200 shares after discovering the company “according to Graham’s rules” in The Intelligent Investor
  • At Columbia, Buffett was invested in Tyer Rubber Company, Sargent & Co. and Marshell-Wells (a hardware company) of which he had jointly purchased 25 shares with his father; Marshell-Wells was the largest hardware wholesaler in the US and traded for $200 but earned $62/share, making it similar to a bond with a 31% yield
  • After visiting with Lou Simpson at GEICO, Buffett dumped 3/4ths of his stock portfolio to buy 350 shares of GEICO, which was trading at 8x current earnings at $42/share and was rapidly growing; Buffett felt his margin of safety was a growing, small company in a large field meaning it had a lot of opportunity ahead of it, especially because it was the lowest cost provider
  • Grief Bros. Cooperage, a barrel maker and Ben Graham stock
  • Philadelphia Reading Coal & Iron Company, selling for $19/share with $8/share worth of culm banks
  • Cleveland Worsted Mills, textile manufacturer selling for less than its current assets of $146/share; the company cut the dividend which was part of Buffett’s investment thesis and he sold the stock in disgust
  • A gas service station, which he bought with a friend for $2,000; the property never made money as they couldn’t entice customers from the nearby Texaco station; Buffett lost his investment and learned the value of customer habit
Related to the theme of early Buffett investments is the course of the young Buffett’s savings and the accumulation of his capital stock:
  • Age 14, his savings totaled around $1,000, “he was ahead of the game… getting ahead of the game, he knew, was the way to the goal”
  • Age 15, his savings totaled around $2,000, much of which was from his newspaper route
  • Age 16, his savings totaled around $5,000 ($53,000 in 2007 dollars), much of it from his pinball and golfball businesses
  • Age 20 (1950), his savings totaled $9,803.70 which was partly invested in stocks, as well as a $500 scholarship and $2,000 from his father for not smoking
  • Age 21, his savings totaled $19,738, he had boosted his capital 75% in a single year and he felt “supremely confident in his own investing abilities”, he also was willing to take on debt equal to a quarter of his net worth, or about $5,000, for total capital of around $25,000

Miscellaneous Buffett lessons

On betting and deal-making in general:

Know what the deal is in advance

What Buffett learned from Graham:

  • A stock is the right to own a little piece of a business
  • Use a margin of safety so the effects of good decisions are not wiped out by errors; the way to advance is to not retreat
  • Mr. Market is your servant, not your master
On influence:

it pays to hang around people better than you are, because you will float upward a little bit. And if you hang around with people that behave worse than you, pretty soon you’ll start sliding down the pole

Buffett’s authorship of the article “The Stock I Like Best” on GEICO attracted the attention of a later financial backer, Bill Rosenwald, son of Julius Rosenwald and longtime chairman of Sears, Roebuck & Co.