You Can't Invest Like Buffett

There's no question that Warren Buffett is one of the most successful investors of all time. But can individual investors replicate his success?

A common view of how Buffett invests is that he finds a business that is undervalued by the market, buys a portion of it (or the entire thing), and waits until the market correctly values or even overvalues the business, or simply collects the cash it spits out, which he uses to buy other businesses.

It seems like anyone can do this. All one needs to do is to learn how to value companies correctly enough to know when their shares are selling at a deep discount.

What this rosy picture leaves out is the many times it was necessary for one of Buffett's proxies or Buffett himself to get involved directly in the invested company's management in order to make a profit, or even salvage the investment.

Sanborn Map

The Sanborn Map Company attracted Warren Buffett's avaricious attention because it held an investment portfolio that was worth more than Sanborn Map's market capitalization. That is, its assets were worth more than its stock price. It also had a profitable business of selling very detailed maps to insurance companies.

The company was trading below its liquidation value, even though it had a monopoly on the fire insurance map business, because insurance companies were gradually doing away with using maps for their underwriting.

This was a perfect "cigar butt" of a stock, good for one last profitable puff and with a big margin of safety. Any investor could see that while Sanborn Map's business was declining, the company was worth much more than the market was valuing it. So, any investor could have bought the shares and made a bunch of money, right? Not really.

The value Buffett saw in the company was locked. A regular investor could buy the stock, but he had no way to unlock that value.

Buffett, on the other hand, had enough money (a substantial portion of his investment partnership's portfolio) to buy enough shares and ally himself with other shareholders to control around 40% of the Sanborn stock. He was able to leverage this control to make Sanborn's management spinoff the company's investment portfolio. Only then was Buffett able to make a profit.

In other words, Buffett had to get a controlling share of Sanborn's stock through using his clients' funds and by negotiating with others to force management to do his bidding to realize any gains. Simply finding and buying a piece of an undervalued business was not enough.

Solomon Brothers

Buffett invested in Solomon Brothers with a big margin of safety. All that had to happen for him to cash in was the investment bank staying in business. Then, a Solomon bond trader, on a few occasions, submitted false bids at Treasury auctions to get around auction rules, corner the market, and make a profit by squeezing short sellers. Upper management covered up this illegal activity.

When the fraudulent trades were revealed, the only reason the company didn't go out of business was because Buffett assumed the Chairman position and basically groveled to government regulators not to let Solomon fail.

As with Sanborn Map, a regular investor wouldn't be able to go this extra mile (or marathon) to save his investment. And no margin of safety would be big enough to lower the risk.

Berkshire Hathaway's Many Insurance Companies

One of the keys to Buffett's (Berkshire Hathaway's) success is his investing the float from cash generating businesses in more cash generating businesses, and to repeat the process over and over. (One of Buffett's earliest implementations of this idea was with pinball machines. The cash generated by the first pinball machine was used to buy a second. Then the cash generated by the first two pinball machines was used to buy a third, and so on.)

That's why Buffett bought so many insurance companies over the years. However, pretty much every insurance company that he bought got into trouble almost immediately. General Re is the biggest and possibly the most famous one (it lost billions of dollars), but most of Buffett's insurance businesses suffered losses as soon as he purchased them. That he bought them below their intrinsic worth proved an insufficient margin of safety.

A regular investor in these companies would have the choice of selling the stock or waiting it out in hopes of a turnaround. Thus, a regular investor would lose most or all of his money by either selling at a loss or holding the stock until the company went bankrupt.

But Buffett, in having bought the companies outright, was able to direct changes, assign capable people, etc to salvage the businesses and make successes out of failure.

The Buffalo News

Buffalo NY was a two newspaper town and Buffett decided to buy one of them. The Buffalo News made its money with a weekday edition, while its competitor made most of its money with the Sunday edition. Buffett bought the Buffalo News with a plan to put out a Sunday edition.

Chaos ensued.

The Buffalo News became embroiled in a lawsuit, where the judge prevented the paper from advertising its new Sunday edition. There were also labor strikes. The paper lost millions of dollars, despite one of Buffett's proxies doing his best to trim the excess fat off of the company's operations.

A regular investor wouldn't be able to weather this storm. Indeed, even Buffett wanted to quit. But his partner Charlie Munger prevailed. Eventually, an appellate court ruled in Buffett's favor. Only then did the investment become profitable.

Coca-Cola

Even when Buffett didn't own the entire company, or a controlling share, he was still able to enact change. For example, Berkshire Hathaway bought billions of dollars of Coca-Cola stock, and the investment did very well (partly due to accounting trickery). When CEO Roberto Goizueta died and was replaced by his protege Douglas Ivester, who did not do as good a job as his predecessor (because the accounting tricks were not sustainable), KO stock took a nose dive.

As in the cases above, a regular investor could either sell or hold on in the hopes of a turnaround. Buffett had another option. Although he didn't have a controlling stake in Coca-Cola, he was able to get together with another board member and have a secret conversation with Ivester. Soon thereafter, Ivester resigned from his position as CEO.

Many other examples could be listed, but the point is that even when one follows Buffett's investment philosophy perfectly (like Buffett did), that in no way ensures success. Often times, a much more active approach is needed. Indeed, in many of his more profitable investments, Buffett resembled Carl Icahn a lot more than Warren Buffett the passive investor. And being Carl Icahn is a lot more different and more difficult than being a passive investor.

Don't Be Like Warren Buffett

I've been enthralled in The Snowball, Alice Schroeder's excellently written biography of Warren Buffett. It's the second Buffett book I've ever tried, the first being University ofBerkshire Hathaway by Daniel Pecaut and Corey Wrenn,* which should have been called "Love Letters to Warren" or something similar.

In both books, despite the effusive praise by Pecaut, Buffett comes off as a self-righteous, didactic miser, and a hypocrite, which is completely different from how he is usually portrayed in the media. Schroeder's more measured descriptions were "cop," "preacher," and "tightfisted." Charlie Munger, who obviously has a prominent part in both books, comes off much the same, except he's also rude. At one point a depiction of Buffett and Munger on the stage at a Berkshire Hathaway shareholder meeting reminded me of the two Ferengi, Kol and Arridor, in the Star Trek Voyager episode "False Profits" (check it out if you have a chance).

Now that I've offended all of the Buffett fans….

We humans tend to have a groupie mentality. By that I mean, when someone is great at something we start acting like they're great at everything. We start to idolize them, and they can do no wrong.

Warren Buffett's investing record is one of the best, if not the best, in history. Unsurprisingly, people ask him for advice about all manner of things outside the investing realm.

But we should remember, as Nietzsche once observed, "If one has become a master in one thing, one has generally remained, precisely thereby, a complete dunce in most other things." This is quite true of Warren Buffett.

Rather than asking for advice, it might be useful to look at other aspects of Buffett's life and see what lessons there are waiting to be learned.

Warren Buffett the Hypocrite

Warren Buffett has advocated and lobbied for more taxes on the rich and against the elimination of the estate tax at least since the early 2000s. He frames it as a moral issue, and often brings up the unfairness of his secretary paying a higher tax rate than he does.

At the same time, Buffett pays the least amount of taxes that he can. If he thinks the rich should pay more, why doesn't he? There's nothing stopping him from doing so. And if he thinks it's immoral to pay less, then he is immoral. It's like someone saying that eating meat should be illegal while they're choosing on a steak. When asked why they're eating meat despite thinking it's wrong, they say, "well, the government didn't ban it."

Warren Buffett the Miser

Much has been written about how humble Buffett is. The fact that he has lived in the same house (which he bought for $31,500) since 1958 is probably Buffett admirers' favorite example. (There's also how he doesn't upgrade his car very often, or that he spends under $4 for breakfast at McDonald's.)

Buffett may be humble, but his living in a house that is a tiny fraction of his net worth is not evidence for his humbleness. Rather, it's a prime example of his tightfistedness. If it were up to Buffett, he would be a renter all his life. It was his wife that ultimately prevailed upon him to buy the house. In Buffett's mind, that $31,500 could've been worth much more if invested properly. In buying the house, not only was he paying with present day dollars, he was also paying with all the future dollars that sum would generate. In buying the house, that $31,500 was doomed to lie fallow. Soon after he bought the house, he complained to a golfing partner that it cost him $300,000.

The collection of money is Buffett's ultimate goal. It is an end in itself. Buffett says money is just a way of keeping score, but it seems to be a lot more than that. No matter how much money he had, he either didn't have enough, or there weren't any good businesses to buy, or he didn't have enough again. It is like filling a bottomless hole.

Tony Robbins talks about the difference between monetary and true wealth. Money is a vehicle, not the solution. Money can help with happiness and having a full life, but it doesn't guarantee it. Despite Buffett having a huge net worth, he doesn't strike me as being very happy outside his work. He's always trying to fill a hole.

Buffett really enjoyed his work (collecting money), but his obsession seems to have caused a deprivation in other, perhaps more important, aspects of his life. He was an absentee father to three children. Even when being with them, his mind was elsewhere--thinking of ways to make money. His marriage fell apart (though it didn't end in divorce), with his wife moving to San Francisco to be with her tennis coach. Even the dog moved out and went to live with friends.

It was only after his marriage fell apart that Buffett started to lessen his miserliness.

Some things that stood out for me:

• Buffett wants to be liked by others. He might like it even more than money, which is why he paid for a Dale Carnegie course. His public persona, therefore, is not necessarily what he's really like.
• Buffett's daughter once asked him for a loan. He told her to go to the bank.
• Buffett's sister asked for help to avoid bankruptcy and losing her house. Buffett cut off all communications. He eventually ended up giving her an advance on her inheritance from their late father.
• As a teenager Buffett stole golf balls from Sears. Lots of golf balls.
• Buffett likes to "Tom Sawyer" people into doing things for him.
• Buffett liked to "Buffett" people--the practice of bidding for a stock, and when the bid is accepted, lowering his bid. And when the lower bid is accepted, lower his bid some more. Then one time, the CEO of Berkshire Hathaway tried to "Buffett" Buffett by lowering his tender offer for the Berkshire shares that Buffett owned. Buffett got so upset at getting a taste of his own medicine that he bought more shares and eventually took control of the company. In more recent times he's said that buying Berkshire was a mistake.
• Buffett lusted after an insurance company, but the owner didn't want to sell. Buffett learned that once or twice a year the guy would get frustrated and want to get rid of his company. Buffett recruited a spy to let him know when this happened. When it did, Buffett put in a bid and the guy agreed to sell. When the guy came to his senses, Buffett didn't let him back out of the deal. In a twist, the guy used his sales proceeds to buy Berkshire stock.
• Buffett was obsessed with his family's weight and provided financial incentives for them weighing under what he thought was too much. To keep his own weight under control, he gave his children an unsigned check for $10,000, which he would sign if he went over his goal weight. They tempted him with ice cream and other junk food, but his love of money was greater than the temptation.
• Buffett is allergic to penicillin. He had taken some and his finger was starting to swell. He gradually got worse and worse, but refused to go to the hospital (because that cost money, per my understanding). He almost died.
• Charlie Munger described Buffett's business strategy as buying a business, taking out all the cash, and raising prices. If that doesn't work, Buffett doesn't know what to do.
• Buffett burns out his employees. He hires the bare minimum and then uses what he learned from Dale Carnegie (assigning work with complements like "you're so smart, it'll be easy for you to have this for me by tomorrow morning") to make them work as hard as possible. His protégé felt under so much pressure that he quit his job and cut off all ties with the Buffetts.
• After his divorce, Charlie Munger tried to find a new wife by searching through court records for recently widowed women.

*The book is essentially a republication of Pecaut's newsletters to his clients, which summarize Berkshire's annual shareholder meetings. It provides an interesting perspective because all the meetings are described one after the other without you having to wait a year in between each. The most inspirational thing that I learned was that you can get most of your predictions wrong and still be a billionaire.

** One may question, "and who are you to write any of this?" That's a great point. But if someone can't anonymously throw rocks in glass houses, what is the internet for?