This is Part 2 of The Superinvestors of Graham-and-Doddsville – (Freshly Transcribed 2016). If you missed Part 1, you can find it here, The Superinvestors of Graham-and-Doddsville – (Freshly Transcribed 2016) – Part 1.
The Superinvestors of Graham-and-Doddsville
By Warren E. Buffett
I submit to you that there are ways of defining an origin other than geography. In addition to geographical origins, there can be what I call an intellectual origin. I think you will find that a disproportionate number of successful coin-flippers in the investment world came from a very small intellectual village that could be called Graham-and-Doddsvile.
A concentration of winners that simply cannot be explained by chance can be traced to this particular intellectual village.
Conditions could exist that would make even that concentration unimportant. Perhaps 100 people were simply imitating the coin-flipping call of some terribly persuasive personality. When he called heads, 100 followers automatically called that coin the same way. If the leader was part of the 215 left at the end, the fact that 100 came from the same intellectual origin would mean nothing. You would simply be identifying one case as a hundred cases.
Similarly, let’s assume that you lived in a strongly patriarchal society and every family in the United States conveniently consisted of ten members. Further assume that the patriarchal culture was so strong that, when the 225 million people went out the first day, every member of the family identified with the father’s call.
Now, at the end of the 20-day period, you would have 215 winners, and you would find that they came from only 21.5 families. Some naive types might say that this indicates an enormous hereditary factor as an explanation of successful coin-flipping. But, of course, it would have no significance at all because it would simply mean that you didn’t have 215 individual winners, but rather 21.5 randomly-distributed families who were winners.
In this group of successful investors that I want to consider, there has been a common intellectual patriarch, Ben Graham. But the children who left the house of this intellectual patriarch have called their “flips” in very different ways. They have gone to different places and bought and sold different stocks and companies, yet they have had a combined record that simply can’t be explained by random chance.
It certainly cannot be explained by the fact that they are all calling flips identically because a leader is signalling the calls to make. The patriarch has merely set forth the intellectual theory for making coin-calling decisions, but each student has decided on his own manner of applying the theory.
The common intellectual theme of the investors cranking into their purchase decision the clay of the week or the month in which the transaction is going to occur. If it doesn’t make any difference whether all of a business is being bought on a Monday or a Friday, I am baffled why academicians invest extensive time and effort to see whether it makes a difference when buying small pieces of those same businesses.
Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model or covariance in returns among securities. These are not subjects of any interest to them. In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value.
I always find it extraordinary that so many studies are made of price and volume behavior, the stuff of chartists. Can you imagine buying an entire business simply because the price of the business had been marked up substantially last week and the week before?
Of course. the reason a lot of studies are made of these price and volume variables is that now, in the age of computers, there are almost endless data available about them. It isn’t necessarily because such studies have any utility; it’s simply that the data are there and academicians have worked hard to learn the mathematical skills needed to manipulate them.
Once these skills are acquired, it seems sinful not to use them, even if the usage has no utility or negative utility. As a friend said, to a man with a hammer, every thing looks like a nail. I think the group that we have identified by a common intellectual home is worthy of study.
Incidentally. despite all the academic studies of the influence of such variables as price, volume, seasonality, capitalization size. etc., upon stock performance, no interest has been evidenced in studying the methods of this unusual concentration of value-oriented winners.
I begin this study of results by going back to a group of four of us who worked at Graham-Newman Corporation from 1954. There were only four—I have not selected these names from among thousands. I offered to go to work at Graham-Newman for nothing after I took Ben Graham’s class, but he turned me down as overvalued. He took this value stuff very seriously!
After much pestering he finally hired me. There were three partners and four of us at the “peasant” level. All four left between 1955 and 1957 when the firm was wound up, and it’s possible to trace the record of three.
The first example (Table 1) is that of Walter Schloss. Walter never went to college, but took a course from Ben Graham at night at the New York Institute of Finance. Walter left Graham-Newman in 1955 and achieved the record shown here over 28 years.
Here is what ‘Adam Smith’—after I told him about Walter—wrote about him in Supermoney (1972): He has no connections or access to useful information. Practically no one in Wall Street knows him and he is not fed any ideas. He looks up the numbers in the manuals and sends for the annual reports, and that’s about it.
In introducing me to [Schloss] Warren had also, to my mind, described himself. ‘He never forgets that he is handling other people’s money and this reinforces his normal strong aversion to loss. He has total integrity and a realistic picture of himself. Money is real to him and stocks are real—and from this flows an attraction to the margin of safety’ principle.
Walter has diversified enormously, owning well over 100 stocks currently. He knows how to identify securities that sell at considerably less than their value to a private owner. And that’s all he does. He doesn’t worry about whether it’s January, he doesn’t worry about whether it’s Monday, he doesn’t worry about whether it’s an election year.
He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me. And he does it over and over and over again. He owns many more stocks than I do—and is far less interested in the underlying nature of the business; I don’t seem to have very much influence on Walter. That’s one of his strengths: no one has much influence on him.
The second case is Tom Knapp who also worked at Graham-Newman with me. Tom was a chemistry major at Princeton before the war; when he came back from the war he was a beach bum. And then one day he read that Dave Dodd was giving a night course in investments at Columbia. Tom took it on a non-credit basis, and he got so interested in the subject from taking that course that he came up and enrolled at Columbia Business School where he got the MBA degree. He took Dodd’s course again, and took Ben Graham’s course.
Incidentally, 35 years later I called Tom to ascertain some of the facts involved here and I found him on the beach again. The only difference is that now he owns the beach! In 1968 Tom Knapp and Ed Anderson, also a Graham disciple, along with one or two other fellows of similar persuasion, formed Tweedy, Browne Partners, and their investment results appear in Table 2.
Tweedy, Browne built that record with very wide diversification. They occasionally bought control of businesses, but the record of the passive investments is equal to the record of the control investment.
Table 3 describes the third member of the group who formed Buffett Partnership in 1957. The best thing he did was to quit in 1969. Since then, in a sense, Berkshire Hathaway has been a continuation of the partnership in some respects. There is no single index I can give you that I would feel would be a fair test of investment management at Berkshire. But I think that any way you figure it, it has been satisfactory.
Table 4 shows the record of the Sequoia Fund, which is managed by a man whom I met in 1951 in Ben Graham’s class. Bill Ruane. After getting out of Harvard Business School, he went to Wall Street. Then he realized that he needed to get a real business education so he came up to take Ben’s course at Columbia, where we met in early 1951.
Bill’s record from 1951 to 1970. working with relatively small sums, was far better than average. When I wound up Buffett Partnership I asked Bill if he would set up a fund to handle all of our partners so he set up the Sequoia Fund. He set it up at a terrible time, just when I was quitting.
He went right into the two-tier market and all the difficulties that made for comparative performance for value oriented investors. I am happy to say that my partners to an amazing degree, not only stayed with him but added money, with the happy result shown.
There’s no hindsight involved here. Bill was the only person I recommended to my partners, and I said at the time that if he achieved a four point per annum advantage over the Standard & Poor’s, that would be solid performance. Bill has achieved well over that, working with progressively larger sums of money.
That makes things much more difficult. Size is the anchor of performance. There is no question about it. It doesn’t mean you can’t do better than average when you get larger, but the margin shrinks. And if you ever get so you’re managing two trillion dollars, and that happens to be the amount of the total equity evaluation in the economy, don’t think that you’ll do better than average!
I should add that, in the records we’ve looked at so far, throughout this whole period there was practically no duplication in these portfolios. These are men who select securities based on discrepancies between price and value, but they make their selections very differently.
Walter’s largest holdings have been such stalwarts as Hudson Pulp & Paper and Jeddo Highland Coal and New York Trap Rock Company and all those other names that come instantly to mind to even a casual reader of the business pages. Tweedy Browne’s selections have sunk even well below that level in terms of name recognition.
On the other hand, Bill has worked with big companies. The overlap among these portfolios has been very, very low. These records do not reflect one guy calling the flip and fifty people yelling out the same thing after him.
Table 5 is the record of a friend of mine who is a Harvard Law graduate, who set up a major law firm. I ran into him in about 1960 and told him that law was fine as a hobby but he could do better.
He set up a partnership quite the opposite of Walter’s. His portfolio was concentrated in very few securities and therefore, his record was much more volatile but it was based on the same discount-from value approach.
He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration, with the results shown. Incidentally, this record belongs to Charlie Munger, my partner for a long time in the operation of Berkshire Hathaway. When he ran his partnership, however, his portfolio holdings were almost completely different from mine and the other fellows mentioned earlier.
Table 6 is the record of a fellow who was a pal of Charlie Munger’s—another non-business school type—who was a math major at USC. He went to work for IBM after graduation and was an IBM sales-man for a while. After I got to Charlie, Charlie got to him. This happens to be the record of Rick Guerin.
Rick, from 1965 to 1983, against a compounded gain of 316 percent for the S&P, came off with 22,200 percent which, probably because he lacks a business school education, he regards as statistically significant. One sidelight here: it is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all. It’s like an inoculation. If it doesn’t grab a person right away, I find that you can talk to him for years and show him records, and it doesn’t make any difference.
They just don’t seem able to grasp the concept, simple as it is. A fellow like Rick Guerin, who had no formal education in business, understands immediately the value approach to investing and he’s applying it five minutes later. I’ve never seen anyone who became a gradual convert over a ten-year period to this approach. It doesn’t seem to be a matter of I. Q. or academic training. It’s instant recognition, or it is nothing.
For all the latest news and podcasts, join our free newsletter here.
Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple: