We Study Billionaires - The Investor’s Podcast Network - TIP482: How Warren Buffett Became the Greatest Investor to Ever Live (Part 1)

Starting point is 00:00:00 You're listening to TIP. Hey everyone, welcome to The Investors Podcast. I'm your host, Clay Fink. You may be somewhat surprised by the new voice that you're hearing on the show, as Stig recently introduced me in our previous episode that I'll be one of the new hosts for the We Study Billioners podcast feed. You might be wondering if I'm taking anyone's place, but really, I'm just filling in and producing episodes on Mondays,

Starting point is 00:00:26 so nothing really changes with the original show of what you're really to I'll be producing episodes that will be released on Mondays related to content, such as covering what billionaire investing strategies are, such as Warren Buffett, Ray Dalio, Howard Marks, and others. I may touch on other investing strategies as well and maybe even dive into some financial history. I'll be doing quite a bit of prep for these episodes, so it'll be a learning journey and experience for not only the listener, but really for me as well. I'm super excited that for today's episode, I'm going to be covering Warren Buffett's investment journey and how he became known as the greatest investor to ever live. I've broken this down into two episodes because the story is quite long.

Starting point is 00:01:11 This episode is labeled as part one, and the second part will be released next Monday. As the basis of these two episodes, most of the content was inspired by Alice Schroeder's biography called The Snowball, as well as Robert Haxstrom's book, The Warren Buffett Way. I highly recommend them both if you haven't read those, and you're interested in learning more about Warren Buffett. The Investor's podcast was actually founded on studying Warren Buffett, and I thought there was really no better way to kick off this journey on the podcast feed other than doing the same. With that, let's get right to it. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Starting point is 00:01:58 First of all, let's start out by looking at Warren Buffett's incredible investment track record. Just how great is he? On May 10, 1965, Warren Buffett, through his investment partnership, took over the management and control of Berkshire Hathaway, which at the time was a struggling New England textile maker. Since then, here's the performance of the company. From 1965 through 2021, which is 56 years, Berkshire stock, is up 3,641,613%, while the S&P 500 with dividends reinvested during that same time period is only up 30,209%.

Starting point is 00:02:50 The annualized return on that performance is 20.1% per year for Berkshire Hathaway and 10.5% for the S&P 500. Assuming your money compounded at 20.1% over 56 years like Berkshire did, that would turn in a thousand dollar initial investment into an astounding $28.4 million. There have been investors that have had higher returns, no doubt, but no investor has had the ability to compound capital and handily beat the market over the span of their entire lives in the manner that Buffett has. Before we dive into the content, the purpose of this episode isn't to teach you how to be Warren Buffett. Honestly, it's very likely that very few of us even have the potential to be as good of an investor as he is. But what we can do is look

Starting point is 00:03:41 into how he invests and try and pull some of these useful ideas and then take those ideas and integrate them into our own approach to investing in a way that makes sense to each of us. So let's talk about how he did it. Starting from the very beginning, Buffett was born in August of 1930 in Omaha, Nebraska. This was right at the beginning of the Great Depression. I think growing up during the Great Depression led to very difficult times for his family. Early on in his life, his family was just trying to do well enough to make ends meet and put food on the table. His father, Howard Buffett, ended up starting a business as a stockbroker, giving Warren a middle-class lifestyle. Growing up during this difficult time period led Warren to

Starting point is 00:04:24 have this just tremendous drive to become very, very, very rich. And it's something he's seriously committed to really his entire life. At a very early age, even as early as kindergarten, Warren developed a deep interest in numbers and it was pretty obvious that he had a very sharp mind. He even developed an interest in business at a very young age. The first dollar he made from business was from selling packs of chewing gum at the age of six. Then he came to figure out that selling bottles of Coca-Cola was much more profitable, so he pivoted to selling those instead. He could buy a six-packed, for $1.00, and if he sold each bottle for $0.20, he could get a 20% return on his initial investment. Even during elementary school, Warren just really enjoyed working so he could save all the

Starting point is 00:05:14 money he made and put it in his drawer at home. Since his dad was a stockbroker and owned his own business, Warren spent a lot of time at the office and spent a ton of time just reading and consuming as many books as possible. One book that had a big effect on him was a book called 1,000 Ways to make $1,000. This book really got Warren's business mind thinking and helps put him on the path of figuring out what makes a good business and what makes a bad business. And especially what type of business he could set up, which didn't really take much of his time and attention. So essentially ways in which he can make money, work for him, rather than constantly just working for money and trading his time for money. This is also when Warren really got started to understand the power of

Starting point is 00:06:00 compounding, which is really the key ingredient to Warren Buffett's success. The book taught him that if you had $1,000 and compounded it at 10% per year, you'd have $1,600 at the end of five years, $2,600 at the end of 10,800 years, and $10,800 at the end of 25 years. If a dollar today was going to be worth $10 sometime in the future, then in Warren's mind, the two were essentially the same thing. So this idea led him to being extremely frugal and very mindful about his spending because he knew that every dollar he let go of was essentially the equivalent of letting go of $10 sometime in the future. One of Warren's motivations around accumulating wealth and having strong business knowledge was the realization that money could make him independent and allow him to spend his time

Starting point is 00:06:50 however he wanted to. One of his biggest goals in life was to work for himself. So he had an immense passion for understanding how great businesses operated. One of the keys to building wealth through investing is to let your money compound over long periods of time. So it's no surprise that Warren had purchased his very first dock when he was 11 years old. And by the age of 14, he had accumulated his first $1,000 primarily through delivering newspapers in the mornings and was on his way to achieving his goal of becoming a millionaire at the age of 35. Warren also started a number of businesses throughout high school,

Starting point is 00:07:26 but one I thought was pretty neat was his pinball machine business that really applied the concept of compound interest he had learned. So he would purchase an old pinball machine for $25 and partner with local barbers in the area to put these pinball machines in their shop. He would just simply split the money with each barber. And in the first week of business, he had collected $25 from the very first pinball machine he put in after he had split the money with the barber. So that was enough to go out and buy another pinball machine to put it in another barbershop. This about wraps up what I'd outlined from his childhood. These were very formative years for Buffett and helped him learn some key lessons about

Starting point is 00:08:07 business and investing. Lessons such as you shouldn't swing at every pitch that is thrown at you for investment or business ideas. You shouldn't rush to take a quick profit and you should be very careful when investing other people's money because he hated losing money for others more than about anything. Then at the age of 17, Warren went off to the Wharton's Business School at the University of Pennsylvania. And initially, Warren didn't really see the point in college because he just saw it as an obstacle in accumulating wealth and he just thought it was going to slow down his path to doing that. He ended up transferring

Starting point is 00:08:42 to Nebraska, which is where I went to college actually. Upon graduation, Warren got the sudden motivation to attend Harvard Business School, which was driven by the prestige he'd received, you know, as well as the networking opportunities and the connections he would make from such an experience. However, Harvard denied him, so he started investigating other graduate programs. And in his research of other universities, he had discovered that Benjamin Graham was a professor at Columbia. Graham wrote the book, The Intelligent Investor, which is what Buffett would consider essential reading for those that want to understand how this stock. market really works. Buffett was someone who would read and reread every single investment book

Starting point is 00:09:25 until he discovered what actually worked the best. He left Graham's approach not only because it worked at the time, but it was very rational, systematic, and it was a reliable investing method. And I think one thing that really sets Buffett apart from many other people, many other investors, was his whole life, and especially from an early age, he just had this intense, session with reading and learning. He was the type of person that when he would get interested in a particular topic, he would go out and read every single book he could find on it. And this most definitely applied to investing as well as he would read and reread all the books he could find. In Benjamin Graham's books, he outlined his own definition of what makes an investment.

Starting point is 00:10:11 Graham said, an investment operation is one in which, upon thorough analysis, promises safety a principal and a satisfactory return. Operations not meeting these requirements are speculative. Graham was also well known for ensuring all of his investments had an adequate margin of safety, giving him some room for error in his stock picks and that if he was somewhat off in any of his assessments, it's still likely he would make money. To try and do this, there are two methods investors could apply. One, purchase shares when the overall market is trading at low price, like when stocks are in a bear market, or to purchase the stock when it trades below its intrinsic value, even though the overall market might not be substantially cheap. In either case,

Starting point is 00:10:59 Graham said that a margin of safety is present in the purchase price. Benjamin Graham also believed that the single most important factor of a company's value is their future earnings power to determine how much the company is actually worth. The simple formula he used was determined by estimating the future earnings of the company in multiplying those earnings by an appropriate earnings multiple, which depended on a number of factors such as the stability of the earnings, the company's assets, dividend policy, as well as the financial health of the company. In the intrinsic value isn't going to be one specific and exact number. Typically for a stable company, you can determine some sort of range of values that the company's intrinsic value is assessed

Starting point is 00:11:45 to fall between. And again, the margin of safety concept plays in here because Graham wants to find a company whose intrinsic value is trading well below the market price in order to end up making that purchase. So Buffett ended up getting into Columbia Business School so we could learn from Benjamin Graham. One of Buffett's very first classes was with David Dodd, who was the author of security analysis alongside Benjamin Graham. This book was over 700 pages, and Warren had practiced memorized this book and he knew all the examples they laid out in the book. Buffett knew the book so well, he claimed to have known it even better than Dodd himself. This goes to show just how smart Buffett was, as he not only was an extremely avid reader, he also had practically an

Starting point is 00:12:33 incredible photographic memory. Buffett paid close attention to the stocks that Benjamin Graham was buying, because he believed that Graham had cracked the code on finding deeply undervalued stocks. Upon his search, he discovered that Graham was the chairman of the board of GEICO, and that Graham's investment company, Graham Newman Corporation, had owned 55% of GEICO at the time. Buffett wanted to learn more about GEICO, so he hopped on a train to head to Washington, D.C., knocked on the company's front door, and said that he was a student of Graham's and wanted to learn more about the business. Gaico's financial vice president, Lorimer Davidson, thought what the heck, I'll give the kid a few minutes of my time and then just politely ask him to leave. However, this guy

Starting point is 00:13:19 quickly realized that he was not talking to your typical student. The questions Warren was asking him are questions that he would be asked by an experienced insurance stock analyst. As many of you might know, Geico had positioned themselves to be a low-cost provider of auto insurance by marketing through the mail without using an insurance agent, which oftentimes get paid a decent commission for each policy sold. Davidson and Buffett sat down and chatted about insurance for four hours that day, and that ended up really being Buffett's introduction to insurance, which many of you also know ended up being an integral part of his investment career. After diving deep into Geigo's business model, he moved 75% of his portfolio into GEICO, which was a bold move for someone who

Starting point is 00:14:07 was pretty cautious with his investments. Despite only being a freshman in college, this was nearly a $15,000 bet for Buffett. It was in Buffett's second semester that he had the opportunity to be in one of Benjamin Graham's classes. Graham's approach to investing was to find companies whose market price was trading far below what the business was worth conservatively. Essentially, he was looking for companies where, in theory, if the debts were repaid and the assets of the company were sold off, how much cash would they have left? That would be your intrinsic value of the business. Put another way, if a person has $50,000 in assets and cash, $40,000 in debt to be paid, the net worth of that person would be $10,000 after the assets are sold and

Starting point is 00:14:53 the debt is repaid. The trick with this approach is that you don't know when the market will eventually come to its senses and bring the market price closer to fair value or the intrinsic value. The way Graham hedged against his certainty in the price was to be sure he built in a margin of safety or plenty of room for error to be made. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, in every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is.

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Starting point is 00:19:33 It's not a blip on a screen, it's not a piece of paper, or something that should be used to trade in and out of constantly. Buying a stock is the same as buying ownership in a real business. Two, use a margin of safety. investing includes estimates and uncertainty. A wide margin of safety ensures that the effects of good decisions are not wiped out by errors. Three, Mr. Market is your servant, not your master. Mr. Market offers you a price every day, and the price that Mr. Market offers should not influence your view of the price. From time to time, he will give you a chance to buy at a low price or even

Starting point is 00:20:13 sell at a high price. Next, Buffett set his sights on doing anything he could to work for Benjamin Graham. He knew that if he could work for him, it was certain that he would excel. At the time, Buffett lacked the self-confidence in many areas of his life. But one area he was very ambitious and confident in was his ability to analyze stocks. So he asked Graham if he could work for him at Graham Newman, which only had four employees. Buffett was Graham's only student who had ever earned an A-plus in his 22 years of teaching. To help seal the deal, Warren even offered to work for Graham for free, but Graham actually turned him down since Graham was adamant about only hiring Jewish people since the big

Starting point is 00:20:58 investment banks at the time wouldn't do so. Since Warren couldn't work for Graham, he decided to move to Omaha, Nebraska and become a stockbroker for his father Howard's company, Buffett Fault. Since he moved to Omaha and not New York City, he was outside of the confines of Wall Street and was really able to think for himself and come to his own conclusions and not be influenced by the herd mentality. And it was at this point that you could see Warren really start to think for himself instead of solely following the two people that had just a huge influence on him up to that point. This was his father Howard and then Benjamin Graham as well.

Starting point is 00:21:37 His father was somewhat of a gold bug and was very concerned about inflation, so he recommended Warren hold gold and mining stocks, whereas Graham was extremely conservative and thought the market was overvalued. Buffett took a very micro approach and saw many great opportunities of businesses that he thought would be fantastic investments, Geico being one of them. Sure, inflation might take hold temporarily, or the economy might have the inevitable hiccup at some point in the future, but he was certain that over the long call, great businesses was where the money was to be made. Buffett also quickly learned about the importance of incentives. As a stockbroker, you're paid a commission each time someone buys or sells a stock through you. But at the time,

Starting point is 00:22:24 Warren wanted to recommend all of his friends and family buy GEICO stock and hold it for the next 20 years. But you can't make a living by giving that advice and being a stockbroker, so he felt there was a bit of a conflict of interest being in this position. So Warren was in search for something new. Luckily, he had kept in touch with Benjamin Graham, and Graham gave him a call in 1954 and asked Warren to come work for him in New York. As many of the listeners know, Warren, Graham, and the rest of the team at Graham Newman focused on finding companies they like to call cigar butts, cheap and unloved stocks that had

Starting point is 00:23:00 been cast aside like a little cigarette that had one or two free puffs left in them, that everyone else would just really overlook. This is what Graham specialized in. Not because he loved these companies in particular, he just recognized that the strategy worked really well for him, and Graham knew that some of these companies would end up going bankrupt and lose him money, so he would spread out his risk over a large number of these companies.

Starting point is 00:23:26 Warren, however, took a slightly different approach personally. He was much more confident in his ability to pick winning stocks, and when he found picks that he was very sure in, he would bet big on them. For Buffett, Graham was much more than a tutor. Graham provided Buffett a clear and reliable roadmap to successful stock picking, which was essentially seen as similar to gambling by many people. Warren then learned the importance of opportunity costs. Without using leverage, he could only invest a certain dollar in one place.

Starting point is 00:23:59 He can't take that dollar and invest it in two different companies. he had to choose the best place for that dollar, so that he could earn the highest possible return without taking any excess risk. Because of this, Buffett had sold off much of his GEICO position because he had found better opportunities such as Western Insurance, which was earning $29 per share while the stock was trading for as little as $3 per share. So to find these companies, Warren would sift through any resource he could, such as Moody's manuals or what were called pink sheets. In 1955, Warren had made $20,000 in profit in just a few

Starting point is 00:24:38 weeks on a bus company that was trading at a big discount to its net assets. Warren was only in his mid-20s at the time, and nobody in Buffett's family had ever made $20,000 on a single idea. The amount was several times more than what the average person earned and a whole year's work. Now, some of you might be wondering, how can I do what Buffett did today and invest my money at high rates of return with very little risk? Well, today, with the rise of technology, large trading firms can spot these opportunities in an instant. So finding these types of deals that Warren Buffett found in the 1950s is extremely difficult, if not impossible. So we as investors will have to find a different approach to investing that works well for us if we

Starting point is 00:25:25 want to take an active investing approach. Then in 1956, Graham decided his time was up with his investment career, and it was time for him to retire. Buffett was offered to become a general partner in Graham's firm, but he turned it down and at the age of 26 moved back to Omaha to start his own partnership where he could invest from his house and could put his friends and relatives into the same stocks he invested in. At this point, Warren was worth $174,000. at the age of 26. He structured the partnership so that he got half of the upside above a 4% threshold, and he took a quarter of the downside himself,

Starting point is 00:26:06 so even if his investments broke even, he ended up losing money. He promised his investors that his investments would be chosen on the basis of value and not popularity, and that the partnership will attempt to reduce the permanent loss of capital to a minimum. Within that first year, Buffett already managed over, $1 million in assets, much of which came over from not just friends and family, but from people who needed a new place to invest after Graham's partnership had ended. During that time period, Buffett was primarily purchasing companies that were around the $1 to $10 million in market cap that

Starting point is 00:26:43 most people knew nothing about. One of Buffett's big problems in the early days was that he had so many opportunities, but not enough capital to pursue such opportunities. So a lot of his time was spent trying to sell others on joining the partnership, whether that would be networking, or introducing himself around Omaha, or reaching out to former members of Graham's partnership. He'd get $10,000 here, $100,000 there, $50,000 there. Month after month, he was getting more and more investors in his partnerships. And this was great from Warren's perspective, because the more money he managed, the more money he could make, and the faster his snowball of wealth to the million dollar mark could accumulate. Like I mentioned before, Warren was very big

Starting point is 00:27:28 on incentives. He knew that his incentives were aligned with his investors' incentives. If he did well in managing their money, then his partners would do well too. If he did poorly, then he would suffer from that just like his partners did. He's really operated in that manner from day one. Many times when Buffett brought on larger investors, he would set up new partnerships that were legally separate from his other partnerships. Legally, he could only take on 100 partners without having to register with the SEC as an investment advisor. And eventually, his partnerships got to the point where word of mouth was really starting

Starting point is 00:28:03 to take hold. People would see the results they were getting from Buffett and they would go out and tell all their friends, hey, if you want to get rich, then you need to invest your money with Warren Buffett. So he didn't need to do much selling at this point as he was getting many organic inbound requests from prospective investors. His second partnership achieved an annualized rate of return of 24.5% versus the market average of 9.3%. Warren eventually dissolved all of the partnerships into one, and in 1961, the partnership returned 46% versus the Dow's 22%. Because of Buffett's massive success up to this point. He had achieved his goal of becoming a millionaire by the age of 35.

Starting point is 00:28:50 His whole family thought he was crazy for setting such a goal and thinking he could achieve such a thing, but he ended up doing it at the age of 30 rather than 35. Although he was on his own investing now, Buffett really didn't deviate too much from Graham's investment strategy of buying the cheapest stocks he could possibly find, and that was until Buffett met Charlie Munger. Warren met Charlie Munger in 1959 when Buffett was around 29 years old, and they clicked and became friends almost instantly. Munger was a lawyer for most of his career up until then, but like Buffett, he was also an avid reader that enjoyed reading about business, investing, and studying successful individuals. Munger enjoyed being a lawyer, but what he decided he really wanted

Starting point is 00:29:39 was to have the freedom and financial independence to do whatever he wanted, similar to Buffett. After he learned about Buffett's partnership bottle, he was hooked and wanted to implement the same model for himself to achieve that independence he wanted. Munger was a bit older, but he wasn't as wealthy as Buffett. One reason was because he was a lawyer and not so focused on accumulating as much money as possible, but another reason was that Munger had eight children, which we all know is not cheap. Now, Munger understood Buffett's approach of buying businesses that were really cheap, but he was much more interested in investing in great companies. He wanted to learn more about a company's

Starting point is 00:30:19 intangibles, intangible assets, such as the strength of the management, the durability of the brand, or how someone else could compete with them. What Munger didn't like about Benjamin Graham's approach was that he was quite pessimistic about the future and invested in a way that was very, very conservative. Whereas Buffett's personality was very optimistic about the future and bullish on where America was heading, the cigar butt style of investing is determining what the company would be worth if it were dead and all of its assets were liquidated. Munger thought that given Buffett was so optimistic about the future, he should be investing in a way that reflects that. One time, Buffett explained why Graham's cigar butt strategy wasn't always the best. He said if you paid $8 million

Starting point is 00:31:03 dollars for a company whose assets were $10 million, you will profit handsomely if the assets are sold on a timely basis. However, if the underlying economics of the business are poor and it takes 10 years to sell the business, your total return is likely to be below average. Remember, time is your friend of the wonderful business and the enemy of the mediocre business. Buffett quoted John Keynes in regards to this transition. The difficulty lies not in the new ideas, but in escaping from the old ones. Buffett, however, didn't ever forget one key principle that Graham taught him. Successful investing involves purchasing stocks when their market price is at a significant

Starting point is 00:31:46 discount to their underlying business value. In 1963 and 1964, Buffett did start to come around to Munger's line of thinking as he purchased American Express as it was being punished by the market. It was by no means a cigar butt style pick, however, Buffett invested. invested $13 million of the partnership's money into the stock, making it the fund's largest position. The stock had been involved in a giant scandal in which it was backed by fraudulent loans, and American Express's share price decreased by over 50%. As Robert Haxstrom put it in his book, if Buffett has learned anything from Ben Graham, it was this.

Starting point is 00:32:25 When a stock of a strong company sells below its intrinsic value, acts decisively. Buffett was aware of the $58 million loss American Express have had from the fraudulent loans, but he went around Omaha and found that people who had American Express cards were still using them as usual. Then he visited several banks and saw that American Express travels checks had no impact on their sales either. So he pulled the trigger as his share price tripled over the next two years. This was a timely move for Buffett as the cigar butt approach was becoming more and more difficult to implement. as the opportunities begun to be arbitraged away by the market. And since Buffett was managing larger sums of money, this also limited the choices of

Starting point is 00:33:10 cigar-but companies to invest in as very small companies were no longer really moving the needle for him. Another individual who had influence on Buffett transitioning to buying quality companies was Phil Fisher. Fisher believed that superior returns could be made by investing in companies with above-average potential that had capable managers. While Graham's approach was very qualitative, Fisher's approach was very much quantitative. He popularized what he called the scuttlebutt method of researching all of the qualitative aspects

Starting point is 00:33:42 of a business, its management, and its competitive advantage, especially from those who are very familiar with the company. Fisher would take those steps that most other investors simply wouldn't take in their research, such as beating with the customers or the vendors to get their opinion on the company, as well as their opinion on the company's competitive So Fisher would go out and chat with the most knowledgeable people about a company, their employees, their investors, and those who were most knowledgeable about them. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect

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Starting point is 00:36:52 to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund's prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. Buffett also adopted ideas from Fisher around portfolio diversification. Graham being very conservative,

Starting point is 00:37:40 like to diversify his bets, whereas Fisher taught Buffett not to overstress diversification. He thought it was a mistake to spread out your risk, given that you were very sure about a handful of stocks that were very well researched. Also, once you have too much, you have too much, many stocks, it makes it practically impossible to watch all of them and monitor their business performance effectively. In Fisher's view, buying shares in a company without thoroughly understanding the business was far riskier than having limited diversification. But Buffett wasn't 100% done with buying cigar butts when he found them, as he had discovered a textile maker in Massachusetts. This company was called Berkshire Hathaway. The plan was to buy the company, liquidate its

Starting point is 00:38:25 assets and shut down the business. According to the accountants and the company's books, the business was worth over $19 per share, but the stock was trading at $7.50, so Buffett started accumulating shares in the company. Originally, Buffett had planned to sell his shares in a tender offer at $11.50. But he received a note that the tender offer or they offered to buy Buffett's shares was not at $11.50, but it was at $11.37.5. Being who he was, this infuriated him to no end, as he was pretty much a tightwad and wanted to maximize every single dollar he could. So instead of selling the stock, he continued to buy as many shares as he could possibly get. He wanted to buy the whole company. There's a whole backstory on how this ended up playing out,

Starting point is 00:39:18 but essentially, it seems like Buffett ended up getting pretty emotional when purchasing these shares. Because he had issues with shutting down operations and companies in the past, he had enough shares to have influence over the management of the business. But he learned from his past he shouldn't shut down Berkshire's operations. Essentially, he had discovered that Berkshire was a cigar butt, but it didn't have any puffs left. And he's on the record for saying he would have been better off if he had never even heard of Berkshire Hathaway, which is pretty funny given that the company is worth over $600 billion today. By 1966, his partnership had grown to $44 million,

Starting point is 00:40:01 and for the first time in his career, he had more money than he had ideas. So he made the decision to close the doors on new investors in his partnership so that he wouldn't disappoint his partners by investing in subpar opportunities. Still at this point, Buffett was making a lot of Cigarbutt approach deals, with the exception of American Express, which had played out extremely well up to that point. However, as we approached the late 1960s, he was beginning to make the transition to buying great businesses rather than cheap businesses. At the time, companies like Polaroid, Xerox, and electronic data systems were taking hold on the market and gaining a lot of hype as technology companies whose products went way

Starting point is 00:40:44 over Buffett's head started to soar. With that, Buffett made two rules for himself. One, he would not invest in businesses whose technology is way over his head and it's crucial to the investment decision. Two, he would not seek out activity in the operations of the investment, even if it offered tremendous opportunities for profit, meaning that he wanted his investments to be very passive and not require a tremendous amount of his time and attention. The first point is that value investing principle that you should only invest in what you truly understand. If you don't truly understand your investment, then it's very difficult to hold on during the inevitable drawdowns in the market. When Buffett was 38 years old, he had

Starting point is 00:41:30 watched Intel start from nothing and turn into a massive success and likely one of the best opportunities he had ever come across, but he never purchased Intel for the partnerships. And he had watched a number of other tech companies be great successes as well, but also many more had ended up failing. He did have a strong, long-standing bias against technology companies because he felt there was no margin of safety in them. Buffett was so focused on margin of safety. Quoting Alice Schroeder in her book, this particular quality to pass up possible riches, if he could limit his risk, was what made him Warren Buffett. End quote.

Starting point is 00:42:11 The second point got to something Buffett learned through experience. He was involved in many deals that led to headaches or just a massive time commitment. The purchase of Berkshire Hathaway stock being one of them. He was on the phone almost daily with Berkshire employees trying to make sure the management team was making the right decisions to ensure he didn't lose any money. In an October 1967 letter to shareholders, he wrote to investors that he would limit himself to activities that were easy, safe, profitable, and pleasant. He also wrote that when I am dealing with people I like in businesses, I find stimulating

Starting point is 00:42:48 and achieving worthwhile overall returns on capital employed, say 10 to 12%. It seems foolish to rush from situation to situation to earn a few more percentage points. It also does not seem sensible to me to trade known, pleasant personal relationships with high-grade people at a decent rate of return for possible irritation, aggravation, or worse at potentially higher returns, end quote. This was a huge step for Warren, as he was the biggest penny-pincher anyone had ever known, and he was always trying to achieve the highest returns possible. So for his investors to hear him say that he was willing to sacrifice returns was quite a

Starting point is 00:43:28 transition for someone so strong willed. Figuring out where he was going to allocate capital next, he had his eye on a company in Omaha named National Indemnity, which was located just a few blocks from his office downtown. Through Buffett's research, he came to find out that national indemnity ensured some unusual people such as circus performers and lion tamers. The company's CEO, Jack Ringwald, used to say, there's no such thing as a bad risk, only bad rates, referring to the premiums that policyholders were charged. Buffett weaseled his way to talk Ringwald into selling national indemnity to him, and Buffett quickly put together the final papers before Ringwald could change his mind and back out of the deal.

Starting point is 00:44:13 And at that point, Buffett had entered the insurance business and was on his way to exiting the textile business. This is when Buffett figured out a whole new business model. When he bought stocks and the company made money, that money would typically stay within, in that particular company. But since he had bought the whole business of national indemnity, he could then use the extra profits from that business to go out and purchase other businesses that offered better opportunities to compound his capital. Another thing that Buffett loved about the insurance business was the float that insurance company had the advantage of holding. Insureds would pay a premium today in return for potentially receiving some benefit in the future.

Starting point is 00:44:54 For the time in between those dates, the insurer had the opportunity to, invest that money and keep the returns they earned for themselves. To someone like Buffett, having other people's money to invest on which he kept the profit was like a dream come true. Despite insurance being essentially a commodity business, it was a key piece for his investing career as he would eventually come around to owning large stakes in GEICO and General Rhee as well. Likely, his best insurance acquisition wasn't a company, but a person, Ajit Jane, whom he would eventually hire to run the Berkshire Hathaway Reinsurance Group. At this point, his partnership had been around for 12 years, and it had achieved an average

Starting point is 00:45:36 annualized rate of return of 31% while the Dow returned 9%. Despite achieving a significantly higher return, Buffett believes that he also achieved those returns with much less risk taken as well. But Buffett's opportunity set was beginning to dry up, and he was realizing it. It worried Buffett that he would potentially let his investors down because he wasn't able to find deals that met his investment criteria. He delivered the bombshell to investors in early 1970, letting them know that he would be closing down the investment partnership.

Starting point is 00:46:09 For many of his investors, this was terrible news because they just didn't trust anyone else to manage their money other than Warren. Buffett's partnership was making waves as Forbes recognized it in their titled article, How Omaha Beats Wall Street. The article stated that $10,000 invested in the partnership in 1957 would now be worth $260,000 13 years later. It ended with $100 million in assets under management and grew at an annualized growth rate of 31% without a single losing year.

Starting point is 00:46:43 At the time, Buffett was now worth $26.5 million, and he owned 26% of the partnership. Forbes said that Buffett is not a simple person, but he does have some of the company. He had four to five bottles of Pepsi per day and would have that instead of wine at dinner parties. If the meal included anything more complicated than a steak or a hamburger, oddly enough, he would just eat dinner rolls. His wife had done plenty to take care of him as far as cooking and preparing his clothes each day for him, but he worked about every waking hour, and he really wasn't attentive

Starting point is 00:47:16 to his children at all. Buffett was most definitely extraordinary when it came to making money and compounding capital, seemed to be anything but that in other areas of his life because of his obsession with business and investing. To Buffett, doing well with money was how he measured success. One thing I really admire about Buffett is how he truly treated his shareholders like partners. He really truly wanted what was best for them. He would be fully transparent in his letters about how the partnership performed, what his strategy was, and what they could do with their money once the partnership have been diluted. As those of you who have read Buffett's shareholder letters know, there is so much

Starting point is 00:47:56 to learn from his brilliant writings and teachings. He would tell his shareholders or partners as much as he would like to be told if he were in their shoes. When the parting shareholders asked Buffett if they should keep their Berkshire shares or to sell them, he has said he plans to hold onto it and continue buying more. At that time, Berkshire owned the failing textile mills, a small bank, and the insurer national indemnity. Later, Buffett would comment that Berkshire is still like a partnership and that you basically have the closest thing to a private business with shareholders who identify with you and who like to come to Omaha. He often said he tried to treat his partners in a way he would treat his family. As I mentioned, Buffett is going through this transition period

Starting point is 00:48:37 as he isn't finding the Cigarba opportunities anymore, so he essentially had to adjust his strategy for Berkshire. Here is how Buffett phrased his new approach, which was largely influenced by Charlie Munger. Time is the friend of the wonderful business and the enemy of the mediocre. It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early. I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class management. That leads right into a related lesson. Good jockeys will do well on good horses, but not on broken down nags, end quote. One day in the early 1970s, Buffett got a call about a company called Seas Candy,

Starting point is 00:49:24 based in California that sold premium quality candy. Seas is a classic example of a great business that was trading at a fair price. This is not a company whose stock price you'd expect to double in one or two years. However, Buffett and Munker were certain that the company would be able to grow and compound their cash flows for the many years to come. They ended up paying $25 million for Seas Candy, which produced roughly in 9% earnings yield at the time or just over $2 million. Munger regarded Seas Candy as the first time Buffett paid for quality. Ten years later, Buffett was offered to sell Seas for $125 million, which was five times the 1972 purchase price, and he decided to pass on the offer. Another area that interested Buffett was the newspaper

Starting point is 00:50:09 and publishing business. By the early 1970s, he had owned Sun newspapers, which was based in Omaha, and he was always on the lookout for other newspapers to purchase for Berkshire Hathaway. In 1973, Buffett had started purchasing shares in Washington Post and a number of other newspaper companies. Buffett believed that the overall market was not appreciating the underlying value of these newspaper companies, so he took advantage of the opportunities he found. Buffett was also involved in a holding company with Charlie Munker called Diversified retail company or DRC. Buffett owned 80% of the company, Munger owned 10% and David Gotsman owned 10% as well. It was created to primarily invest in cheap retail companies. Despite having quote-unquote

Starting point is 00:50:53 retired from being a money manager on behalf of others, he was still very busy finding companies to buy on the cheap. It was what he loved to do and he had no plans on ever stopping. During the 1970s, inflation had started to take hold, eventually bringing down most stocks and Buffett was out looking for more deals. Since he was fully immersed and understood the newspaper business, he found stocks of advertising agencies such as Interpublic, J. Walters-Thompson, and Al-Gilvie and Mothar that he put nearly $3 million into as they were trading at less than three times earnings. Through the inflationary 1970s, Buffett believed that owning stocks and companies that had strong pricing power were the best protection against inflation.

Starting point is 00:51:35 inflation. Inflation was running in the double digits, and investors were piling into gold, diamonds, platinum, art, real estate, and commodities. Everyone thought that cash was trash in Business Week titled an article The Death of Equities. Meanwhile, Buffett wrote that it was time for investors to be buying stocks, thinking that when everyone else wants to avoid stocks is the best time to purchase, as investors are getting more favorable prices when the consensus outlook is poor. Many of Buffett's holdings were down 25% or so. His former partners had wondered if it was a mistake to hold on to Berkshire, but Buffett saw it as the opposite, as he started buying as much of the stock as he could until he had run out of

Starting point is 00:52:16 cash. Buffett remained calm throughout the downturn as he believed Mr. Markets' opinion of the stock's price at the time had no bearing on the company's true intrinsic value. At this time, Buffett was receiving a $50,000 annual salary from Berkshire Hathaway and come to realize that he was very rich from a net worth perspective, but very cash poor. Despite Buffett being cash poor, his companies were producing plenty of cash, which he could then use to reinvest in other companies. Buffett decided to set up a reinsurance company to link Berkshire Hathaway to his holding company, DRC. The reinsurance company insured national indemnity,

Starting point is 00:52:55 and he set it up in a way that allowed him to take the immense profits from national indemnity and invest them in DRC. that is all I had for part one of how Warren Buffett became the greatest investor to ever live. To give a quick rundown on what we covered today, we touched on Buffett's childhood and how he was really just a learning machine that was just obsessed with business and making money. Then he attended college and started learning directly from his mentor, Benjamin Graham. Then he started his extremely successful investment partnership and eventually met Charlie Munger who joined him at Berkshire Hathaway.

Starting point is 00:53:31 At this point in Buffett's journey, we are now in the mid-1970s, as we have a lot more ground to cover in next week's episode. Next week, we'll be diving into his purchase of GEICO, Nebraska Furniture Mart, Coca-Cola, and many others, how Solomon Brothers nearly destroyed Buffett's entire investment career, how he ventured through the 2000 tech bubble and crashed to follow, as well as how Berkshire Hathaway weathered through the Great Financial Crisis, which occurred from 2007 to 2009. Again, part two will be released next Monday on October 17th, 2022. This will be titled WSB 484.

Starting point is 00:54:09 To stay tuned for Part 2, be sure to subscribe to the show so you can get notified next Monday when the episode gets released. In the episodes to come, I'll be diving in even more on how Warren Buffett invests exactly today and what is principles entail. I'll also be getting into some real-world examples and applying Warren Buffett's framework. Thank you so much for tuning in. really, really appreciate it and hope you've enjoyed this series so far on Warren Buffett. With that, I'll see you again next week.

Starting point is 00:54:37 Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP482: How Warren Buffett Became the Greatest Investor to Ever Live (Part 1)

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