Portfolio ManagementWarren Buffett

A 1977 Warren Buffett Interview From the WSJ Archives

Someone I’m connected with on Linkedin sent me this old article from 1977 in the Wall Street Journal on Warren Buffett. I thought I’d share it here, along with a few highlights. It’s an article I haven’t seen previously. There isn’t much new here, but I thought it was quick read with a couple passages worth commenting on.

One thing I don’t recall Buffett ever describing were the pressures of money management that he felt while running his partnership. This is Buffett describing the relief he felt after closing his fund:

“I’m having a lot of fun because I’m only going into businesses that I find interesting and where I like the people running them, and their products,” Mr. Buffett says. “It’s a tremendous relief being out of money management. I’m not constantly thinking about business anymore. During the partnership my ego was on the line, and I was trying to lead the league in hitting every year.”

I think there are a couple things to note here. First, Buffett knew that his overall record was due to his skill as an investor. But I think he also knew that his individual yearly results, where he beat the market each and every year for 13 years, was very unlikely and almost certain not to be repeated (or continued if he kept his partnership open). He knew that over 5 year periods, he would beat the market handily. But he also knew that any given year was much more up for grabs.

If we compare the results of Charlie Munger and Walter Schloss (who also ran partnerships during the same time), all three produced fantastic records, but Munger and Schloss underperformed the market about 1 in every 3 years, despite beating the market overall by huge margins (see this post for details on their performance records).

So I think the unrealistic expectations that Buffett thought his investors were placing on him began to wear on him. It’s unlikely these investors would have been so demanding (after all, Buffett made them all rich), but I can understand—being in the money management business and actively managing money for clients—that there is pressure when it comes to other peoples’ money. You treat it with much more importance than you do your own capital. That said, I was surprised to hear Buffett say he was glad to be out. I personally couldn’t imagine wanting to do anything else.

But Buffett felt a relief after shutting his partnership, and in the early years, it almost sounded like a semi-retirement. This is ironic of course, because he now is a fiduciary on a much larger scale than he was in the 1960’s.

But ultra-competitive people have a hard time staying away from the game, and Buffett is certainly no exception.

Retail is a Tough Business

“Mr. Buffett has taken some lumps. Several years ago, for example, Berkshire Hathaway lost half of a $6 million investment in Vornado Inc., a discount retailing concern based in New Jersey. ‘The stock looked undervalued when I bought it, but I proved to be incredibly wrong about the discount department-store business,’ Mr. Buffett says. ‘It turned out that the industry was over-stored, and Vornado and the rest of the discounters were getting killed by competition from K mart stores.’”

What’s interesting is that this quote is as relevant now as it was in 1977. It’s the same game with different players. Macy’s, JC Penney’s, Kohl’s and other struggling department stores have replaced Vornado, and the competitor wreaking havoc is no longer K-mart, but Amazon.

But it’s also interesting that Buffett says, “The stock looked undervalued when I bought it.” It’s strangely reassuring to know that Buffett himself was tempted by mediocre businesses that looked cheap. And most retailers are mediocre businesses that look cheap.

Whenever I review my own investment mistakes, they almost always come from situations where I was attracted much more to the valuation than to the business. These are the so-called value-traps—catnip to most value investors, but very often poor choices as investment candidates. I’ve learned to steer clear.

The problem for many investors is that sometimes these so-called value traps work out. You’re able to buy them and sell them for a 50% gain. But a year or two later they are often trading at or below (often well below) your original purchase price. The investment looked smart based on the realized gain, but was it really being smart, or just fortunate timing?

Each investment situation is unique, but the general lesson from this particular passage is that retail, specifically discount department stores, is a very tough business. Your competitors are offering the same merchandise you are (for the most part), and Amazon can match or surpass you in terms of price, selection and convenience. This puts you between a rock and a hard place—either cede market share to Amazon or other competitors (which isn’t really an option because that means lower revenue to spread across a largely fixed cost base), or cut prices to compete for customers (which, unless your lower prices lead to faster inventory turns, will still lead to lower revenue on already thin margins).

For some store concepts, this operating leverage can be a positive driver of margin expansion, returns on capital and earnings growth, but when your store that was once a favorite with customers begins losing its luster, this leverage works in reverse. All along the way, competition is brutal.

As Buffett has said regarding the retail store he ran in Baltimore (paraphrasing), “If the guy across the street started offering a 15% weekend discount, we had no choice but to match that promotion.”

It’s a very difficult game. There will be some winners for sure, but there will be a lot of losers. And it’s hard to predict (other than maybe Amazon) who will win. Some will “win” for a period of time before losing (K-mart and Sears once dominated before getting disrupted by Wal-mart, which itself is now getting disrupted by Amazon, etc…)

Inflation

“Wall Street sources close to Mr. Buffett say that his stock investments in the past few years have been largely dictated by his concern over inflation. David Gottesman, senior partner of the New York investment concern First Manhattan Corp says:

“Warren has been largely restricting himself to companies which he feels offer some protection against inflation in that they have a unique product, low capital needs and the ability to generate cash. For example, Warren likens owning a monopoly or market-dominant newspaper to owning an unregulated toll bridge. You have relative freedom to increase rates when and as much as you want.”

I don’t think Gottesman’s reasoning is completely accurate here. I doubt Buffett necessarily was buying companies as an inflation hedge—although that was a byproduct of the types of investments he made. I think his preference for durable businesses with strong competitive positions and excess free cash flow would have been his preference regardless of whether the economy was experiencing high inflation, low inflation, or even deflation.

I am not suggesting Buffett didn’t consider inflation as a major factor (he did discuss inflation often in his letters as well as this famous piece in Fortune), but I don’t think he changed his investment preferences much, if at all, based on what inflation was doing.

Regardless, it was an interesting piece from the Wall Street Journal archives.

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John Huber is the portfolio manager of Saber Capital Management, LLC, an investment firm that manages separate accounts for clients. Saber employs a value investing strategy with a primary goal of patiently compounding capital for the long-term.

John also writes about investing at the blog Base Hit Investing, and can be reached at john@sabercapitalmgt.com.

5 thoughts on “A 1977 Warren Buffett Interview From the WSJ Archives

  1. Great post, I love those old articles on Buffett!
    I suppose your resource is MCC? (Reference to the same article yesterday)
    Buffett “beating the market each and every year” is not exactly true, though, in reality.
    If I remember correctly, Joshua Kennon wrote that Buffett used (questionable) accounting to his advantage in the old days.
    (Just found the Link: http://bit.ly/2biSj1L ; Josh’s second response in the comments.
    “But, yes, reality is much different than perception. He’s actually much smarter than people realize. An illustration: All the bragging about the partnership never having a down year was partially accomplished by him taking control stakes so he could use estimated private market value in the partnership accounting records, insulating the return figures from stock market fluctuations, which could then be ignored (e.g., the stock declined but the position was recorded at a higher value under a discounted cash flow analysis because he owned over x% of the equity). That requires an intimate understanding of accounting rules and I’m sure he knows it adds to his legend that he never had a decline, which isn’t entirely honest (he’s probably never going to point this out, though). The same thing happened at Berkshire, too (there were years the portfolio declined) but because he had a holding company structure, the new profits coming in exceeded the decline and allowed him to take advantage, buying more as the book value continued to increase.”
    Last paragraph is just brilliant as well:
    “The “aww shucks” demeanor is partially a facade, at least in my analysis of his behavior and contracts. He’s ruthless, logical, and knows exactly how to structure an arrangement so it’s fair and he is paid handsomely. He also knows marketing and branding. He’s created this image of Warren Buffett as an all-knowing oracle when the reality is much messier and far more interesting.”

    1. Thanks for the comment Moritz. You bring up an interesting topic. I disagree with the idea that Buffett gained any advantage by his “use of accounting”. He wound down the partnership at the end of 1969 and everyone either got cash or easily valued BRK stock at market value, and the total return from the partnership (somewhere around 25% CAGR net of fees) is accurate. That’s what people received.

      As for the control positions you mentioned (or referenced in the comment): yes, he did have control positions. But for one, they weren’t a majority of the portfolio (maybe 20-30% on average). And b) they were likely understated if anything. For example, Buffett marked his Dempster Mill position around $35 per share, which was above his cost basis, but well below fair value (Buffett sold the company and got $80 per share). I think his marks were very fair, and likely conservative.

      And the gains he had over the Dow in most of those years cannot be explained simply by inflating privately or closely held investments (he beat the Dow by 22% annually during his partnership before fees). The majority of his gains came from stocks (AMEX for instance resulted in around $20 million profit, which was around a fifth of the total value of the partnership when he wound it down).

      That said, I do agree that he plays up his “aww shucks” reputation to his advantage. And I agree that he has a firm grasp on branding and how to market himself (his reputation has been a big part of BRK’s success). But to suggest that he did anything untoward with his partnership is just not true.

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