Financial History Issue 125 (Spring 2018) - Page 25

Many other brilliant investments were to follow, resulting in extraordinary growth for Berkshire. Between 1965 and 1978, the annual compound rate of growth of the S&P 500 was 4.63%. But for Berk- shire, the compound rate of growth in per share book value was 21%. It is not until you see the effect of that differential on final dollar amounts that you really appreciate the truly stunning performance of Buffett. Whereas the S&P 500 rate of return resulted in a $1,000 investment in 1965 being turned into $1,885 by Decem- ber 1978, in that same time a $1,000 invest- ment in BH shares grew to be worth over $14,000. Berkshire Hathaway Annual Percentage Increase (1979–2015) Buffett’s Early Mistakes All investors make mistakes. A key char- acteristic of Buffett is that he continues to learn from his investing mistakes. Some of his early errors include: GEICO  Buffett invested about 65% of his net worth ($10,282) in GEICO in 1951, and he sold his shares in 1952 for $15,259. Not a bad return, but consider this: if he had held onto those shares for the next 20 years, he could have sold them for $1.3 million in the late 1960s. The painful lesson was in the inadvisability of selling a stake in an identifiably wonderful company. Source: Letter from the Chairman of Berkshire Hathaway (2016) he pitched the formal offer at only $11.375. Buffett bristled at Stanton’s behavior and chose not to sell. Instead, Buffett made what he later called “a monumentally stupid decision.” It was plain to see that New England textile mills were going out of business, as they rarely made profits due to cheap imports. BH itself had closed most of its mills as it failed to compete. But Buffett was upset, and so he began to aggressively buy more shares (great investors are not perfectly rational). By April 1965, BPL held 39% of BH and formally took control of the company, using one-quarter of the funds under Buffett’s command to do so. Buffett’s self-confessed “childish behav- ior” resulted in him having to organize “a terrible business.” As a result of losses and share repurchases, Berkshire’s balance sheet net worth was only $22 million. It had no excess cash and $2.5 million of debt. Buffett put strict limits on further invest- ment in textile machinery and other assets. He gradually moved the capital of the original business to other areas. Because he was a capital allocator with a knowledge of many types of businesses, and not a textiles man specifically, he was able to spot better investment opportunities than those who were focused on only the textile industry. Transforming Berkshire In 1967, Buffett made a great leap for BH by getting it to buy the insurance company National Indemnity in his home town of Omaha for $8.6 million. For Buffett, one of the attractions of insurance companies was the pile of cash (the “float”) sitting within the firm, created because policy- holders pay up front, but claims occur later. This float could be invested. Buffett later bought many more insurance com- panies and made very good use of their floats too. The National Indemnity acqui- sition was followed by another master- stroke: the purchase of a chain of branded candy stores in 1972 for $25 million. See’s Candies has since generated more than $2 billion for BH to invest elsewhere, and it is still pumping out money today. Cleveland Worsted Mills  Cleveland Wor- sted Mills’ share price was less than half the business’ net current asset value in 1951, so market capitalization was under half the amount tied up in the current assets after deduction of all liabilities. And it paid a high proportion of its earnings in dividends. After buying in, Buffett discovered that the company faced intense competition from textile plants in the southern US states and from synthetic fibers. It made lar ge losses, cut its dividend and its share price dropped. Buffett learned the importance of strategic competitive positioning and pricing power. The Gas Station  Buffett bought an Omaha gasoline station in partnership with a friend. Unfortunately, it was sited opposite a Texaco station which consistently outsold them. Amazingly, Buffett even took up physical work to help out — on weekends he actually served customers. He learned lessons in competitive advantage: the Tex- aco station “was very well-established and very well-liked…customer loyalty…a cli- entele… Nothing we could do to change  |  Spring 2018  |  FINANCIAL HISTORY  23