Inside the Investments of Warren Buffett

Twenty Cases

Yefei Lu

• Publisher: Columbia University Press
• Year: 2016
• ISBN:
  9780231541688
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Since the 1950s, Warren Buffett and his partners have backed some of the twentieth century's most profitable, trendsetting companies. But how did they know they were making the right investments? What did Buffet and his partners look for in an up-and-coming company, and how can others replicate their approach?

A gift to Buffett followers who have long sought a pattern to the investor's success, Inside the Investments of Warren Buffett presents the most detailed analysis to date of Buffet's long-term investment portfolio. Yefei Lu, an experienced investor, starts with Buffett's interest in the Sanborn Map Company in 1958 and tracks nineteen more of his major investments in companies like See's Candies, the Washington Post, GEICO, Coca-Cola, US Air, Wells Fargo, and IBM. Accessing partnership letters, company documents, annual reports, third-party references, and other original sources, Lu pinpoints what is unique about Buffett's timing, instinct, use of outside knowledge, and postinvestment actions, and he identifies what could work well for all investors in companies big and small, domestic and global. His substantial chronology accounts for broader world events and fluctuations in the U.S. stock market, suggesting Buffett's most important trait may be the breadth of his expertise.

Part I

The Partnership Years (1957–1968)

Warren Buffett’s investment career started in earnest in 1957, with the formation of his first investment partnership. Following two years of working as a securities analyst at the Graham-Newman Corporation and the well-documented experience of studying at the Columbia Business School under Benjamin Graham, Buffett established Buffett Partnership Limited (BPL) with the funding of a few friends, family, and close associates.¹

While details of Buffett’s investment thought process are much more widely documented later in his career, a few obvious themes can be discerned in his partnership years. Foremost is the focus on being a buyer at a good price. In his 1962 partnership letter, Buffett states that the cornerstone of his investment philosophy is to purchase assets at a bargain price, which he considers in the traditional Benjamin Graham view of low price versus intrinsic valuation—a fundamental assessment of a company’s ability to generate cash flow or a company’s value in assets. Second, Buffett adopts a strong view of a moving market; Mr. Market either overvalues or undervalues a company, but over the long run does pass around the intrinsic value. Third, Buffett also pays attention to investor psychology as pertains to who is investing in the market and what impact this investor thinking has. Specifically, he mentions several times the concept of whether investors have steady hands and the manias of different periods.

In running his partnership, Buffett kept secret his holdings during this period and adopted a black-box type of strategy with his limited partners. In the appendix of his 1963 year-end partnership letter he states, “We cannot talk about our current investment operations. Such an open-mouth policy could never improve our results and in some situations could seriously hurt us. For this reason, should anyone, including partners, ask us whether we are interested in any security, we must plead the Fifth Amendment.”

The significant investments Buffett made during this time were a mix of value bets and corporate actions. At times BPL would invest up to 35 percent of its net assets into a single company and at times, given the opportunity, take a majority ownership stake in the company.

When Buffett ran his partnership during the late 1950s and 1960s, the United States was enjoying relatively calm and economically prosperous times: on the heels of the Korean War in the 1950s and in the midst of the Cold War at the beginning of the 1960s, the U.S. economy was less eventful than its politics. In the 1950s the Dow climbed from approximately 200 points in 1950 to roughly 600 points in 1960 (a 200 percent increase). Although there was a small recession at the beginning of the 1960s that saw the Dow pull back into the 530s in 1962 from a high in the 730s at the end of 1961 (a decrease of 27 percent), the Dow would rise again to over 900 by 1965 (a 70 percent increase from the low). The economy continued to grow through the Kennedy years, with signs of the first serious concerns only surfacing at the end of the 1960s when inflation rates started increasing ever more quickly. By the time Buffett closed his investment partnership in 1968, economic prosperity abounded to a level where he found it increasingly difficult to find the value investments that he was looking for. This was in fact one of the key rationales for ending his partnership amidst great performance.

The five investments discussed in part I of this book are the investments I deemed the most significant or otherwise most interesting during Buffett’s partnership years.

1

1958: Sanborn Map Company

The history of the Sanborn Map Company is fascinating. In the 1860s a young surveyor by the name of D. A. Sanborn was hired by the Aetna Insurance Company to produce several maps of the city of Boston. Aetna used these maps to assess the fire insurance risks for specific buildings in the areas surveyed. The maps produced proved so successful that D. A. Sanborn started his own company, which came to be known as the Sanborn Map Company. Throughout the 1860s and 1870s, Sanborn expanded regionally, and by the late 1870s he had already mapped over fifty cities.¹ By the 1920s, Sanborn Maps had become the market leader in fire insurance mapping in the United States.

To better understand Sanborn Maps and what it produced, it is important to understand the fire insurance industry. Fire insurance had its origins in England after the Great Fire of 1666, which destroyed more than 13,000 houses in the city of London and made approximately 20 percent of London’s inhabitants homeless. During the 1700s and 1800s, this industry migrated over to the United States, administered first by British companies that had the royal decree to operate this business, and later by American firms that pioneered the industry locally. By the late 1800s, fire insurance companies were prominent in larger cities such as Boston and Philadelphia. These companies underwrote risk and determined pricing by inspecting the individual building in question for construction type, construction materials, number of windows, and other factors related to the structure including the surrounding structures. The methodology used thus required a field inspection by a professional surveyor. As field inspections were both time-consuming and very expensive, a company that produced maps with enough detail to assess fire risk appropriately had obvious advantages. First, rather than assessing one structure at a time, it was far more efficient to work through a block or even a city neighborhood at a time. More important, rather than using the generated information once for one insurer, a map had the advantage of scale; once produced, a map could be used by multiple insurance companies to assess the risk for the same set of underlying structures.² This is similar to, for example, the modern seismic exploration industry—the industry that generates the cartography necessary for oil companies to drill for oil offshore. Companies such as TGS-Nopec, for example, benefit from similar benefits of scale. TGS-Nopec conducts 2D and 3D surveys of ocean floor regions such as the Gulf of Mexico and then sells this information to major oil companies who are interested in drilling in the region. In the context of its time, Sanborn Maps’ mapping was also very much aligned with the practice of m...

Table of contents

• Cover 
• Title Page
• Copyright
• Dedication
• Contents 
• Acknowledgments
• Introduction
• Part I: The Partnership Years (1957–1968)
• Part II: The Middle Years (1968–1990)
• Part III: The Late Years (1990–2014)
• Part IV: Lessons Learned
• Appendix A
• Appendix B
• Notes
• Selected Bibliography
• Index