Buffett’s First $100 Million: The Early Successes & Failures

Steve Pomeranz: Okay. I’ll admit it. I’m a Warren Buffett-o-phile. Warren Buffett-o-phile. I’ve studied him. I’ve invested like him. I’ve attended his Berkshire Hathaway meetings for quite a while. So, when I came across another book about him, I’m interested, but I gave it a wary eye. What more can someone say about the man? This time, however, I discovered a book that looks at the early years of Buffett, something few books have attempted. I’ve discovered lessons that I think are particularly important in this day and time. It took the world’s greatest investor nearly four decades to make his first $100 million. He made a lot of mistakes in the early years. It wasn’t all smooth or instant. It took decades of ups and downs. Let’s meet the author of this book and see what we can glean from his work. His book is The Deals of Warren Buffett. With me is author Glen Arnold. Welcome to the show, Glen.

Glen Arnold: Hi. Good to be here.

Steve Pomeranz: You analyzed the individual investment deals in detail to reveal his approach. Why did you approach it from that angle, looking at the deals themselves?

Glen Arnold: Well, it didn’t start off as a book at all, in fact. What I do is … I left university about four years ago. I had a university chair here in the UK and left that in order to concentrate on investing. What I spend my time doing is analyzing companies, obviously using Warren Buffett techniques amongst others. I was a professor of investing, so I had a number of Ph.D. students. I have other techniques from that sort of background as well. Anyway, I analyze companies. And then, I starting putting my analysis on a website that my wife just created, very cheap website.

That helped me, in order to get my thoughts in order and also to remember why I invested in something and then I track it a long time, different rationales, as time, as the year passes, I explain why I’m still invested or whether to buy or whatever. Anyway, eventually, a major investment website in the UK took that up and asked me if I would put it on their system and then they could have subscribers for that. In between analyses of companies—because I didn’t always have a company to analyze—I had to think of others things that I could present, so I presented academic material. I thought, “Well, I need to learn about the details of Warren Buffett’s analysis.” How did he go about analyzing companies? That wasn’t in the books up until that point because it’s very much a case of they’ve got a lot to cover.

I got 80-odd years to cover, and they sort of go along the lines, this a caricature, but it’s along the lines of: Buffett invested in this, and then he made a fortune out of it, and then he invested in something else and made a fortune. I wanted to know the details of why, why did he invest in something, and what was the real outcome, what were the details of those outcomes.

Steve Pomeranz: Well, that’s what we want to know. Why? Why? Tell us about his very early years, as a teenager, talking about before he went to college. Now, you wrote in the book that at 11 years old, he had already accumulated $120. Now, this was in 1941 or so. I did some online math. I found out that $120 in 1941 dollars is the equivalent of about $2,000 today. Unless you have a young child who’s been through a confirmation or a bar mitzvah or something, very few of them are going to have 2,000 bucks that they’ve earned on their own. How did he make this much money at such a young age?

Glen Arnold: Well, you got to remember the time. We’re talking early 1930s or rather right through the 1930s was his formative years. Of course, he saw a lot of poverty at that time. He became determined to make money and never to be dependent on others. He found all sorts of ways of making a dollar. He would take cans of Coke or bottles of Coca-Cola to school or Wrigley’s chewing gum to school and sell them individually, make a little bit of money that way. Then later on, in his teenage years, he would do things like collect golf balls or have pinball machines in barber shops. Make money all sorts of different ways, and obviously, it was saving as he went along. I would guess that when he got Christmas money or birthday money, he would save that. He was really determined.

Steve Pomeranz: All right. So focus and this early desire to avoid poverty or to avoid what he saw around him. Next, as we fast forward a little bit, I think his first real investment in the stock market … Now, his father was a stockbroker for a while, and then he became a congressman or a senator. I’m not sure. They moved to Washington, but the first investment that he made was a preferred stock that he bought, City Service. There were some lessons there because he went in with his sister, and not long after he bought it, it went down, and he felt pretty bad about that. Take us through that a little.

Glen Arnold: Yes. It started to go down. He felt really guilty because he persuaded his sister to go in for this. They held on. It managed to go back above the price that they paid. They only bought three shares, by the way. He sold out. The profit was $5.25. That was it. The lessons he took from that was simply that … He followed the shares after that and that they rocketed after he’d sold. So he learned, “well, don’t grab at a small profit. Hold on in there if you’re convinced of your analysis. Don’t fixate on the price that you paid for a share.”

Steve Pomeranz: There you go. That’s a big lesson right there.

Glen Arnold: That’s a sunk cost. When investing other people’s money, ill feeling can be created and mistakes made. I remember John Templeton used to say, “OPM is sacred.” Other people’s money is sacred.

Steve Pomeranz: So it changes the way you look at things than if you would rather just do them yourself, you’re responsible for others. Let’s fast forward 10 years later. Age 20, he’s now worth $20,000. By the way, that’s $188,000 today. He bought Geico. That’s a name we all know because he still owns it. He still talks about it. We see it advertised all the time. He spent $10,000 for Geico. Why Geico back then?

Glen Arnold: Ah, well. What started him off on that one was Benjamin Graham. By this stage, he was at university, being taught by Benjamin Graham. He noticed that Graham’s company had shares in this company called Geico. In fact, they had a controlling interest in Geico. So he set off one Saturday morning to Washington and knocked on the door, hoping to speak to somebody. Luckily enough, there was a chap called Lorimer. Sorry I’d forgotten the name. Is it Lorimer Davis?

Steve Pomeranz: I’m not sure.

Glen Arnold: Anyway. Anyway. The corporate finance chap at Geico was there. This guy very generously gave this 21-year-old Buffett who’d knocked on the door a few minutes to talk about insurance and the company. They ended up talking for about four hours because Warren Buffett kept on throwing questions, very highly intelligent questions at him. He’d obviously done his homework. Warren decided to invest in that company. The reason was because of the strength of its franchise. The shares were lowly priced, but it had a terrific franchise. It had a very low-cost distribution model, which was telephone sales. It was to particularly low-risk people, government employees. Warren felt that there was a degree of customer captivity there, so the insurance could be sold nice and cheap, and it was a strong ongoing franchise.

Steve Pomeranz: I think there were big profit margins as well-

Glen Arnold: Yeah.

Steve Pomeranz: … Which he was attracted to, but I think one of the lessons here is you said that the price was low. This was not a popular stock.

Glen Arnold: No.

Steve Pomeranz: We all get caught up in these companies that are in today’s news or that are sexy in some way. They make great products or whatever. You pay a lot for them in terms of the price that you’re paying for every dollar’s worth of earnings. It’s a different kind of personality that goes in and doesn’t care what’s popular but looks kind of at the fundamentals saying, “There’s value here for me to unlock.”

Glen Arnold: Absolutely. The insurance analysts on Wall Street were quite down on the company mainly because it had a very small market share. They thought market share was everything, but of course, it’s not. If you’ve got a very strong franchise because you’ve got strong relationships with your customers and you’ve got a unique distribution model, you can beat the big boys.

Steve Pomeranz: All you needed to do at some point is get someone in there who could lead the company and scale it up, which eventually happened, but it didn’t happen before Buffett sold it because he sold it for a 50% gain, not-

Glen Arnold: Yeah, just a year-

Steve Pomeranz: Go ahead.

Glen Arnold: Yeah. Just a year later, he sold it.

Steve Pomeranz: Just a year later. Right. He bought it back many years later.

Glen Arnold: Oh, yes. There had to be a major crisis for him to buy back in. I think it was 1974, early ’70s anyway. A new bunch of managers had taken over. In insurance, you can do some very, very silly things, chasing after writing premiums, you can underprice insurance risk dramatically. It looks great for a while, but then something’s going to hit you eventually, and it really did. That company was pretty well bust when-

Steve Pomeranz: Well, there’s also a lesson in him having total understanding of the way that business worked and to see the difference between what bad management had wrought and what could be done to fix it.

Glen Arnold: Yeah, yeah. So you needed two things. When he investigated the company, he went to speak to the bloke that had just taken charge. The first thing he needed was somebody who saw things his way, a really rational manager. The other thing he needed confirmation of was that it still had that economic franchise, that relationship, that low-cost model, and it did. So he was willing to put in, initially mostly preference shares rather than common stock.

Steve Pomeranz: The book is, The Deals of Warren Buffett: Volume I, The First $100 Million. My guest is Glen Arnold, the author, I guess former college professor, we can say now.

Glen Arnold: Yeah.

Steve Pomeranz: Let’s fast forward to 1964, he began investing in and accumulating shares, I think over a three-year period, of American Express, which is kind of interesting because we all know that company. Again, he’s not that old. He’s in his 30s, and he invest to the tune of $13 million buying 5% of the company. First of all, I think that says a lot about his willingness to concentrate his money on fewer bets where most managers like to spread his risk around and so on. But also, why did he pick American Express at that time? What was going on?

Glen Arnold: Well, the share price had fallen a lot. The reason it had fallen was because of the salad oil crisis. American Express had guaranteed that a whole load of salad oil that was stored, I think in New York, was there and was valuable. A number of banks lent against that salad oil, and it was to a crook. A total crook. What he did was fill the tanks with sea water and then put a bit of salad oil on the top or where you actually go in and measure-

Steve Pomeranz: Oh, because it rises to the top, right?

Glen Arnold: Yep. Yep. So this crook got tens of millions out of various banks. Everything was fine. He could afford to repay. It was like a Ponzi scheme to some degree, and then all of a sudden, America imposed sanctions on Russia and refused the export of oil or something. Anyway, the price of salad oil fell. People went to reclaim their loans from this guy. They all discovered that there was hardly any salad oil there at all. American Express, having guaranteed this salad oil, had to pay up or was threatened with various lawsuits. There was a period of time where it was wondering whether to pay up or not pay up. The share price fell. Warren got in at that point. The reason he got in was this economic franchise idea again.

Up until about that time, Warren was highly influenced by Benjamin Graham’s approach where you look principally at the balance sheet. He was looking for net current asset value type investments particularly, but here in American Express, we have an example of a company with not a particularly strong balance sheet, certainly not a net current value asset investment, but it had a strong franchise. So he had to check that out. The way he checked that out was he knew that the American Express card was a world beater. It had, I can’t remember the percentage, but something like 50% of the market at that time.

Now, the question was: were people abandoning that card, and therefore was the franchise reducing? He went to restaurants and noticed that people were still using the American Express card. They were still going and getting travelers checks, American Express travelers checks. People, ordinary people outside of Wall Street, were fine with American Express. They weren’t worried about it. So he started accumulating these shares in American Express, thinking the franchise was absolutely fine. In the minds of ordinary people, it was fine.

Steve Pomeranz: This idea of buying into a brand or franchise I think came from his partner Charlie Munger. I think Buffett started transitioning from the old Ben Graham ideas of buying a dollar’s worth of assets on your balance sheet for 50 cents, which is what you were talking about, to thinking, “Well, maybe there’s a limit to that idea. Why don’t we just talk about the ability of companies that have a strong brand name to have to be able to price their product with good profit margins, to increase prices over time and products, and grow with the earnings of that company?” You think that was the beginning of that idea for him?

Glen Arnold: Around that sort of time, yes. Another one pretty well the same year was I think the following year was Disney. Again, Disney was bottomed out. You could buy the whole of Disney for less than $100 million at that time.

Steve Pomeranz: Wow. This was when Roy Disney was in charge before Michael Eisner got in charge? Is that this period of time?

Glen Arnold: You had Walt. In fact-

Steve Pomeranz: Oh, you had Walt. Still Walt. Oh, I didn’t know that.

Glen Arnold: Yeah. Warren was taken around Disneyland by Walt. Yeah, yeah. They got on like a house on fire. There’s another element there. He really wants to know the people that are running these things and found Walt to be a great guy and obviously, knew what he was doing in terms of business. That’s another element of why he invested, apart from the franchise. I mean the fantastic thing about that franchise is that you already have Snow White and the Seven Dwarves made and all those other characters. The marginal cost of putting that out for the next generations of kids is hardly anything at all. It’s a franchise that’s got virtually no cost now and loads of income.

Steve Pomeranz: Well, I remember reading about that. I mean after Walt died, Roy Disney took over. He was really unable to kind of unlock the hidden asset value of all these properties. Then they finally brought in Michael Eisner from Paramount. I don’t remember the dollar amounts, but Michael Eisner’s ability to take sales from a relatively small number to some astronomic number is really what brought Disney into the current giant size and power. It’s again this unlocking of value and seeing underlying value when it’s not apparent. It’s not looking at the price to tell you whether this is a good company or not. That’s so important. Everybody looks at a price. If a price like Google is $700, $800, $900 a share, they say it must be good. Now, I’m not saying Google’s not, but if Google got what got down to $100 a share, people would start to say, well, maybe it’s bad. Well, Glen, we’re out of time. I could do this for another two hours I think, but unfortunately.

Glen Arnold: Yeah.

Steve Pomeranz: Congratulations on this book. For anybody who’s interested in investing and kind of what it takes and what the mindset is and you want to break away from kind of the mindset of what the media expounds as the way to invest and so on and go your own way, this book is a good start for that. The book is The Deals of Warren Buffett: Volume I, The First $100 Million. The author is Glen Arnold. If you want to hear this interview again, read its transcript, read a summary, don’t forget to come to our website, Stevepomeranz.com. While you’re there, check out our weekly updates, sign up for that, where you’ll see every single segment that we do. You can read it, you can listen to it, or you can listen to the whole show. Glen Arnold, thank you so much for joining us.

Glen Arnold: Thanks, Steve.