Financial History Issue 125 (Spring 2018) | Page 24

be learned vicariously from other people ’ s mistakes and successes .
Temperament is more important than IQ when it comes to being a good investor . Graham taught Buffett that the most intelligent people often make poor investors because they frequently lack the right mental approach . For example , if they are highly rational , they get frustrated at the irrationality in the market and often cannot figure a way of exploiting irrationality . They may also fall in love with their predictions , thereby neglecting to build in a margin of safety . Other aspects of bad temperament for investors are the tendency to follow the crowd when it is panicking , or to become irrationally exuberant when everyone else is . Then , there are the people who can ’ t help noticing others making money on a new idea for speculative selection , or the latest technology , and want some of the action . In short , the investor ’ s own worst enemy is often himself .
Graham emphasized to Buffett that he must understand the focus of other people in the markets if he wanted to outperform them . For example , many investors are primarily concerned with expectations concerning the future , such as how many customers a company would have over the next 10 years , which cannot be predicted with any degree of certainty . Meanwhile , they pay little heed to more important details , such as the balance sheet , earnings history and share price . The lesson is to not become engrossed in the “ story ” of a business while ignoring the “ facts ” about it .
Graham created a wonderfully simple parable of “ Mr . Market ,” which goes something like this : You are in a business partnership with Mr . Market . You own 50 %, the same as he . Every day , Mr . Market comes to you offering either to buy your half of the business , or to sell his half to you . He is very obliging indeed — in fact he ’ ll offer prices throughout the day . The thing is , Mr . Market has moods . Sometimes he is very optimistic and offers you a high price for your share of the business . Other times he is down in the dumps and just wants out ; he will sell his half to you at a low price . So , what you have to ask yourself is whether you should value your shares based on the prices that Mr . Market is currently offering . Of course , true investors will carry out their own analysis and compare their intrinsic value calculation with Mr . Market ’ s offer .
Source : Letter from the Chairman of Berkshire Hathaway ( 2016 )
The Graduate from Graham and Doddsville
Upon returning home to Omaha , Nebraska , following Graham ’ s retirement , 25-year-old Buffett set up an investment partnership with seven relatives and friends . They had $ 105,000 available , and Buffett made the investment decisions . The partnership ’ s returns far exceeded the stock market , as Buffett found bargain after bargain — such as Sanborn Maps , which was sitting on net assets ( mostly tradable securities ) — worth much more than its share price . Buffett ’ s partners made about a 50 % return on that investment when Buffett was 29 years old .
Other people observed what Buffett was doing and wanted him to invest their money , so he set up other partnerships , eventually bringing them together in one group , the Buffett Partnership Limited ( BPL ). He found some solid companies that were temporarily out of favor with Wall Street , such as American Express ( a tripling of share price ) and Walt Disney ( a 55 % return ).
Berkshire Hathaway Annual Percentage Increase ( 1965 – 78 )
Between the start of the partnership phase of Buffett ’ s investing career ( first full year 1957 ) and near its end in 1968 , the Dow grew by 185.7 %, but a dollar invested with Buffett went up by 2,610.6 %. After Buffett ’ s fees , a typical partner who had invested $ 1,000 in 1957 would have over $ 15,000 within 12 years . In contrast , each $ 1,000 invested in the Dow in 1957 increased to only $ 2,857 .
Berkshire Hathaway Enters the Scene
In 1962 , Buffett used a portion of his partners ’ money to buy shares in a down-atheel New England textile company , Berkshire Hathaway ( BH ). The price of each share averaged $ 7.50 . By May 1964 , BPL held 7 % of the shares of BH . The dominant shareholder and executive was Seabury Stanton . He made a deal with Buffett for Berkshire Hathaway to buy BPL ’ s BH shares for $ 11.50 — 50 % more than Buffett had paid to acquire them . Then , Stanton thought he ’ d chisel Buffett . In a petty way ,
22 FINANCIAL HISTORY | Spring 2018 | www . MoAF . org