Financial History Issue 125 (Spring 2018) | Page 26
Photograph of Warren Buffett,
dated July 1, 1965.
that.” With this lesson absorbed, it later
led to some of his best buys as he sought
companies with the most pronounced cus-
tomer loyalties in their industries, such as
Coca-Cola. But, at the time, the 22-year-old
was smarting from losing $2,000 on petrol.
Dempster Mill Based in Beatrice, Nebraska,
Dempster Mill supplied agricultural irriga-
tion systems. Buffett began acquiring shares
in 1956 at $16–$18. It had a net worth (book
value) of about $4.5 million, or $75 per share.
Net current asset value was about $50 per
share and annual sales about $9 million.
The price was so low because it kept making
small profits or losses, and the manage-
ment seemed clueless as to how to correct
this miserable pattern. Also, it had high
debt and was in an industry with very poor
economics.
BPL became the 70% shareholder in
mid-1961, spending $1 million at an aver-
age price of $28. Buffett was appointed
chairman. The company engaged in a lot
of unprofitable business ventures, using
large amounts of shareholders’ money
in inventory and receivables. The logical
thing to do was to cut drastically, releasing
cash for deployment elsewhere, especially
the purchase of other stock market quoted
value shares. The managers nodded when
Chairman Buffett spoke about reducing
inventory on his monthly visits from
Omaha — and then promptly did nothing.
The cash shortage was so worrying that
Dempster’s bankers considered closing
the company down, and in 1962 it was
months away from disaster. Buffett faced
the prospect of explaining to his partners
that 21% of their assets had disappeared.
Then, Harry Bottle was put in charge.
He quickly identified loss-making areas,
fired people, sold equipment, introduced a
cost data system, slashed inventory, closed
five branches and raised prices for the
rump business (for items where they were
the sole suppliers, they increased prices by
up to 500%). The value of the BPL stake
rose threefold to $3.3 million.
Buffett learned the value of excellent
managers, exhibiting competence and
integrity. He also learned that many busi-
nesses use too much money in operations
(40% of the capital was taken from opera-
tions for Buffett to invest elsewhere) and
that patience can be rewarded — it took
seven years to realize this investment.
Hochschild-Kohn In 1966, Hochschild-
Kohn (HK) was uncompetitive and
needed investment. Buffett knew he was
buying “a second-class department store
at a third-class price.” Still, he liked the
look of the net asset level, which was
24 FINANCIAL HISTORY | Spring 2018 | www.MoAF.org
more than the market capitalization, and
the hidden assets: unrecorded real estate
values and a significant LIFO (last-in-first-
out) inventory cushion. It was sold at $12
million, and BPL bought 80%. In 1968,
sales plummeted. It was sold in December
1969, leaving Buffett with a loss.
Buffett learned about the dangers of
retailing. The managers are usually under
constant attack from competitors. If they
come up with a good idea, it is usually not
long before rivals copy. In other industries
the managers do not destroy the business
even if they perform in a mediocre fashion
for a period. Thus, brands such as Gillette,
Wrigley and Disney maintain the largest
part of their franchises (their position in
customer’s minds) even if they have poor
managers for a year or two.
The HK episode also helped crystal-
ize in Buffett’s mind that quantitative
investment factors were not sufficient to
make a great investment. He increasingly
began to focus on qualitative factors as his
career developed. He particularly looked
for strong economic franchises, being will-
ing to offer a fair price for a wonderful
company rather a low price for a mediocre
business. If the economic characteristics
of the business and its industry are poor,
then managers — even if excellent — will
not succeed in generating high rates of
return on capital.
Buffett’s early years show the wisdom of
the imperative to fail fast, and fail young,
for that way lies insight and the knowledge
to create future success.
Despite holding the position of Professor
of Investment, Glen Arnold concluded
that academic life was not nearly as
much fun (nor as intellectually stimulat-
ing) as making money in the markets. As
a wealthy investor, he now spends most
of his time running his equity portfolio
from an office in rural Leicestershire,
far from the noise of the City of London.
His main research focus explores the
question, “What works in investment?”
drawing on the ideas of the great inves-
tors, academic discoveries and corporate
strategic analysis. He is the author of the
UK’s best-selling investment book and
best-selling corporate finance textbook.
His most recent book is The Deals of
Warren Buffett, Volume 1: The First
$100m, published by Harriman House,
from which this article has been adapted.
See: www.glen-arnold-investments.co.uk