The Deals of Warren Buffett | A Chapter by Chapter Summary

By Robert Miller | Portfolio Manager at NAOS Asset Management

A chapter by chapter summary of The Deals of Warren Buffett Volume 1, The First $100m by Glen Arnold. The book describes the key investment lessons learnt by Warren Buffett in making his first $100m. In our view, the book covers most of the lessons an investor would ever need, so this summary can be a useful reference tool when analysing companies.

The definition of an investment by Graham & Dodd:

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

Chapter 1 – Graham & Dodd Learnings Points

• It is only necessary to outperform the market by a few percentage points to end up with vast amounts more wealth.
• It is only worth investing if you have made a thorough analysis of the company, there is a built-in margin of safety and the objective is set as merely a satisfactory return.
• Do not accept Mr Market’s valuation of a share, do your own research.

Investment 1 – Cities Services (1941) - $5 profit

• Do not unthinkingly grab at a small profit (hold on to your winners).
• Do not fixate on what you paid for a share.
• When investing other people’s money, ill feeling can be created if a mistake is made.

Investment 2 – Geico (1951) – $5k profit

• Do your homework on stocks – qualitative, quantitative, management talent and reputation.
• It is possible for you to see so much more than the so-called experts, if you are prepared to put in the effort.
• Look for businesses that make profitable use of capital.

Investments 3 & 4 – Cleveland Worsted Mills & a gas station (both failed investments)

• Every investor will make mistakes – many of them. Develop personality traits to put failure into perspective.
• Net current asset value was essential to Buffets approach.
• Do not neglect the qualitative factors, understand the competitive positioning & management quality.

Investment 5 – Rockwood & Co (1954) –$13k profit

• It is important to thoroughly consider a company’s actions and their impact on future value as opposed to thinking of things as a short term, virtually risk free payback.
• These opportunities only come along to those willing to do the groundwork.

Investment 6 – Sanborn Maps (1958-60) - $500k profit (50%)

• Focus on the margin of safety, always.
• You have greater clout when you marshal millions (due to an increased ability to gain control of a company or influence management).

Investment 7 – Dempster Mills (1956-63) - $2.3m profit (230%)

• Business logic is one thing, being disliked is another, often overwhelming thing. Helped Buffett form his methods around trust and admired managers.
• Good managers can work wonders.
• Patience will be rewarded.
• The importance of identifying companies using too much shareholder money.
• The buying price is crucial as you’ve tilted the odds in your favour if purchased at a low price.
• Look for pricing power in businesses where prices can be raised with customer captivity remaining.

Investment 8 – American Express (1964-68) - $20m profit (154%)

• Think about the business. Short term problems can bring down a share price but long term value is unaffected.
• When the odds are good, invest a lot. Buffet put 40% of his partnership into AMEX.
• Ask around for qualitative data. Do your own scuttlebutt research with competitors, employees, suppliers, customers, etc.

Investment 9 – Disney (1966-7) –$2.2m profit (55%)

• Mr Market can be a dumbo.
• Businesses needing little additional capital to generate increased profits can be a goldmine.
• Scuttlebutt again. Do your research.
• Observe quality in everyday life.
• Don’t sell too soon!

Investment 10 – Berkshire Hathaway (1962 onwards) – profit $bn’s!

• Don’t get emotional, either by buying or selling.
• Management of high ability and integrity are crucial.
• Reallocate capital to areas with higher returns on capital employed.
• Try to behave decently with all who you come into contact with.

Investment 11 – National Indemnity (1967 onwards) – profit $bn’s

• The investor should be prepared to observe a good company for years before buying it. Have a valuation in mind, do the analysis and wait.
• The float held by insurance companies can be invested to make a fortune.
• Hold on to a good thing, for DECADES.

Investment 12 – Hochschild-Kohn (1966-9) –$800k loss

• It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Look for a first class business with first class management.
• Good jockeys will do well on good horses, but not on broken down nags.
• Avoid businesses with problems. Don’t learn how to solve difficult business problems, learn how to avoid them.
• Buffett was born neither an investor nor a businessman, he learned through experience.
• Be aware that in business there is the Institutional Imperative:

• The tendency of executives to mindlessly imitate the behaviour of their peers, no matter how foolish it may be to do so.

Investment 13 – Associated Cotton Shops (1967) – profit, good but hard to identify

• Focus only on your circle of competence, regardless of how narrow it is.
• It is great to partner with keen cost-cutting managers.
• People value respect as much as financial reward.

Investment 14 – Investing in Relationships

• Markets go through periods of irrationality.
• Stick with sound investing principles in good times and bad.
• Life is not all, or even principally about making money. Human relationships matter.

Investment 15 – Illinois National Bank & Trust (1969-80) –$32m profit (200%)

• Invest in outstanding businesses at reasonable prices. It’s worth paying full price for a business with historical strong earnings power if there is every reason this will continue.
• Even better, if you can get such a business at a low price then you will do very well.
• Buy high proportions of great companies – be as concentrated as you can.
• It is a very good sign when a company founder cares greatly about who’s buying the business and not about selling out for every last penny.
• A manager continually looking to gain efficiencies and cost savings is one that is likely to be worth backing.

Investment 16 – Omaha Sun Newspapers  (1969-80) – Loss making but qualitative gain (won a Pulitzer Prize)

• There’s more to life than short term financial gain.
• Payment for education.
• Hold on to good people.
• Don’t forget the qualitative.

Investment 17 – More insurance deals

• Grand principles are more important than a grand plan. Grand principle = good return on capital employed from low-risk businesses obtainable at fair prices.
• Intrinsic value is the focus of attention, not share prices.
• Capital allocation was at the heart of Buffett’s good investment performance.

Investment 18 – Investment in sanity

• Market moods can be incomprehensible to value investors at times.
• High cash balances are a suitable policy within an investment portfolio when few investments are available with margins of safety.
• Behave with integrity and diligence to those who you partner in business.
• Short term performance stats are meaningless in judging investment ability.
• Small investors have an advantage, as they can invest in small caps.

Investment 19 – Blue Chip Stamps (1968 onwards) –$100m’s profit

• Capital float is a very useful way to leverage a skilled investors resources.
• A buying opportunity may arise when there are many reluctant holders of shares.
• A failing operating business does not necessarily make a bad investment if the resources can be redirected to generate superior returns.
• Working with like-minded investors can allow greater influence and therefore a better outcome for all shareholders.

Investment 20 – See’s Candies (1972 onwards) –$2bn+ profit

• Be in a position to buy inputs in a competitive market with many suppliers but sell where you have pricing power.
• Always praise your key managers.
• Evaluate what is in the minds of customers.
• Look for high returns on small amounts of capital – businesses with low levels of capital investment.
• Pay up for franchises.

Investment 21 – Washington Post (1974 onwards) –$100m’s profit

• Look through temporary problems to the quality of the franchise when estimating intrinsic value.
• Do not be disheartened if the share price falls after purchase.
• Keep holding if high returns on capital employed are likely.
• Share buy-backs are good for shareholders if the price is low enough.
• Do not pay high prices in bidding wars for hot businesses.
• High quality economic franchises can disappear, be prepared to reallocate capital.
• Do not churn your stock portfolio.

Investment 22 – Wesco Financial (1974 onwards) –$2bn+ profit

• Treat your reputation as a highly important asset.
• Mistakes in capital allocation will be made but good managers will have resilience to press forward regardless.
• Watch for downside risk.
• The element of trust brings large financial savings.

Read further insights by Robert Miller on What we Look for on Company Site Visits or Five Ways to Avoid the 'Value Trap'

Important Information: This material has been prepared by NAOS Asset Management Limited (ABN 23 107 624 126, AFSL 273529 and is provided for general information purposes only and must not be construed as investment advice. It does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision, investors should consider obtaining professional investment advice that is tailored to their specific circumstances.

Published: 5 July 2018