In four parts, author Yefei Lu covers specific cases from Warren Buffett’s career. Lu digs through old annual reports, Moody’s Investors Service manuals, and partnership letters to provide the reader with the key data points and metrics that Buffett would have seen when he first researched the 20 businesses. This kind of valuation work should be of great interest to equity analysts and value-minded portfolio managers.
What makes Warren Buffett a hero to many ambitious investors is that he makes success seem achievable. In testimony to his gifts as a writer and teacher, Buffett’s annual letters to Berkshire Hathaway’s shareholders read with the ease of a dime store novel yet pack the wisdom of a philosophy textbook. Additionally, Buffett did not accumulate his wealth perched in a lower Manhattan skyscraper. He did it from a modest office in the unassuming midwestern city of Omaha; sipping Cokes and chomping on hamburgers, he amassed a fortune.
The Oracle of Omaha’s ability to relate to the “common investor” can be both inspiring and misleading. We should not forget, for instance, that behind Buffett’s folksy writing style and approachable demeanor lies an unparalleled investment mind. The two most notable Buffett biographies, Roger Lowenstein’sBuffett: The Making of an American Capitalist and Alice Schroeder’s The Snowball: Warren Buffett and the Business of Life, reveal that Buffett is fueled by a (likely) photographic memory, an encyclopedic knowledge, and an ability to quickly distill complex business problems into logical and actionable solutions. Few investors possess all of these skills, yet a disproportionate number believe they can replicate or mimic Buffett’s approach with comparable results. Perhaps in acknowledgment of this widespread mismatch of aspiration and skill, Buffett has in his recent shareholder letters become an advocate of low-cost index funds, much as his mentor, Benjamin Graham, did late in his life.
In contrast, the inside jacket cover of Inside the Investments of Warren Buffett: Twenty Cases by the Germany-based portfolio manager Yefei Lu calls the book “a gift to Buffett followers who have long sought a pattern to the investor’s success.” It is a bold claim, particularly because Buffett’s “patterns” are not rigid and have at times morphed to seize opportunities or adapt to new realities. Examples include the transitioning of his activities from a partnership to a corporate business structure, moving from a deep-value to a growth-at-a-reasonable-price mindset, and managing increasing amounts of assets.
Undeterred, Lu, in an attempt to “understand from a third-party perspective what rationales [Buffett] or any investor was likely to have seen in each situation,” examines a cross section of 20 formative investments that Buffett has made. The author deserves credit for tremendous effort, even though the outcome turns out to be meager.His book is a positive contribution but falls short of its goal.
The book is in four parts, the first three of which analyze specific periods of Buffett’s career—“The Partnership Years (1957–1968),” “The Middle Years (1968–1990),” and “The Late Years (1990–2014).” Section Four summarizes the lessons learned from researching the 20 investments. Buffett followers will particularly enjoy the case studies of See’s Candies, GEICO, and Nebraska Furniture Mart, which are widely regarded as some of his best investment decisions. The case studies vary widely in depth. Some (Capital Cities, General Reinsurance Corporation) are more than 15 pages long; others (National Indemnity and The Buffalo Evening News) run to around 5 pages.
Lu is at his best in “The Partnership Years,” where he examines five investments Buffett made while running his partnership for a close group of friends and family. The investments are Sanborn Maps, Dempster Mill, Texas National Petroleum, American Express, and Berkshire Hathaway, the struggling textile company that eventually became today’s well-known conglomerate. Considering the difficulty of obtaining financial data from the 1950s, compared with the situation today, Lu conducts impressive financial research in this section. He digs through old annual reports, Moody’s Investors Service manuals, and partnership letters to provide the reader with the key data points and metrics that Buffett would have seen when he first researched the businesses. These analyses are in themselves worth the price of the book. This section also reveals Buffett’s wide-ranging abilities and confidence as an investor, even early in his career. Buffett variously assumed the role of activist investor (in Dempster Mill and Sanborn Maps), merger arbitrage investor (in Texas National Petroleum), opportunistic quality investor (in American Express), and classic deep-value investor (in Berkshire Hathaway). Furthermore, Buffett was willing—and had a loyal investor base that allowed him—to concentrate more than 30% of the partnership’s net worth in a single opportunity. Most money managers today focus on only one type of strategy and are reasonably cautious about making such large bets in their portfolios lest they lose both their investment value and their business if things fail to go according to plan.
The book falls short in two important ways. First, it is not tough enough in assessing Buffett’s decisions and soft-pedals his mistakes, even those Buffett himself readily admits to, such as US Air. For example, at the conclusion of the US Air case study, Lu writes, “Despite going through huge fundamental issues, and becoming the most infamous Buffett mistake, US Air was, in fact, a profitable investment.” Also, some of Buffett’s major early mistakes, such as Dexter Shoe and the Baltimore department store chain Hochschild Kohn’s, were regrettably not included in the 20 case studies, nor was the recent investment in Tesco, the British multinational grocery and general merchandise retailer, which amounted to a $444 million after-tax loss for Berkshire Hathaway. Each of these investments was probably just as formative as the 20 selected for the book and could have yielded important lessons for investors to consider.
Second, with the benefit of hindsight, readers can easily conclude that many of Buffett’s investment decisions were masterstrokes. The outcomes, however, were not always obvious at the outset. In some of the case studies, Lu makes a respectable attempt at valuing the companies with such metrics as enterprise value (EV) to EBITA (earnings before interest, taxes, and amortization). He considers what might have constituted an attractive multiple based on the company’s profitability and growth characteristics. In the Coca-Cola case study, for instance, Lu writes, “The price of 10.0× EV/EBITA is not dirt cheap, but it seems to be a very good price given the quality of the business.” To be most useful, however, this sort of valuation requires a comparison with multiples for similar companies at the time. In some cases, Lu overuses the words “clear” and “clearly” to describe what Buffett might have seen when he studied companies 30 or more years ago. Without seeing journal entries outlining what Buffett viewed prior to making the decisions, to be so certain is problematic.
To the author’s credit, he admits in the conclusion that “demystifying Warren Buffett is no easy task,” and yet he makes a laudable effort to do so in this book. Lowenstein’s and Schroeder’s biographies provide readers with plenty of qualitative insights for understanding how and why Buffett acquired the companies he did. Inside the Investments of Warren Buffett, however, fills in the financial gaps and valuation work, which might be of greater interest to equity analysts and value-minded portfolio managers.
—T.M.W.