How Warren Buffett built his fortune
The more you learn, the more you earn.
- Warren Buffett
Sometimes success is the product of being in the right place at the right time, being born into the right conditions, getting the right piece of advice, or perhaps even having that one-in-a-million moment of perfect insight. Other times, it is the product of seeming inevitability.
This last one is the case of the man we are looking at today. To be clear, this is not a born into wealth kind of story. Quite the contrary, Warren Buffett was born into a working class family in 1930.
So what is the secret of his success? How did this seemingly ordinary guy accomplish what we are all trying to accomplish? Most importantly, if he really was like any of us, how can we say that his rise was essentially inevitable?
There is almost certainly something that has to be original and unborn when we speak about someone as being inevitable. Case and point, Buffett was 7 years old when he read the book One Thousand Ways to Make $1000.
He made his first transactions at that age, buying and selling Coca-cola (bottles not stock) for extra cash. This is of course deliciously ironic because today Buffett is one of the major stockholders of Coca-cola. At an age when most kids are watching television and spending time in the playground, Buffett was already wheeling and dealing. Ask him about it, "I like numbers," he would reply.
Despite his obvious natural inclination, perhaps what really made Buffett the man he is today were the early defeats and the perseverance he had to cultivate, as well as his pioneering spirit.
As a young man, he loved learning and competition but faltered academically. He ended up at the unimpressive University of Nebraska. After completing his degree he interviewed for Harvard Business School but was turned down. Many would have given up but he tried again.
At Columbia, Buffett found what every success story needs, mentors. Ben Graham and David Dodd would become his guides in his early forays into the investing world. Graham gave him the "two rules of investing":
Rule #1: "Never lose money."
Rule #2: "Never forget Rule #1."
Too often, when one finds a way that works, a path to follow, then that becomes enough. Ben Graham, in particular, provided Buffett with a formula for investing wisely, investing safely and profitably.
Had Buffett taken this formula as his own, and merely followed the path, would he be a household name today? We will never know the answer to that. What we do know however is that Buffett followed his mentor to a point and then blazed his own path according to his own original understanding.
There was a fundamental choice that Buffett had to make in parting ways with his mentor and it is a philosophical divide that made Buffett who he is today.
At the heart of the Buffett philosophy is the idea of compounding wealth. Where some would be content taking $100 and safely making 15%, Buffett was about, eschewing safety, taking that same amount and turning it into $2700. In other words, growing rich was always the end goal.
The Magic of Compounding Interest.
What is fascinating about Buffett's approach is that he would often buy the exact same stocks as other investors - as his own mentors - but somehow get better results. How is this possible?! Buffett says about himself, that it is not that he had better ideas than other investors, but that he simply had less bad ones. In other words, where some would diversify for safety, he would "focus" on his best ideas and invest as much money as possible in them.
Despite the clarity of his vision, there were some significant setbacks. Out of Columbia, he wanted to go to work for the investment firm of Benjamin Graham, his mentor.
He offered to work for free and was rejected. He went back to Omaha, bought a gas station and it too faltered. Again, Buffett persevered and while still in his early twenties, in buying up the stock of a then little-known company called Geico, he applied that "no-holds-barred" approach that would become his trademark.
First came trying to figure out if Geico was indeed a good company to invest in. Buffett did his research. How? He got on a train from New York to Washington D.C., to the company's headquarters and literally knocked on Geico’s front door.
The man who answered was Lorimer Davidson the future CEO of Geico. Buffett pelted Davidson with in-depth questions for hours and once he was convinced that the company had a bright future, Buffett got back on the train and headed back to New York where he promptly proceeded to invest two-thirds of his total net worth on the fledgling company. He believed Geico’s stock was bound to double within 5 years.
He believed in The Geico agentless business model, and went where few investors dared to go. He over-committed to a single company. In doing so he was directly contradicting his mentor’s approach. He did so, simply put, because his goal was different.
Buffett did not value safe diversification (where one invests in a great idea but also buys other safe, but mediocre stocks for safety). Buffett wanted to get rich and repeating this approach is how he did it.
After Geico, Buffett didn’t need to put 75% of his net worth on the table again, but he continued to buy the most shares possible in his best ideas.
Warren Buffett’s early career is marked by countless investments, all very different, with varied levels of success. There was Greif Brothers Cooperage, Cleveland Worsted Mills, Western Insurance, and National American Fire Insurance, among many.
What, if anything, linked all of these investments? What is the one thing that we can say Buffett looked for in a company. We know he brought an aggressive commitment to the table, so what is the unifying quality he expected his investment prospects to have? Many of Buffett’s early investments had a strong management team.
This means that Buffett thought capital was going to be used more wisely by the right management team. This idea might seem simple and commonplace at first, but it really isn’t. Too often a good investment is seen as one that goes to some sort of incredible idea, or to a wunderkind CEO, but this was not what drew his attention.
In Buffett's mind "management quality" was not a flashy, elusive concept but rather something synonymous with smart capital allocation. In other words, to this day he is not after the one-of-a-kind genius with the precious but fragile idea that will change the world. He's looking for someone who thinks like he does on issues of compounding wealth and getting that return on capital.
That's what he wants in a CEO; someone who is an investor at heart, someone who has and is aware of their competitive advantage in the marketplace; someone who has their eyes fixed on the plausibility of a substantial return on investment. The numbers, just as he is obsessed with them, he wants to see the obsession mirrored in management.
It is an interesting paradox that plays out in the investment style that made Warren Buffett who he is today. At a glance, he appears to be a risk taker, someone who deliberately avoids safety and puts himself out on a limb for a chance at the big money. Logic, however, tells us this can’t be so. Otherwise, he'd be a gambler and a half century of success would have to be attributed to luck.
That would be the wrong lesson to take away from Mr. Buffett. He is no gambler. The way a gambler rests his faith on luck, he rests his on a method, on thorough and deep research, on scrutiny. The supreme confidence he has in his investments is the product of research not just in the numbers but in the people and philosophies behind them.