Warren Buffett’s Investments – 20 Cases | 9.21.

16
Leo Cruz
Adapted summary of Inside the Investments of Warren Buffett by Yefei Lu
 PERFORMANCE

THE PARTNERSHIP YEARS (1957 – 1968)

1. 1958: Sanborn Map Company

2. 1961: Dempster Mill Manufacturing Company

3. 1964: Texas National Petroleum

4. 1964: American Express

5. 1965: Berkshire Hathaway

THE MIDDLE YEARS (1968 – 1990)

6. 1967: National Indemnity Company

7. 1972: See’s Candies

8. 1973: The Washington Post

9. 1976: GEICO (Government Employees Insurance Company)

10. 1977: The Buffalo Evening News

11. 1983: Nebraska Furniture Mart

12. 1985: Capital Cities / ABC

13. 1987: Salomon Inc.—Preferred Stock Investments

14. 1988: Coca-Cola

THE LATE YEARS (1990 – 2014)

15. 1989: US Air Group

16. 1990: Wells Fargo

17. 1998: General Re

18. 1999: MidAmerican Energy Holdings Company

19. 2007-2009: Burlington Northern

20. 2011: IBM

LESSONS LEARNED

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 Performance

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Performance

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Performance

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 THE PARTNERSHIP YEARS (1957 – 1968)

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The Partnership Years Summary

Partnership Years
 Warren E. Buffett’s (WEB) investments varied
─ Invested in cigar-butts (e.g. Sanborn Maps and Dempster Mills), great businesses (e.g. American Express), special situations
(e.g. Texas National Oil), and control situations (Dempster Mills).
 Commonalities
─ 1. Avoided situations where business fundamentals were completely broken or deteriorating.
 Even in cases where value was primarily based on asset value (Sanborn Maps, Dempster Mills, and Berkshire), WEB
invested in companies when there was positive change in the business.
 Often invested when there was a management change where capable management replaced poor previous
management in a business where execution mattered.
 Typically identified clear operational improvement opportunities where a positive catalyst could be expected (Sanborn,
Dempster, and Berkshire).
 Most important—WEB only invested in businesses that were still profitable.
 None were hemorrhaging cash.
 All made money and many had positive catalysts.
─ 2. Conducted primary research on each business he invested in.
 Had a detailed understanding of how the businesses functioned fundamentally.
 Thoroughly understood both the management and ownership structures to an astounding level of detail (e.g. in Sanborn
Maps, he knew the exact structure of the BOD and their motivations; in Berkshire, he knew both the management team
and the owners he was buying from).
─ 3. Strived to understand the individual economics of all the business segments and sub-segments vs. as a group.
 In AXP, he saw a rapidly growing credit card business temporarily set back by operational issues but was showing clear
signs of recovery and growth in 1963.
 Saw Dempster Mill was not simply a deteriorating windmill business.
 Demonstrates that he did not only focus on aggregate financial metrics.

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1. 1958: Sanborn Map Company

Investment Thesis Summary Stats

 Substantial asset value.  Stock Price $45
─ $7.3M securities portfolio exceeds total market cap of  Shares Outstanding 105,000
$4.73M—requires a control position to unlock value.  Market Capitalization $4.75M
 Revenues $2M
 Core mapping business, though in structural decline, is still  EBIT (incl. investment income) $360k
profitable with clear operational improvement potential.  Net Income $283k
─ Positive operating earnings of $132k in 1959 vs. $163k  EPS (incl. investment income) $2.69
in 1958, down 7% (investment income was $228k and  Adj. EPS (excl. investment income) $.95
$243k, respectively).  P/S 2.4x
─ Core mapping business is threatened from “carding,”  P/E (1959 TTM—incl. investment income) 16.7x
but services in community planning, public utility  P/E (1959 TTM—excl. investment income) 47x
records, and market analysis is still intact.

Outcome
 WEB invested 35% of the Buffett Partnership Ltd (BPL) assets
in SMC.
 Turned his original stake into a control holding by acquiring a
majority of SMC between 1958 and 1961.
 In 1961, WEB successfully separated SMC into two entities.
─ Separated the stifling BOD from the fundamental map
business, which he left to pursue operational
improvements—this entity also received a $1.25M
reserve fund of stocks and bonds as additional capital
for the turnaround.
─ The investment portfolio was realized via an exchange
of portfolio securities for SMC stock, which involved
~72% of outstanding SMC stock.
─ As a sweetener, the deal also included a smart tax
structuring, which further saved shareholders ~$1M in
capital gains tax.

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1. 1958: Sanborn Map Company

 Market leader in fire insurance mapping in the United States—95% revs from 30 insurance companies.
 Charges subscription fees of $100 / year for medium sized cities.
 Insurance companies use SMC to price risk, which saves them significant costs in conducting field inspections.
 Significant up front time and resource investment involved in mapping cities.
 Same product (map), different revenue streams to insurance, community planning, public utilities, and market analysis.
Business  Decades of experience in mapping and training staff to produce high quality maps.
 De facto standard—insurance companies preferred to train their underwriters on one standard; SMC ensured a
systematic surveying process on a national scale.

 SMC is the dominant national player—other competitors include Jefferson Insurance and Hexamer & Locher.
 SMC has local EOS in mapping—once it maps a city, it can take significant share to amortize upfront investment costs
that competitors can’t match economically (unattractive to enter a market by taking smaller share).
 Provides a critical service and generates recurring revenues from subscriptions.
 Field inspection is required by a professional surveyor which is time-consuming and expensive so insurance companies
Competitive Position used maps that provided all the requisite details to assess the fire risk (the finished commercial product could be a
volume of maps weighing 50 lbs).
 Insurance companies underwrite and price risk by inspecting individual buildings for construction type, construction
materials, number of windows, and other factors related to the structure itself and surrounding structures.
 Substitution threat—”carding,” is a new methodology that allows insurance companies to price risk using algorithmic
calculations instead of maps; profit margins have declined, demonstrating the threat is clear and present.

 Nine of the fourteen directors owned 46 combined shares of stock out of 105,000.
 According to WEB, management officers were ‘capable, aware of the problems of the business, but kept in a subservient
role by the BOD.’

Management

 Traded at 2.4x revs and 47x 1959 trailing earnings.

 Significant asset value: market value of securities portfolio of bonds and stock = $7.3M vs. $4.75M market cap.

Valuation

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1. 1958: Sanborn Map Company

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1. 1958: Sanborn Map Company

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2. 1961: Dempster Mill Manufacturing Company

Investment Thesis Summary Stats

 Dempster Mill’s core windmill business is threatened by  Stock Price $28
electric pumps but far from dead.  Shares Outstanding 60,146
─ generates long-tail recurring revenues through spare  Market Capitalization $1.7M
part sales and servicing.  Revenues $7.2M
 Operational improvement can be catalyzed by installing hand  EBIT (incl. other income) $452k
picked manager: Harry Bottle.  Net Income $146k
─ Can increase pricing on replacement parts to captive  EPS $2.43
audience.  P/E 11.5x
─ Higher cash conversion on inventory.  P/B (adj.) .80x
─ SG&A reductions of 50%.  P/LV .88x
─ Shuttering unprofitable branches.
 The bulk of DM’s assets could be sold and converted to cash
(81% of the adjusted asset value is inventory and accounts
receivable). Outcome
 Classic net-net—purchase price of $28 / share is less than
liquidation value of ~$32 (net current assets less all liabilities).  WEB started building a stake in DM since 1956 as a general
value investment that evolved into a control situation—by the
end of 1961, BPL owned 70% directly and 10% indirectly
through associates and DM represented 20%+ of BPL’s
assets.
 Purchased shares at $28 / share, a 68% discount to BV and
20% to asset value of $35 / share (see BPL exhibit).
 Exited in 1963 at $80 / share in a private transaction.
 WEB disliked playing the role of activist, laying off personnel
and selling off assets—this was the beginning of his hands-off
preference as an investor.

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2. 1961: Dempster Mill Manufacturing Company

 Sells windmills and assorted agricultural equipment (e.g. seed drills and fertilizer applications) along with spare parts and
servicing.
 Between the late 1880s and 1930s, DM pioneered windmill development and farm irrigation systems in the Great Plains.
 Built many related water systems such as pumps and irrigation machinery.
 After sales of new equipment, DM sells spare parts and servicing which provides a long-tail recurring revenue stream.
Business

 Strong substitution from electrical pumps—federal govt. stimulus helped extend the electricity grid in the Midwest;
electrical pumps had the advantage of being turned on whenever water was needed vs. windmill-driven pumps where a
farmer had only the water provided in a reservoir which was replenished by the windmills at an unpredictable rate.
 Servicing business is decent given the installed base of customers.
 Strong brand name in windmill business but not new product categories; new product categories includes many
Competitive Position competitors.

 Incapable management to be replaced by capable management in Harry Bottle.

 Harry Bottle:
─ Key performance indicators (KPIs): incented through clear KPIs and managed the business based on key
financial metrics: high percent of inventory to cash; SGA reductions of 50%; shutting down unprofitable
Management ─
businesses.
Tackles “tough things first”: did not shy away from necessary action including quick disposal of unprofitable
branches and writing off dead merchandise.
─ Hardworking: WEB described Harry as someone who focused on the tasks at hand: “I like dealing with
someone who is not trying to figure how to get the fixtures in the executive washroom gold-plated.”

 Adjusted asset value of $35 vs. purchase price of $28

 Liquidation value of $32

Valuation

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 2. 1961: Dempster Mill Manufacturing Company

Liquidation Value / Share:

Current Assets $5,491
Less: current liabilities $1,230
Net Current Assets $4,261
Less: Total Liabilities $2,318
Liquidation Value $1,943
Shares Outstanding 60,146
LV / Share $32

Source: Warren Buffett to Buffett Partnership Ltd, Jan 18, 1963

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2. 1961: Dempster Mill Manufacturing Company

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3. 1964: Texas National Petroleum

Investment Thesis Summary Stats

 Merger arb workout: Texas National Petroleum in the process of  Bond Price $98.78
being acquired by Union Oil of California—deal announced but not  Stock Price $6.69
completed.  Warrants $3.19
 M&A in oil and gas industry is common in the 1960s
 Bonds Outstanding $6.5M
 Union Oil of California acquired Wooley Petroleum in 1959 and would
 Shares Outstanding 60,146
merge with Pure Oil Company in 1965.
 Bonds  Warrants Outstanding 650,000
─ 6.5% cpn redeemable at $104.25
─ $6.5M outstanding
─ Return calculation (6 month holding period):
▫ $3.25 cpn + $5.47 ($104.25-$98.78) = $8.72
▫ $8.72 / $98.78 = 9%, or 18% annualized
 Common Stock
─ 3.7M shares outstanding
─ $7.42 offer price Outcome
─ 40% owned by insiders
─ Return calculation (6 month holding period):  WEB invested in all three classes of securities:
▫ $7.42 - $6.69 = $.73 ─ Debentures with FV of $260k
▫ $.73 / $6.69 = ~11%, or 22% annualized
─ 60,035 shares of common stock
 Warrants
─ 650k outstanding ─ 83,200 warrants
─ Option to purchase stock at $3.50 / share  Deal closed in November.
─ Estimated value of $3.92 ($7.42 - $3.50)  Payout was $7.59 / share vs. $7.42.
─ Return calculation (6 month holding period):  WEB observed: “This illustrates the usual pattern: (1) the
▫ Same as common stock $3.19 + $3.50 = $6.69 deals take longer than originally projected; and (2) the payouts
purchase price tend to average a little better than estimates.”
 Timeline  WEB’s annualized return was ~20% for the bonds and 22% for
─ No formal date announced the stock and warrants.
─ Management conversation indicated August or September
1963
─ 6 month holding period
 Risks:
─ Shareholder approval risk: low due to 40% insider ownership
─ Antitrust: low; numerous similar deals completed over the
decade.

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4. 1964: American Express

Investment Thesis Summary Stats

 American Express is great business with significant growth  Stock Price $40
prospects temporarily unfavored from salad oil scandal  Shares Outstanding 4.46M
overhang:  Market Capitalization $178.4M
─ The estimated $150M liability is overblown; the real  Revenues $100M
liability is ~$60M and AXP has $250M+ in cash.  EBIT $16M
─ American Express possesses two great franchise  Net Income $11.3M
businesses in travelers checks and credit cards:  EPS $2.52
▫ Travelers checks are fast replacing letters of  P/E 16x
credit and AXP is at the forefront of this secular  P/E (incl. investment earnings + $40M liability) 14.2x
shift.  EV / EBIT 8x
▫ Credit card business is a small but fast growing  EV / EBIT (adj for $40M liability) 11x
business with strong yoy increases in card  EV / EBIT (adj for investment earnings +$40M liability) 8.5x
member purchases and the number of  ROCE 78%
cardholders.  ROE 14%
▫ ROCE is 78% and ROE is 14%.
 Valuable float. Outcome
─ AXP earned $4.4M after tax in realized investment
gains which is credited directly to equity.  WEB became interested during the salad oil incident—he
 Great management. sensed there was an opportunity beneath the scandal.
─ Howard Clark demonstrates integrity and is a proven  He conducted his own diligence by speaking to customers and
operator (turned around the credit card business). vendors in Omaha, including restaurants and restaurant
customers to see if their habits changed; he also went to
banks and travel agencies and even spoke to competitors.
 He concluded that the travelers checks and credit card
businesses were intact.
 Also felt that AXP was unlikely to go insolvent.
 One of his first investments where prime emphasis was on the
business quality and future growth prospects.

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4. 1964: American Express

 Travelers checks: AXP’s largest business and growing fast—these were checks that customers could purchase before
they travel and were accepted at venues and banks internationally; AXP collected cash and a small fee from customers
while providing a network of banks and venues where they could transact; it also paid a small commission to
international merchants to accept their products.
 Money order and utility bills business—safe delivery via courier or mail service of money; in 1963, AXP’s money orders
Business were the largest selling commercial instrument of its kind in the U.S.
 Travel business—sold steamship cruise tickets and organized travel excursions.
 Credit card business—not a big business but growing; quickly became a leader with its strong network and brand.

 Travelers checks are far superior to letters of credit and taking share (7% CAGR from 1954 to 1963; outstanding
travelers checks increased to $470M from $260M)—simpler to purchase, much less paperwork, and processed faster;
they also have fewer transaction costs and could be replaced if stolen.
 Issuing banks also liked selling travelers checks since it increased their cross-sell, reduced their workload for LOC work
which came with smaller fees, and AXP guaranteed customer checks vs. relying on creditworthiness of issuing LOC
Competitive Position banks.
 Money orders and utilities—stagnant business but useful.
 Travel business—no BTE.
 Credit card business—strong network effects; network of cardholders and merchants gets more valuable with size.
 Other—banking, foreign remittances, freight, Wells Fargo, Hertz, and warehousing; no clear advantages.

 Howard Clark, CEO, led the turnaround of the credit card business and drove marketing efforts before becoming CEO.
─ Credit card business was losing money due to overwhelming back-office transaction payment processing—he
instituted immediate measures to lighten the burden including a requirement for cardholders to pay back debt in
30 days, stricter credit approval guidelines, and higher fees for merchants and cardholders.
Management ─ In marketing, he increased the ad budget annually and hired Ogilvy, Benson, and Mater to develop AXP’s first
modern campaign.
─ Seemed to have integrity given the promise to make good on the salad oil liability even though AXP had not
been determined as the liable party.

 Salad oil liability

─ Market says $150M
─ Management says $100M, but wrote verification receipts on $82M; another $15M in delivery orders were
disputed; and 1/3 of $39M in receipts for additional sunflower oil were found to be forged so AXP would likely
not be liable for this amount.
Valuation ─ High-quality seawater also has some market value
─ Real liability is ~$60M minus tax shelter of $20M (34% tax rate), or ~$40M net cash liability.
 AXP had cash of $250M+, more than enough to cover the liability.
 P/E (adjusted for salad oil liability of $40M and investment income): 14.2x
 EV / EBIT (adjusted for salad oil liability of $40M and investment income): 8.5x

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4. 1964: American Express

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4. 1964: American Express

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4. 1964: American Express

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5. 1965: Berkshire Hathaway

Investment Thesis Summary Stats

 Berkshire Hathaway is facing challenges but can undergo  Stock Price $14.06
positive operational change while enjoying a favorable COGS  Shares Outstanding 1.14M
environment.  Market Capitalization $16M
─ Ken Chace can be instituted as CEO and improve  Revenues $49.3
operational efficiency.  EBIT $4.7M
─ Congress passed legislation in 1965 to extend one-  Net Income $2.3M
price cotton through 1970 which allows American textile  EPS (reported) $2.24
mills to purchase American cotton at the same  EPS (adjusted for loss carryovers) $4.24
government established price at which it is sold to  P/E 3.5x
foreign countries.  EV / EBIT (on net cash of $3.7M) 2.4x
 Highly attractive valuation.  P/B .60x
─ Berkshire trades at 2.4x EV / EBIT and 3.5x earnings.
─ It generated $5.3M in cash; on a market cap of $11.3M
(stock priced ranged from $7.60 to $15), this is less Outcome
than 2x FCF or 3x on a market cap of $16M.
─ Net working capital alone is $19 / share.  WEB made the bulk of his purchase between 1962 and 1965
at prices between $7.60 and $15 / share (average price was
$14.06).
 Considers Berkshire one of his worst investment errors—
although it did not lose money in absolute terms.
 Berkshire provided the capital WEB invested in other
businesses starting in 1967 with the purchase of National
Indemnity.

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5. 1965: Berkshire Hathaway

 Berkshire Hathaway is comprised of two textile manufacturing businesses dating back to the 1800s that merged in 1955:
─ Berkshire Cotton Manufacturing Company
─ Hathaway Manufacturing
 Shrunk from 12 mills and 11k employees in 1948 to 2 mills and 2,300 employees by 1965.
 Berkshire’s fabrics are sold to other clothing manufacturers as well as directly in retail channels as curtains and other
Business home furnishings.

 Business is facing strong competition from imports and textiles are a commoditized product.
 No real BTE.
 Execution is critical (i.e. operational effectiveness).

Competitive Position

 WEB sees Ken Chace as an excellent manager and placed him as CEO.
 Chace was already beginning to release value analogous to Harry Bottle at Dempster Mill.

Management

 WEB values Berkshire at ~$21.30 / share vs. an average price of $14.06: “a price halfway between net current asset
and book value…[with] current assets at 100 cents on the dollar and fixed assets at 50 cents on the dollar”; this implies
a 31% discount.

Valuation

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5. 1965: Berkshire Hathaway

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5. 1965: Berkshire Hathaway

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5. 1965: Berkshire Hathaway

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 THE MIDDLE YEARS (1968 – 1990)

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The Middle Years Summary

Middle Years
 Increasingly invests in private companies and builds up his asset base.
─ Insurance.
─ Regional banks.
─ Other control assets—Nebraska Furniture Mart and See’s Candies.
 Gradual shift from asset value focus to franchise earning power (high ROTCE) and qualitative factors.
─ Favored demonstrated franchise earning power—strong consistency and high ROTCE.
─ Entrenched competitive position.
 See’s Candies—local mindshare and pricing power.
 The Washington Post—duopoly position.
 GEICO—structural cost advantage and growth prospects.
 The Buffalo Evening News—duopoly position with monopoly potential.
 Nebraska Furniture Mart—local scale and cost advantage.
 Cap Cities / ABC—high national penetration.
 Coca-Cola—distribution and brand power.
─ Growth prospects
 See’s Candies—pricing power and yoy growth in lbs of candy sold.
 The Washington Post—strong growth in lines of advertising and circulation; also has pricing power.
 GEICO—consistent policyholder growth and pricing power.
 The Buffalo Evening News—potential to move from a duopoly to a monopoly.
 Nebraska Furniture Mart—continually taking share from local players due to virtuous circle of scale and low-cost
advantage.
 Cap Cities / ABC—publishing business growing in circulation and ad revs.
 Coca-Cola—62% of soft drink sales are in underpenetrated international markets with rapid volume growth.
─ Capable Management
 Jack Ringwalt, National Indemnity—”Everything was as advertised or better.”
 Katharine Graham and John Prescott, The Washington Post—disciplined and metric focused.
 Jack Byrne, GEICO—“cool, unflappable, professional, a leader and promoter.”
 Rose Blumkin, Nebraska Furniture Mart—legendary work ethic and maniacally focused on delivering the best customer
value.
 Tom Murphy, Cap Cities / ABC—“the best [CEO / management] of any publicly owned-company in the country.”
 Roberto Goizueta and Don Keough, Coca-Cola—WEB praised them as one of the best management duos he’s ever
seen.

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6. 1967: National Indemnity Company

Investment Thesis Summary Stats

 Attractive valuation.  Purchase Share Price $50
─ Growing business earning $16.8M in premiums and  Market Cap $8.6M
$1.6M in earnings—5.4x earnings on $8.6M purchase  Premiums earned $16.8M
price.  Earnings $1.6M
─ Bond portfolio of $24.7M and stock portfolio of $7.2M is  P/E (1967) 5.4x
3x the purchase price.  ROC 20%
 Great economics.
─ 20% ROC
─ ~15-20% growth (1st year as Berkshire subsidiary it
grew top-line to $20M from $16.8M).
 Strong and proven management.
─ Jack Ringwalt’s mantra is “there are no bad risks, only
bad rates.”
─ Extremely disciplined underwriter—willing to walk away Outcome
from bad risks.
 WEB paid $8.6M for National Indemnity (incl. National Fire &
Marine, an affiliated company) on $1.6M in earnings, or 5.4x—
he valued the business at $35 / share but offered $50 / share.
 Key quality is: the ability to raise capital (float) and use it to
invest in stocks.
 Soon after purchasing National Indemnity, WEB started
investing the float successfully—after two years, he took the
portfolio from $32M to $42M.
 This was the start of Buffett’s career-long fascination with
insurance which he continues to use for float and investments.

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6. 1967: National Indemnity Company

 Established in 1941 and wrote liability insurance on taxis—the company specialized in writing specialty insurance.
 Prior to 1967, NI became broader in scope and was closer to a more general fire and casualty insurance operator.
 Founding principle is that there is a proper rate for every legitimate risk and the insurer was always to make the correct
assessment to earn an underwriting profit.
 Unlike peer auto insurers, it was willing to insure risks such as casualty for long-haul trucks, taxis, and rental cares.
Business  Extremely disciplined—does not chase revenues when it’s unprofitable to write.
 Aim is profits, not size.

 Main strength is underwriting discipline.

 Earns 20% ROC

Competitive Position

 WEB praised Jack Ringwalt in the purchase: “Everything was as advertised or better.”
 Strong reputation for underwriting discipline.

Management

 Paid $8.6M on $1.6M in net income, or 5.4x earnings.

 National Indemnity and National Fire & Insurance also had a bond portfolio worth $24.7M and a stock portfolio worth
$7.2M—a total portfolio of $30M+, and 3x the purchase price.

Valuation

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7. 1972: See’s Candies

Investment Thesis Summary Stats

 Great franchise business with mindshare on the west coast.  Purchase Price $25M
─ 25% ROTCE.  Revenues $31.3M
─ 15% CAGR on revenue per directly owned store  After Tax Net Income $2.1M
─ Modest store growth.  ROTCE 26%
─ Strong brand power => pricing power.  Store Count 167
 Good price  Revenue / Directly Owned Store $326k
─ At 11.9x, growth is nearly free.  P/E 11.9x
─ See’s should get 3%+ growth; with 5% growth, a $25M  EV / EBIT 6.3x
purchase price has a ~30% MOS.

Outcome
 In 1972, Blue Chip Stamp, a Berkshire subsidiary, contacted
WEB to inform him that See’s was for sale.
 WEB was immediately interested and his wife Susie was
already crazy about its candy.
 In 2010, See’s earned $82M pretax on $383M in sales.
 Assets in 2010 were $40M—only $32M in incremental capital
needed to be invested since 1972.
 At the same 11.9x multiple, in 2010 See’s would be worth
$683M, or 25x over WEB’s $25M purchase price (9.1%
compounded).

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7. 1972: See’s Candies

 Private business founded in Pasadena in 1921 by Charles See and his mother Mary See—family run business.
 Strong brand power in California with a reputation for quality—maintained its recipe even during the sugar-rationing
period of WWII.

Business

 Dominant market share on the west coast.

 Enjoys a network of owned stores with dedicated personnel rather than franchisees.
 Little technological risk and consistent financial performance.
 Strong yoy increases in revenue per directly owned store.

Competitive Position

 Family owned.

Management

 $25M on $2.1M is ~11.9x.

 Quick Math: $2.1M / (10% - 3%) = $30M. This assumes zero growth capex but shows that anything greater than 3%
makes See’s much more valuable (WEB probably assumes 5%+ growth).

Valuation

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7. 1972: See’s Candies

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8. 1973: The Washington Post

Investment Thesis Summary Stats

 Great collection of businesses.  Stock Price $22.69
─ Newspaper publishing—duopoly position with 60%  Shares Outstanding 4.7M
share and growing.  Market Capitalization $106M
─ Magazine and book publishing—Newsweek is #4 in ad  Revenues $218M
revenues and growing.  EBIT $21.8M
─ Broadcasting—revs up 17% and op income up 55%.  EPS (incl. investment income) $2.08
─ Total ROTCE of 17.9%  P/E 10.9x
 Capable management.  *EV / EBIT 5.3x
─ Disciplined management with strong focus on key  ROTCE 17.9%
metrics.
─ Shareholder friendly.
 Cheap price. *tax rate in 1973 was 49.5%
─ 10.9x earnings implies free growth behind a durable
franchise. Outcome
 From 1972-1973, WEB accumulated shares totaling ~10%.
 WEB struck a lifelong friendship with Graham (would later
become a key part of his network when looking at other
businesses) and became a director of the Washington Post in
1974 and one of Graham’s trusted advisors—his influence
kept her capital allocation policies conservative and she rarely
spent on acquisitions.
 By 1985, op margins increased to 19% from 10% in 1974.
 The company also retired ~40% of its total shares over the
same period.

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8. 1973: The Washington Post

 Publicly listed in 1971, and in 1973, after the chairman Fritz Beebe passed, Katharine Graham became the first female
chairman of a Fortune 500.
 Three major divisions
─ Newspaper publishing—dominant 60% market share; duopoly position.
─ Magazine and book publishing—owns Newsweek which ranked 4th in ad revs vs. all magazines
Business ─ Broadcasting—revs up 17% and op income up 55% with same set of TV channels and radio stations; currently
there are two competitive challenges to license renewals for two of its TV stations
 Overall, revs increased to $217.8M from $85.5M, or 11% CAGR over 10 years; op income grew 10% from $9.4M to
$21.8M.

 Duopoly position in newspapers—in 1972, one of the three remaining D.C. papers disappeared, leaving two major
players: The Washington Post and Star News.
─ Lines of advertising increased by 6.5M from 73M, representing 63% of all advertising lines placed in metro
papers in its area.
─ Circulation increased by 6k for the daily paper (~1%) and by 15k for the Sunday edition (~2%), which implies
Competitive Position that they’re taking share.
─ 60% of all adults in its market read the Post.
 Magazine and book publishing—4th in ad revs; revs up 8% yoy (1972 a record year); 2.75M circulation vs. 2.6M last year.
 Broadcasting—strong organic growth of 17% top line and 55% op income growth; 25% EBIT margins.

 Strong management and metric focused—John Prescott, CEO, communicates the metrics and is extremely
knowledgeable about competition.
─ Prescott calibrated the survey conducted by W.R. Simmons & Associates (to determine that 60% read the Post)
with other newspapers that led their markets throughout the country.
Management  In the magazine segment, the Newsweek management team resumed management responsibility of the paper—resulted
in winning 11 major journalism awards during the year.
 Management seems clearly focused on operational efficiency given op margin expansion from 7.9% in 1971 to 10% in
1972 (margins ranged from 7.8% to 12.2% over 10 years).

 10.9x earnings for a growing business behind a strong franchise.

 17.9% ROTCE

Valuation

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8. 1973: The Washington Post

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8. 1973: The Washington Post

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8. 1973: The Washington Post

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8. 1973: The Washington Post

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9. 1976: GEICO (Government Employees Insurance Company)

Investment Thesis Summary Stats

 Franchise business with a growing policyholder base  Stock Price $3.18
experiencing fixable / temporary problems.  Shares Outstanding 26.6M
─ GEICO sells insurance directly, to better customers, at  Market Capitalization $84.5M
lower costs.  Revenues $900M
─ Structural cost advantage in selling direct: underwriting  EPS ($7.14)
costs are 13% vs. 30% for peers.  P/E NM
─ Untapped pricing power (from relative cost advantage).  Combined ratio 124%
─ Valuable float.
 Stellar management capable of quick turnaround.
─ Jack Byrne developed a strong reputation for disciplined
underwriting—he’s “cool, unflappable, professional, a
leader and promoter.” Outcome
 WEB bought 1.3M shares at $3.18.
 WEB learned of GEICO at Columbia Business School when
Ben Graham sat on the board—he visited their HQ and struck
up a conversation with Lorimer Davidson, GEICO’s investment
officer.
 Put ¾ of his money at the time when he was a student and
sold out at a 50% profit a year later.
 Key question was whether Jack Byrne could turn GEICO
around (GEICO was facing bankruptcy—had $190M in
underwriting losses and was underreserved for claims); after
his meeting with Kathy Graham and Lorimer Davidson, WEB
was so impressed that he bought shares the next morning.
 WEB needed to get capital for GEICO so he went to D.C. to
personally negotiate the deadlines and the stringency of the
regulatory capital requirements set for GEICO (his personal
investment also served as a vote of confidence); Salomon Inc.
(specifically John Gutfreund) agreed to underwrite a $76M
convertible stock offering; other reinsurance companies came
forward to provide reinsurance and the stock jumped from $2
to $8.
 WEB continued to invest in GEICO and by 1995 owned 100%.

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9. 1976: GEICO (Government Employees Insurance Company)

 GEICO has a simple business model: selling insurance directly, to better customers, at lower costs.
 Had consistently growth policyholders through the 1950s and 1960s.
 Reported $190M in underwriting losses in 1975 and was underreserved for claims—faced bankruptcy.
 Generates float, which can produce significant investment income.

Business

 Cost advantage—underwriting costs are 13% vs. 30% with peers given its direct-to-customer model.
 Can pass some of the savings to customers given its structural cost advantage.
 Captivity in lower risk customer base—government employees are lower risks which translate to lower claims expenses.

Competitive Position

 Previous CEO Norm Giddens’ focus on growth led to poor underwriting decisions and claims costs skyrocketed.
 Sam Butler, a lawyer from Cravath, Swain, & Moore and current chairman, took over as temporary CEO.
 In May 1976, Jack Byrne, a self-made insurance prodigy who turned around Travelers Group, was recruited and
appointed CEO (he was disgruntled after being passed over for CEO at Travelers).
Management ─ WEB scheduled a meeting with Katharine Graham and Lorimer Davidson to assess Byrne: he needed to know
if Byrne was “cool, unflappable, and professional…a leader and promoter…[able] to solve [GEICO’s]
problem..[and] make that sale to all the constituencies.”
 Post investment, Byrne did everything right: instituted proper underwriting standards; cut unprofitable business; raised
premiums by an average of 38%; by 1977 he returned GEICO to profitability

 GEICO lost $190M in 1975, but a quick back of the envelope shows a dirt cheap valuation:
─ Premiums cut in half from $900M to $450M
─ Combined ratio of 95%
─ Underwriting profit of ~$22.5M or ~$1 / share
─ Half of a year’s premium held as float and invested at prevailing interest rate of ~7%
Valuation ─ Investment income of ~$.50 / share
─ Steady state earning power of ~$1.50 ($.75 after tax)
─ At 10x, EPV is $7.50 / share
─ Upside optionality if returns are > 7% (WEB could get 20%) and premiums could grow beyond $450M.

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9. 1976: GEICO (Government Employees Insurance Company)

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10. 1977: The Buffalo Evening News

Investment Thesis Summary Stats

 Franchise business and the stronger player in a duopoly  Company Price $32.5M
market.  Operating Income $1.7M
─ 58% and 61% share in daily and Saturday edition vs.  EV / EBIT 19x
Courier-Express’s 24% and 53% (Sunday edition).
─ Strong brand power and long history in Buffalo.
 Significant operational improvement potential.
─ Excessive salaries and capex (extravagant offices)
could be rationalized.
─ Publishing on Sunday has potential to give them Outcome
monopoly power.
─ Ability to replace management with hand-picked  Kathy Graham declined to acquire the Buffalo Evening News
operators—Stan Lipsey, former head of the Omaha but WEB decided to invest for Berkshire.
Sun.  WEB already knew a lot about media companies and saw that
improvements were possible.
 Immediately after WEB’s purchase, they launched a Sunday
edition with a free introductory offer to its weekday customers.
─ The Courier-Express brought a lawsuit against them on
grounds of monopolistic behavior; the initial verdict
ruled in favor of the Courier.
─ In 1979, the U.S. Court of Appeals in New York
reversed the earlier decision allowing the Evening News
more freedom to compete aggressively.
─ Over the next few years, both companies lost money in
an all-out war.
─ By 1982, the Evening News accumulated total losses of
$12.5M since 1977 and on September 4th, the Courier-
Express shut down.
 In the first year as a monopoly, the newly renamed Buffalo
News made $19M pretax.
 In 1986, they made $35M (more than the purchase price);
WEB reported: “The Buffalo News has the highest weekday
penetration rate among any of the top 50 papers in the
country..Sunday penetration now has a penetration ratio of
83%...”

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10. 1977: The Buffalo Evening News

 Privately owned and founded in 1873, it was originally a Sunday paper but transitioned to a Monday through Saturday
paper.
 By 1977, it was one of two major newspapers in Buffalo; the other was the Buffalo Courier-Express.
 Both papers were family owned and operated under a ‘gentlemen’s agreement’ between the families that resulted in the
Evening News being exclusively an afternoon paper while the Courier-Express sold morning editions seven days a week,
Business including an important Sunday edition (Sundays are when most families had the most time to read and this was
important to advertisers).
 Buffalo was unique in that it had the highest percentage of local household subscriptions vs. any other big city in the
country.

 Duopoly position—the Evening News had 268k in readership circulation vs. 123k for Courier-Express.
─ 58% of the 471.5k households in the Evening News daily paper; 61% for its Saturday edition; compares
favorably to 24% covered during the weekday Courier-Express and 53% covered by the Sunday Courier-
Express.
─ Strong potential to monopolize the Buffalo market if it publishes a Sunday paper.
Competitive Position  Brand power—the Evening News had a stronger name and long history in the city.

 Kate Robinson Butler ran the paper until her death in 1974 and Henry Z. Urban came in as the new publisher.

Management

 High valuation of 19x EV / EBIT, but significant optionality on operational improvements and potential monopoly power.
─ Untapped pricing power if only one paper exists.
─ New management could strip out excess opex.
─ Good benchmark in Washington Post—in 1977 it made 43% on capital and op margins of 16%.

Valuation

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11. 1983: Nebraska Furniture Mart

Investment Thesis Summary Stats

 Franchise business with scale and low cost advantage.  Company Price $68.8M
 200k sq feet of floor space and $100M in sales; largest  Revenues $100M
volume in the country.  Pretax earnings $15M
 Local scale advantage in advertising and purchasing.  Net Income $8.1M
 Wide selection attracts customers who want one-stop  EV / EBIT 4.3x
solution.  P/E 8.5x
 Attractive valuation.  P/B .80x
 4.3x EV / EBIT
 8.5x P/E
 .8x P/B
 Maniacally focused management.
 Mrs. B destroyed all competition on her way to building
NFM.
 Legendary work-ethic and integrity. Outcome
 WEB walked into Mrs. B’s store and after a short conversation
bought 90% of the company for $60M on a handshake; Rose
Blumkin (Mrs. B) remained chairwoman and her son Louie
remained president.
 Made sure that the family retained a 20% stake in the
business.
 By 1986, revenues grew to $132M and pretax earnings
reached $18M.
 Mrs. B lived to 104, spending her last weeks closely in touch of
the business she built from nothing.

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11. 1983: Nebraska Furniture Mart

 200k sq. feet of floor space and wide selection of home furnishings from sofas to kitchens to appliances.
 Buys directly from suppliers and sells directly to customers.

Business

 Low cost advantage; local EOS gives it scale in advertising and purchasing—can pass savings on to customers; zero
debt and paid everything in cash ($7M in overhead vs. $100M in sales—7% vs. 19.8% SG&A for Wal-Mart).
 Virtuous circle of low prices => more customers => greater scale and cost savings => lower prices; early pioneer of
‘discount’ retailing.

Competitive Position

 Rose Blumkin had unmatched guts, determination, and an iron will to succeed.
 “Mrs. B” demolished all competition on her way to building the largest furniture store in the country; she started in a
basement room across the street from her husband’s clothing store.
 Relentlessly focused on bringing the best value to customers; when competitors pressured suppliers to boycott her, she
Management went to other cities—Chicago, Kansas City, New York, wherever she could—to buy products her customers wanted.

 EV / EBIT of 4.3x
 P / E of 8.5x
 P / B of 8.x
 Attractive valuation given local dominance and strong growth potential.

Valuation

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11. 1983: Nebraska Furniture Mart

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12. 1985: Capital Cities / ABC

Investment Thesis Summary Stats

 Strong franchises with high ROTCE and growth prospects.  Stock Price $172.5
─ Demonstrated track record of steady growth and high  Shares Outstanding (upon merger completion) 16.1M
ROTCE.  Market Capitalization $2,777.3M
─ 26.4% ROTCE for Cap Cities.  Net Debt $2,027.9M
─ 21.1% ROTCE for ABC.  Enterprise Value $4,805.2M
─ Combined business would have ~24% TV station  Operating Income (adj. for potential divestments) $377.6M
penetration (max allowed by FCC).  EBITA (adj. for potential divestments) $577.6M
─ ABC is the world’s largest ad medium.  Adj Earnings (adj. for potential divestments) $192.6M
 Good valuation.  Revenues $4.6B
─ 14.4x P/E for a great franchise and good growth  EPS $12
prospects.  P/E 14.4x
─ EV / EBITA of 8.3x.  ROTCE (Cap Cities) 26.4%
 World class management.  ROTCE (ABC) 21.1%
─ Tom Murphy is “the best [CEO / management] of any  EV / EBITA 8.3x
publicly owned-company in the country.”  ABC acquisition price $3.52B
─ Charlie Munger wrote to Buffett that Murphy had been
able to compound the intrinsic value of Capital Cities
since 1958 (for 25 years) at 23% per annum. Outcome
 WEB first invested in Capital Cities in 1977 with $10.9M at a
P/E of 10x.
 In 1985, ABC asked Cap Cities CEO Tom Murphy to consider
a merger while they faced the threat of corporate raiders.
 WEB recommended to Murphy to find a ‘gorilla’ investor to
protect the joint company from corporate raiders and Murphy
recommended that Buffett himself be that investor.
 Berkshire contributed $517M in cash for 3M shares of new
equity in the combined company.
 Interesting to note that Buffett paid near the 52 week high as
Cap Cities’ share price ranged from $123.5 and $174.5 in
1984.

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12. 1985: Capital Cities / ABC

 Combined business would have 8 TV stations that had an outreach of 24.4% of the country’s TV audience (FCC limited
this to a max of 25%).
 Cap Cities / ABC owned 17 radio stations.
 Publishing business—diverse mix of traditional publishing companies (e.g. Institutional Investor, an electronic database,
and a large number of newspapers)
Business  Cable television—smallest of the 3 cap cities divisions and broke even in 1982
 ABC broadcasting—ABC television network that distributes ABC Entertainment content, ABC News, and ABC Sports.
 ABC publishing—comprised of several magazine and niche periodicals as well as a book publishing business.
 Other—includes a set of cable businesses with ownership of ESPM and a motion pictures studio.

 Max penetration of 24% allowed by the FCC.

 All 8 TV stations were ranked #1 or #2 in their markets, all of which are major metropolitan U.S. cities.
 7 of the 17 radio stations occupied strong roles in the top 10 U.S. metro areas; the FCC would require some divestment
of its radio assets but they should still have a strong combination of assets.
 Publishing business growing in circulation and ad revs and included leading publications in niche market segments;
Competitive Position CAGR of 20%+ in revenues and operating earnings.
 Cable television business is growing revenues and operating profits.
 ABC broadcasting—reach of 99% of the nation’s 84.9M television homes in 1984; claims to be the “world’s largest
advertising medium for the 8th consecutive year”; other two major players are NBC and CBS; scale and bargaining
power with content providers and advertisers; had rights to Winter and Summer Olympics in 1984.

 In 1986, WEB stated: “I have been on record for many years about the management of Cap Cities: I think it is the best
of any publicly-owned company in the country.”

Management

 Combined EV / EBITA of 8.3x.

 Fair value for a great business behind good growth prospects.

Valuation

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12. 1985: Capital Cities / ABC

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12. 1985: Capital Cities / ABC

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12. 1985: Capital Cities / ABC

Capital Cities ABC

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12. 1985: Capital Cities / ABC

Combined Entity

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12. 1985: Capital Cities / ABC

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12. 1985: Capital Cities / ABC

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13. 1987: Salomon Inc.—Preferred Stock Investments

Investment Thesis Summary Stats

 Attractive investment instrument:  Stock Price $38
─ $700M convertible preferreds for a well executed  Shares Outstanding 156.3M
business.  Market Capitalization $5,939M
─ 9% dividend.  Revenues $6.8B
─ Convertible option at $38 / share after 3 years—  EBT $793M
conversion feature tailored to provide an expected 15%  Net Income $516M
return.  EPS $3.32
─ If not converted, preferreds would be redeemed over 5  P/E 11.4x
years starting in 1995.  P/B 1.7x
 ROE (1986) 16%

Outcome
 WEB came in as a white knight to John Gutfreund and
Salomon when they heard that Ronald Perelman, one of the
takeover kings who took over Revlon in 1985, was in
discussions to acquire a major stake.
 Buffett told Gutfreund that he would be happy to buy $700M of
Salomon preferred stock “as long as it made fifteen percent.”
 The stock market crash in October 1987 came shortly after
WEB’s investment.
 In August 1991, Salomon announced that it had violated U.S.
Treasury rules regarding bond auctions and top management
resigned in the cover up; the Treasury Dept. threatened to
removed Salomon from its role as a primary govt bond dealer.
 Buffett took control of the company as interim chairman and
restructured the entire business with a key focus on integrity.
 In the endSalomon was fined $290M and Gutfreund left the
company.
 In 1997, the Travelers Group purchased Salomon for $9B.
 In 1998, Travelers merged with Citicorp.
 WEB earned the 9% dividend and exercised the conversion
option.
 This investment reflected a wider trend of WEB investing in
companies through convertible preferred shares.
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13. 1987: Salomon Inc.—Preferred Stock Investments

 Securities—The largest operating segment comprised of numerous national entities in addition to the main U.S. business:
Salomon Brothers International Ltd, based in London; Salomon Brothers AG in Frankfurt; Salomon Brothers Asia in Tokyo.
 Debt and equity underwriting
 Trading / market making
 Research
Business  In 1986, managed / comanaged 764 corporate issues worth $100B+ in the U.S. capital markets (617 were
corporate debt issues worth $86.2B); strong expertise in debt
 Commercial finance—makes short term loans to mostly European and Asian clients including corporations, banks,
governments and financial institutions.
 Phibro Energy—owns refinery plants with capacity of 200k barrels per day; full spectrum oil refiner; also trades
commodities.

 Securities—strong position in debt markets and growing in equities.

 Trading / market making—executed largest trade in the history of the NYSE: 48.8M share block trade of Navistar
International totaling $488M.
 Research—strengthening internationally to focus on Japanese companies in Tokyo and European equities in London.
 Overall, a transaction based business.
Competitive Position  Key assets are its reputation, people, and relationships.
 No apparent structural advantage vs. competitors in any segment.

 John Gutfreund managed Salomon well until the auction scandal—his involvement in the cover up cost him his career.
 Buffett took over as interim CEO and restored Salomon’s reputation.

Management

 9% dividend yield with attractive convertible feature provided an expected return of 15%.

Valuation

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13. 1987: Salomon Inc.—Preferred Stock Investments

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13. 1987: Salomon Inc.—Preferred Stock Investments

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14. 1988: Coca-Cola

Investment Thesis Summary Stats

 Strong franchise with significant international secular growth  Stock Price $40
prospects.  Shares Outstanding 375M
─ 55.5% ROTCE; duopoly positioned with Pepsi.  Market Capitalization $15B
─ 62% of soft drinks sold in significantly underpenetrated  Revenues $7.7B
international markets with strong double digit volume  EBIT $1.4B
growth.  Net Income $916M
 Operational efficiency gains  EPS $2.43
─ Soft drink division operating income increased 21% in  P/E (adjusted for unconsolidated subsidiaries) 13.7x
1987 yoy on continued consolidation and density of  EV / EBITA (adjusted for unconsolidated subsidiaries) 10.1x
distribution networks.  ROTCE 55.5%
 World class management
─ Roberto Goizueta and Don Keough achieved EPS
growth in every year over the last decade.
─ Strong focus on ROC and operational efficiency. Outcome
 Good valuation
─ 10.1x EV / EBITA and 13.7x P/E implies free optionality  WEB began buying shares in the fall of 1988 after the stock fell
on international growth behind a strong franchise and 25% from its pre-1987 Black Monday crash high at an average
great management that should continue to improve price of $42 / share—he accumulated ~7% of the company.
margins.  Prior to 1988, Coke fumbled on the introduction of the more
sugary “New Coke” as a competitive response to the “Pepsi
Challenge”, in which Pepsi gained share through their ad-
campaign and victories in blind taste tests; outrage ensued
and their was strong demand for a return to original Coke—in
1985, Old Coke rebranded as “Coca-Cola Classic” and in
months it outsold both New Coke and Pepsi.
 Languishing share price implied the market’s over-emphasis
on Pepsi vs. Coke’s 62% growing international market.
 WEB invested over $1B between 1988 and 1989, or ~25% of
Berkshire’s market value.
 Coca-Cola was clearly one of Buffett’s greatest investments.

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14. 1988: Coca-Cola

 Founded in the 1880s and publicly listed in 1919, Coca-Cola was a well-entrenched soft drink company with a strong
and growing international presence.
 Soft drinks (95% of operating income)—sells core soft drink syrups and concentrates to bottlers and fountain customers
and builds a brand under the Coca-Cola franchise that facilitates the purchase of end-consumers.
─ 62% of soft drink sales sold outside of the U.S. in 1985.
Business ─ In 1982, introduced Diet Coke; In 1985, introduced Cherry Coke.
 Foods—Owns Minute Maid which is the market leader in the frozen concentrate segment and 2 nd in the chilled category.
 Other—Owns 49% stakes in bottling subsidiaries Coca-Cola Enterprises (CCE) in the U.S. and T.C.C. Beverages in
Canada; owns lesser stakes in Coca-Cola Bottling Co., Johnston Coca-Cola Bottling Group, and New York Coca-Cola
Bottling Company, as well as those of several overseas bottlers; owns 49% in Columbia Pictures Entertainment, a major
motion pictures studio and also owned 300 theaters.

 Duopoly position with Pepsi as main competitor; Pepsi launched the “Pepsi Challenge” in 1975 and came out ahead in
blind taste tests which enabled them to gain share from Coke.
 Strong brand power and pricing power (10% revenue growth on 6% volume growth implies a 4% price increase in 1987).
 No taste memory in colas allows for repeat per capita consumption vs. other drinks.
 Unmatched distribution power.
Competitive Position

 World class management in Roberto Goizuetta and Don Keough.

─ Goizuetta was CEO and chairman since 1980 .
─ Keough was COO and president since 1981 (also a long-time friend of WEB).
─ Focused intensely on shareholder returns and key operating metrics like returns on capital.
Management

 13.7x P/E and 10.1x EV / EBITA adjusted for unconsolidated subsidiaries on a costs basis.
 Implies free optionality on international growth prospects (double digit growth with long runway) and underappreciated
unconsolidated subs reported at cost.

Valuation

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14. 1988: Coca-Cola

Yefei models what the numbers would look like if domestic and international revenue
growth continues (he models no margin expansion from 1987, which is conservative
given KO’s scale in distribution and pricing power). EBIT would grow 20% yoy.

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 14. 1988: Coca-Cola

12%
CAGR

12%
CAGR

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14. 1988: Coca-Cola

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14. 1988: Coca-Cola

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14. 1988: Coca-Cola

Adjusted for unconsolidated entities, the market cap would be $12.452B, or

$33.21 / share on 375M share outstanding.
Adjusting for a lower corporate tax rate introduced in the U.S. in 1988 vs.
1987, the P/E would be even lower.

EV drops to $13,689 adjusting for $2,548M in unconsolidated entities (at cost).

At market value, EV / EBITA would be even lower.

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 THE LATE YEARS (1990 – 2014)

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The Late Years Summary

Late Years
 Enlarged asset base necessitated focus on larger deals and organic growth.
─ More capital meant more deal flow and the ability to opportunistically provide capital when others couldn’t.
─ Seemingly lowered his internal return target of 15%+ to 10%+.
 U.S. Air—9.25% dividend on preferreds with deep out of the money conversion option ($60 strike with $35 current
price).
 MidAmerican Energy—11% fixed income stream with attractive equity purchase (paid half for 75% of earnings).
 Continued focus on quality and competitive position.
─ Wells Fargo—entrenched position in California.
─ Burlington Northern Santa Fe—oligopoly railroad with significant scale.
─ IBM—sticky customer base and recurring revenue.
 Continued focus on management.
─ Ed Colodny, U.S. Air—never lost money and built the company from $500M in revs to one of the largest airlines in the country.
─ Carl Reichardt, Wells Fargo—strong reputation for efficiency and ability to manage through multiple downturns.
─ Walter Scott and David Sokol, MidAmerican Energy—the top “two draft picks” WEB would choose out of the entire industry.
─ Matthew Rose, BNSF—achieved better volume and efficiency vs. Union Pacific.
─ Sam Palmisano, IBM—led IBM through smart acquisitions and repositioned the company for the future.

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15. 1989: US Air Group

Investment Thesis Summary Stats

 Attractive security behind a well executed airline business.  Stock Price $35
─ $358M of preferred stock.  Shares Outstanding 42.8M
─ Mandatory redemption in 10 years.  Market Capitalization $1.5B
─ 9.25% dividend.  Revenues $5.7B
─ $60 conversion price (12.4x earnings).  EBIT $434M
 Strong management with demonstrated track record.  Net Income $165M
─ Ed Colodny is a well respected CEO and US Air never  EPS $3.81
lost money under his leadership.  ROTCE 5.2%
─ Colodny built US Air from a small regional airline to one  P/E 9.2x
of the largest in the country.  EV/EBIT 6.6x

Outcome
 Often described as one of WEB’s biggest mistakes, he still
made money.
 Immediately after his investment, route competition and pricing
pressure ensued; through the 1990 and 1991 recession, the
whole industry was decimated with Midway, Pan Am, America
West, Continental and TWA going into bankruptcy (their
continued presence pushed prices even lower).
 Between 1990 and 1994 US Air lost $2.4B, wiping out all the
equity—WEB wrote off ¾ of his $358M investment and
unsuccessfully tried to sell the shares in 1995 at 50% of face
value.
 US Air had a good year in 1995 and the dividend resumed and
in 1997 it improved—the common stock rose from $4 to $73
making the conversion valuable.
 In 1998, the preferreds were redeemed; WEB collected
$250M in dividends over 8 years.
 In 1996 shareholder letter Buffett says: “I liked Ed Colodny,
the company’s then-CEO, and I still do. But my analysis of US
Air’s business was both superficial and wrong…”

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69
15. 1989: US Air Group

 Leading airline.
 Just completed integration of Pacific Southwest Airlines (PSA) and was starting to integrate Piedmont Airlines which was
to merge in 1989—these two acquisitions more than doubled US Air’s operations.
 Strong hubs major cities including Baltimore, Cleveland, Philadelphia and Los Angeles.
 More jet departures than any other U.S. airline.
Business  Pioneer in customer royalty—boasted one of the largest club networks with 28 preferred member lounges at 24 airports

 Fiercely competitive industry with no low BTE; operational effectiveness is key.

 ROTCE of 5.2% is significantly less than cost of capital (interest rates on US Air commercial paper were 9.5 – 9.9%).
 Some local density advantages resulting from its size and hub and spoke system.

Competitive Position

 Ed Colodny was a well respected CEO with an impeccable track record.

 Colodny led US Air from a small regional airline with $500M in revenues to one of the largest in the U.S.
 No single year of losses.
 Improved passenger load factors and average passenger journeys.
Management

 9.25% dividend with $60 conversion (12.4x earnings)

Valuation

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70
15. 1989: US Air Group

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71
15. 1989: US Air Group

LDC
72
15. 1989: US Air Group

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73
15. 1989: US Air Group

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74
15. 1989: US Air Group

LDC
75
16. 1990: Wells Fargo

Investment Thesis Summary Stats

 Franchise bank with local dominance in California.  Stock Price $58
─ 24.5% ROE  Shares Outstanding 54.98M
─ Largest middle market lender, commercial real-estate  Market Capitalization $3.189M
lender, and second in retail deposits.  Revenues (Total interest & non-interest income) $5.7B
─ Strong loan growth.  EBT $1B
 Proven and capable management.  Net income $601.1M
─ Carl Reichardt is known for efficiency.  EPS $11.02
─ Management team managed through the real estate  P/E 5.3x
recessions of 1973 to 1975 and 1981 to 1982.  P/B 1.1x
 Significant MOS  ROA 1.26%
─ P/E 5.3x  ROE 24.5%
─ P/B of 1.1x (should trade at 2x+ if cost of equity is 10%)
─ If valued at 10x earnings, earnings would need to halve
from $601M to $300M to justify a $58 share price. Outcome
─ Bad loans would have to triple to impair 1989 earnings
and justify the current share price (impairment would  In 1989 the banking industry was under significant
also have to be permanent). consolidation and “cleansing”—many savings and loans and
weaker banks were having serious problems with several
going bankrupt; the number of S&Ls cut in half between 1980
and 1990 and the number of commercial banks shrunk by
20%.
 Financial stocks were hit hard and there was fear that Wells
Fargo could be in trouble; it had huge exposure to real estate
in California which seemed to be in bubble territory; the price
dropped in Q3 and Q4 of 1990 when WEB purchased his
shares.
 In 1991, WFC faced pressure on loan losses and increased its
loss allowance by nearly 100% to $1.65B or 3.73% of total
loans.
 In 1991, shares traded between $48 and $97.
 WFC still remains one of Berkshire’s largest positions with
significant unrealized gains (notably still remains one of
Charlie Munger’s favorite investments).

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76
16. 1990: Wells Fargo

 4 divisions under one integrated business:

─ Retail and branch banking—largest division comprising most of the $36.4B in deposits and 40% of the $41.7B
loan portfolio; consumer, small business, and home mortgage loans; company’s focus is to build a core branch
network in California which meant acquiring branch networks and favoring international partnerships while
divesting international offices.
Business ─ Commercial and corporate banking—provides commercial enterprises with loans and fee-based services like
cash management and transaction processing; focusing on building more density in California.
─ Real-estate lending—provides real-estate loans including mortgage and construction loans; together with the
commercial and corporate division, these loans account for the other 60% of the loan portfolio.
─ Investment management—includes index fund manager Wells Fargo Investment Advisors and a private banking
division catering to the wealthy; the former had AUM of $80B and the latter $34B.

 Strong tier 1 risk-based capital ratio of 4.95% (vs. 4% stipulated by the Federal Reserve Board) vs. 4.57% in 1988.
 Total loans past due by 90+ days is $126.8M, or .32% of total loans in 1989.
 Local concentration in California.
 Largest middle market lender, commercial real-estate lender, and second in retail deposits.

Competitive Position

 Proven management:
─ Carl Reichardt, chairman and CEO, had a strong reputation for efficiency.
─ Management team has been with the company for many years and managed through the real estate recessions
of 1973 to 1975 and 1981 to 1982.
Management  Strong competence—management speaks intelligently in their annual reports.

 P/E of 5.3x
 P/B of 1.1x
 Optically cheap for a bank earning 24.5% ROE and growing.

Valuation

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77
16. 1990: Wells Fargo

$126.8M / $41B = .32%

At year-end 1989, allowance for loan losses were 1.77% of total loans, lower
than the 2% figure in 1988 (shows that fears regarding Wells Fargo’s collapse
from exposure to real estate loans were not reflected in the reported financials).

LDC
78
16. 1990: Wells Fargo

LDC
79
17. 1998: General Re

Investment Thesis Summary Stats

 General Re / Berkshire combination gives it a unique structural  Stock Price (30% premium paid to $212 closing price) $276.50
advantage.  Shares Outstanding 79.6M
─ Can absorb any earnings volatility—earnings volatility is  Market Capitalization $22B
inherent in a good reinsurance business that writes  Revenues $8.3B
policies based on expected returns vs. smoothness.  Net Income $968M
─ Gen Re can expand Berkshire’s worldwide distribution  EPS $11.76
in selling insurance and technical abilities in  P/E 23.5x
underwriting.  P/B 2.7x
 Elevated valuation on strategic value.  ROE (after-tax operating ROE) 11.9%
─ P/E of 23.5x  Total ROE (incl. investment income) 23.4%
─ P/B of 2.7x
─ Higher price on more disciplined underwriting
(Berkshire’s volatility absorption), distribution, and
cheap access to float. Outcome
 Berkshire acquired 100% of Gen Re for $22B using cash and
stock.
 Strategic rationale was that Berkshire’s strong cash generation
from its operating businesses made it ideal to absorb the
volatility in large scale reinsurance—Berkshire didn’t need to
worry about short-term financial volatility in one business
segment and Gen Re could write more business profitably vs.
as a standalone business; Berkshire could also invest the float
and gain a broader international distribution network.
 One of the highest prices paid for a seemingly average looking
company; however, WEB saw the strategic value in the
combined firm along with low cost float that could possibly get
to zero cost (international business could be improved to 100%
combined ratio).

LDC
80
17. 1998: General Re

 Global reinsurer with 4 main divisions:

─ North American property / casualty (48% of revs; 63% of op income)—principally focused on direct underwriting
of treaty (set by a framework contract and that automatically covers all of a certain class of risks passed on by
the primary insurer to the reinsurer) and facultative reinsurance (underwriting of individual risks through specific
contracts).
Business ─ International property / casualty (33% of revs; 23% of op income)—writes reinsurance in 150 countries.
─ Life / health insurance (15% of revs; 6% of op income)—38% in Europe, 47% in North America; individual and
group life insurance.
─ Financial services (4% of revs; 8% of op income)—real estate brokerage and real estate management as well as
derivative and structured products.

 Strong presence in North America with average combined ratios of ~100.6% through the decade from disciplined
underwriting—loss ratio improved from 74.5% to 68%.4% but offset by expenses creeping up to 30.8% from 24.7%.
 Growing international presence with combined ratio trending down from 113% in 1992 to 102% in 1997—could indicate
stronger competition and / or undisciplined underwriting.

Competitive Position

 Ronald Ferguson, CEO since 1987—good signs in a move towards underwriting conservatism; WEB thinks he has a
great reputation.
 Joseph Brandon, CFO since 1989

Management

 P/E of 23.5x and P/B of 2.7x is pricey for a business generating 11.9% ROE.
 WEB sees advantage in a Berkshire / Gen Re merger through greater disciplined underwriting and wider distribution
along with access to significant (and cheap) float.

Valuation

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81
17. 1998: General Re

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82
17. 1998: General Re

Combined Ratio of Overall Nonlife Insurance

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83
17. 1998: General Re

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84
17. 1998: General Re

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85
17. 1998: General Re

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86
17. 1998: General Re

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18. 1999: MidAmerican Energy Holdings Company

Investment Thesis Summary Stats

 Attractive investment structure (avoided a breach of the Public  Stock Price (29% premium over closing price) $35.05
Utility Holding Company Act regs).  Shares Outstanding 72.6M
─ $1.25B in common stock and nondividend-paying  Market Capitalization $2.5B
convertible stock.  Revenues $2.55B
─ $800M in a nontransferable-trust preferred stock  EBIT $491M
yielding 11%.  Net Income $127M
─ Paid $1.25B, or 50% of the market cap, for 76% of the  EPS $2.01
earnings, and $800M for an 11% fixed income stream;  P/E 17.4x
voting interest of just under 10%.  EV / EBIT 16x
 ROTCE 7.2%
 ROE 15%

Outcome
 WEB paid $2B with two coinvestors: Walter Scott, who was on
the Berkshire board and introduced the deal to Buffett and
David Sokol, MidAmerican’s CEO.
 Invested in a team of managers he trusted and believed would
continue to grow the business.
 The deal setup was more attractive than a private investor
could get on the common equity.

LDC
88
18. 1999: MidAmerican Energy Holdings Company

 Diversified energy business with 3 main segments

─ Domestic generation--$583M in revs; $314M in op income; coal, gas, geothermal, hydro and nuclear power
plants.
─ Foreign generation (primarily in the Philippines)--$224M in revs; $143M in op income
─ Foreign utility (primarily in the UK)--$1843M in revs; $173M in op income; owns Northern Electric Distribution
Business Ltd, a distributor of electricity—1.5M customer base.
 Builds and operates power plants—purchases fuel, such as coal, and sells electricity.

 Government regulation is key—power generation is one of the most heavily regulated industries in the world.
 Profitability ties substantially to the regulatory environment.
 The Public Utilities Regulatory Policies Act (PURPA) governed regulations at the national level—independent energy
producers were encouraged to sell and utilities had to buy their electricity; regulation also extends to price levels.
 State level regulation—determined MidAmerican’s allowable ROE of 12%; required to share excess returns with
Competitive Position customers and could not increase prices unless ROE was <9%.
 In the UK, electricity had to be bought and sold in a market for electricity called the ‘Pool’, which set prices.

 Strong management—Walter Scott and David Sokol are the only “two draft picks” he would choose for this industry.
 Management grew revenues from $154M to $2.5B from 1994 – 1998 and net income from $37M to $127M.

Management

 P/E of 17.4x
 EV /EBIT of 16x
 High valuation for common equity.
 Structure of the deal is attractive--$1.25B (1/2 the market cap) for 76% of the earnings and $800M for a fixed income
security yielding 11%.
Valuation

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89
18. 1999: MidAmerican Energy Holdings Company

LDC
90
18. 1999: MidAmerican Energy Holdings Company

LDC
91
18. 1999: MidAmerican Energy Holdings Company

LDC
92
18. 1999: MidAmerican Energy Holdings Company

LDC
93
18. 1999: MidAmerican Energy Holdings Company

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94
19. 2007-2009: Burlington Northern

Investment Thesis Summary Stats

 Oligopoly player with high marginal ROTCE of 15%+ in  Stock Price $100
growing market.  Shares Outstanding 341.2M
─ Rail is growing and continually taking share from  Market Capitalization $34B
trucking.  Revenues (2008) $18B
─ Large presence in the West in more favorable vs. the  EBIT (2009E) $3.26B
East.  Net Income (2008) $2.1B
─ Incremental capex (i.e. new and maintenance track  EPS $5.10
miles laid) are ~1.6% of total operated miles of track—  P/E (2007) 15.3x
small outlay relative to freight revenue growth.  P/E (2009E) 19.9x
 Good price on entrenched franchise and strong growth on a  EV / EBIT (2007) 10.1x
long runway.  EV / EBIT (2009E) 13.2x
─ P/E OF 20x  ROTCE 7.6%
─ EV / EBIT of 13.2x  Marginal ROTCE 15%+
─ Rail continues to grow while also taking share from
trucking. Outcome
 In 2007, WEB owned 60.8M shares of BNSF at a cost basis of
$4.73B, representing a 17.5% stake at a price of $77.76 /
share.
 In 2009, Buffett bought the remaining 341.2M shares for $100 /
share, valuing BNSF at $34B.
 WEB famously said this was an ‘all-in wager on the economic
future of the United States’—it has to do well if the country
does well.
─ ‘This country is going to grow, it’s going to have more
people, it’s going to have more goods moving, and rail
is the logical way for many of those goods to travel…in
terms of cost efficiency, fuel efficiency, and
environmentally friendly…There’s no way rail is going to
lose share…the pie is going to grow and the rails’ share
of the pie is going to grow.’
─ ‘I think I know how the country is going to develop. I
think the West is going to do well. I’d rather be in the
West than the East.’

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95
19. 2007-2009: Burlington Northern

 4 core divisions (all involve the transportation of bulk products):

─ Consumer products—90% containers (international shipping containers and domestic goods) and 10%
automotive products.
─ Industrial products—construction products, building products, petroleum products, chemical / plastics, and food
and beverage products.
Business ─ Coal—low-sulfur coal from the Powder River Basin in Wyoming and Montana.
─ Agricultural products—transportation of corn, wheat, soybeans, and other bulk foods, as well as ethanol,
fertilizers, and related products.
 2/3 of revs are covered by individual customer contracts of varying durations; 1/3 of revs come from customers who pay
the common carrier published prices.

 Oligopoly position with rational players; Union Pacific has 48k employees and 8,700 locomotive; steered away from
price competition.
 Pricing power—both BNSF and UP were increasing prices.
 Substitutes—truck, water, and aircraft; water transport is limited to areas near waterways; aircraft transport is high cost;
truck transport is main substitute.
Competitive Position ─ Trains transport on average a ton of freight 3x as far as a truck on the same amount of fuel.
─ Freight accounts for 40% of the nation’s freight but accounts for only 2.6% of the greenhouse gas emissions.
 Overall, rail is the most efficient, cheap, and environmentally friendly option for regular transport.
 Freight should be able to capture share from overall freight transportation given its advantages.

 Capable management in Matthew Rose, chairman and CEO since 2000, AND Thomas Hund, CFO since 1999.
 BNSF added trackage or managed volumes slightly better than Union Pacific.
 BNSF increased revenue ton-miles by 3% vs. a slight decrease with Union Pacific.
 Increased revs from $9.2B in 2000 to $15.8B in 2007, or 8% CAGR.
Management  Increased EBIT from $2.2B in 2000 to $3.5B in 2007, or 7% CAGR.
 Increased net earnings from $980M in 2000 to $1.8B in 2007, or 9% CAGR.
 Reduced the share count by 23% from 2000 to 2007.
 Increased the dividend to $1.14 from $.48 from 2000 to 2007.

 P/E of 19.9x
 EV / EBIT of 13.2x
 Elevated valuation, but great long-term growth prospects in an operationally efficient oligopoly player within a secular
growing market.

Valuation

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96
19. 2007-2009: Burlington Northern

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97
19. 2007-2009: Burlington Northern

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98
19. 2007-2009: Burlington Northern

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99
19. 2007-2009: Burlington Northern

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100
19. 2007-2009: Burlington Northern

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101
19. 2007-2009: Burlington Northern

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102
20. 2011: IBM

Investment Thesis Summary Stats

 Sticky business with good growth prospects.  Stock Price $169.9
─ Strong client relationships.  Shares Outstanding 1228M
─ High switching / search costs—complex  Market Capitalization $208.6B
implementation, re-training, and changing behavior  Net Debt $29.8B
involved.  Enterprise Value $238.4B
 Attractive valuation.  Revenues $100B
─ P/E of 14.7x  EBIT $20.1B
─ FCF Yield of 7.8%  Net Income $14.8B
 Strong and capable management.  EPS $11.52
─ Sam Palmisano led an acquisition binge that helped  P/E 14.7x
reposition IBM for the future.  EV / EBIT 11.9x
─ Palmisano laid out a clear vision to increase margins,  ROTCE 36%
return cash to shareholders via buybacks and  FCF Yield 7.8%
dividends, and focus intensely in growth markets.

Outcome
 On November 2011, WEB announced on CNBC that Berkshire
took a $10.7B stake in IBM—5.5% of the company.
 He stated that he had been reading the annual reports for the
past 50 years and only recently realized how important its
business was for IT organizations around the world.
 Buffett spoke to several IT organizations within Berkshire’s
subsidiaries about IBM and the takeaway was the strength of
IBM’s role and the stickiness of those relationships.
 IBM became one of WEB’s largest four investments along with
Coca-Cola, American Express, and Wells Fargo.
 “[IBM is] a company that helps IT department do their job
better…it is a big deal for a big company to change auditors,
change law firms. The IT departments…very much get
working hand in glove with suppliers…there is a lot of
continuity to it.”

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103
20. 2011: IBM

 5 business segments
─ Global Tech Services (technology consulting business focused on implementing tech capabilities)
▫ 1. Strategic outsourcing services—IT outsourcing and the execution of business processes such as HR
; 2. Integrated technology services—increases enterprise efficiency or productivity; 3. technology
support; 4. maintenance services—offers product support service and software / system maintenance
Business ─ Global Business Services (mix of consulting and customized software solutions implementation)
▫ 1. Consulting and systems integration—helps customers develop and implement IT solutions; 2.
Application management services—customized software and software support.
─ Software—middleware used to integrate information from different systems software from different functions.
─ Systems and Tech—business solutions based on advanced computing power and storage capabilities.
─ Global Financing—helps customers finance their purchases.

 40% recurring revs (software) and 40% mixed quality revs (consulting and business services).
 High switching costs in mission critical software, services, and support.
 Global tech services—competitors include Accenture, Deloitte, Infosys, and Cognizant.
 Global business services—possibly sticky business due to existing customer base.
 Software—competitors include Oracle, Microsoft, and Software AG.
Competitive Position

 Sam Palmisano (joined in 1973), chaIrman, president, and CEO lays out a clear vision:
─ Goal is to transform IBM into an international, high-margin products and services business.
─ Focus on EPS performance over the next 5 years through 1. operating leverage (mix shift to high margin
businesses and improving productivity), 2. share repurchases ($50M in repurchases and $20M in dividends over
the next 5 years), and 3. growth (targeting growth markets like China, India and Brazil and increasing growth
Management market revenues from 20% to 30% by 2015).
─ Emphasis on megatrend towards business analytics and optimization and how IBM could help companies
leverage data and improve decision making.
─ Grow cloud computing—help clients develop private clouds and utilize IBM’s cloud-based infrastructure.
 Purchased PwC’s consulting practice; pushed for data analytics and cloud computing; sold IBM’s PC unit to Lenovo.
 Between 2000 and 2010, IBM purchased 116 companies for $27B to plug into IBM’s distribution network.

 P/E of 14.7x
 FCF Yield of 7.8%
 Good price for strong FCF generative business behind strong management.

Valuation

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104
20. 2011: IBM

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105
20. 2011: IBM

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106
20. 2011: IBM

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107
20. 2011: IBM

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108
20. 2011: IBM

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109
20. 2011: IBM

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110
 LESSONS LEARNED

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Evolution of Buffett’s Investment Strategy

Evolution
 Partnership Years
─ Strong focus on low price relative to asset value (often realizable asset value).
 Sanborn Maps and Dempster Mill had little earnings but the former had an investment portfolio greater than the price of
the whole company and the latter has sellable inventory; Berkshire had a combination of cash and realizable working
capital.
─ Always focused on the fundamental businesses.
 Didn’t just look for net-nets, but companies with positive earnings and preferably positive catalysts in the underlying
business prospects.
 Sanborn Maps was in structural decline due to technological change, but still earned positive profits and stabilized in the
years preceding WEB’s investment.
 Wanted companies where operational improvements were already occurring or where he could act as a catalyst himself.
─ Always paid attention to management.
 Showed an early interest in selecting great operating managers.
─ Stayed opportunistic.
 Investment in merger arbs and control investments when the opportunities came.
 Middle Years
─ Stronger focus on quality
 Cared more about sustainable earning power—in See’s Candies, GEICO, and Coca-Cola, the key rationale was
attractive long-term earnings.
 More comfortable paying higher multiples (15x in many cases)
 Quality included both quantitative and qualitative aspects (WEB increasingly trusted his qualitative insights).
▫ Quantitative benchmarks: consistent growth and high ROTCE; mid single digit growth that was extremely
consistent and driven by an understood structural cause; Coke grew revs and op income in 9 of 10 previous
years, and See’s showed increasing same store sales and 5 straight years of rev growth; growth was always
present even when he paid less (e.g. Washington Post); wanted compounders with a long demonstrated track
record of growth he could depend on.
▫ Qualitative benchmarks: GEICO—he understood the credit card division’s competitive position that would allow
it to grow significantly in the future; Buffalo Evening News—on low earnings, he knew the newspaper business
had structural advantages with sticky revs and pricing power.
─ Built increasing expertise in a handful of industries—insurance, media, consumer brands.
 In insurance, he knew how to evaluate the underwriting practices of insurers and assess the types of risks management
was taking; on the investment side, he knew how to judge an insurer’s competency managing its float.

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Evolution of Buffett’s Investment Strategy

Evolution
─ Built a strong network including many CEOs.
 Helped him understand industries / companies more deeply.
 Helped him generate more deal flow.
─ Continued his emphasis on management.
 Integrity and operating ability.
 Cared more about capital allocation ability.

 Later Years
─ Greater emphasis on larger companies.
─ Maintained qualitative focus.
 Primary concern was his ability to understand fundamental insights better than everyone else; therefore, he often came
back to the same industries and even the same companies he became expert in decades before.
 In Gen Re, WEB already knew the owners and owned GEICO himself;
▫ Anecdote: When he first met with Gen Re’s management WEB said: “I’m strictly hands-off. You guys run your
own business. I won’t interfere.” But when he spat out GEICO’s stats, the team was overly amazed and the chief
underwriter Tad Montross exclaimed, in so many words: “Holy cow! This is hands off?”
─ Sought out mature companies where large amounts of capital could be intelligently deployed.
 MidAmerican Energy—annuity-like business that generated average returns.
 BNSF—large $34B outlay on a ‘good’ return business (David Sokol said that their expectation was for a 10-12% return).
 Invested in attractive ‘investment structures’—i.e. preferred or convertible shares with fixed-income characteristics.
▫ U.S. Air
▫ Goldman Sachs
▫ General Electric
▫ Bank of America
▫ Burger King

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Lessons Learned

Lessons Learned
 Quality of Information.
─ Always had high level of information in anything he invested in—good research to WEB meant an extremely deep
understanding of each business (he worked a lot); this favored a concentrated approach.
─ Gravitated toward industries where the level of available objective data was high; focused especially on investments that could
be backed by verifiable and objective data to support any qualitative insights.
 BNSF reported detailed financials along with relevant operating metrics like revenue-ton-miles traveled, freight revs per
thousand tons, and customer satisfaction scores over several years; BNSF also clearly explained each major business
segment and their key drivers, capital requirements, and how rail compares to trucking (the industry’s biggest substitute
threat).
 Coca-Cola had objective data that could confirm that international expansion and increasing consumption (reported in 8
oz. servings per year) across different countries would drive future growth.
 WEB also focused on industry data.
▫ The Association of American Railroads published detailed operational data (such as operating ratios and
downtimes) every month for every major U.S. railroad.
▫ For Buffalo Evening News, industry level data was readily available for circulation figures and advertising data.
 Focus on high quality data often resulted in WEB revisiting the same industries.
▫ Focusing on select industries helped him hone and understand what high-quality information meant and how to
deploy his knowledge repeatedly after compounding so much knowledge.
• The Washington Post—knowing the detailed subscription numbers, churn rates, and operating margins of
The Post helped in evaluating the Buffalo News.
 Media, insurance, financials, and branded products were industries with a lot of objective industry information.

 Consistency of Earnings Growth.

─ A dependable prediction of future prospects trumped ‘moats’ and ROTCE.
 Evidence in the form of numbers and objective data was more dependable to him in proving a structural advantage.
 Moats and ROTCE have to be supported by quantitative data (WEB still stuck to Graham’s idea of having ‘demonstrated
earning power’)—he never invested in high growth, VC-like companies with unproven moats.
─ Majority of investments had extremely consistent revenue and earnings growth preceding WEB’s investment (many grew revs
or earnings 9 out of the 10 previous years).
─ Consistent historical financials and good data supported his understanding of the qualitative reasons for a business’s
consistent growth (in revs or earnings) and his rationale that such performance would continue.
 AXP—insight was that more international travel would lead to a growing need for AXP’s travelers checks.
 BNSF—insight was that cargo transport by rail would continue to take share from trucking and that this would continue
because of the inherently more fuel-efficient nature of rail transportation.

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Lessons Learned

Lessons Learned
 Opportunistically Driven.
─ WEB transcended investment styles (i.e. ‘value,’ ‘growth,’ ‘event driven, etc.)—he matched his style to market conditions and his
personal investment setup.
 Partnership years—had 3 categories
▫ Generals—securities significantly undervalued relative to intrinsic value (often relative to earnings or asset value);
no definite timeline for value convergence; his experience was that these stocks were correlated to the markets but
would decline much less in downturns and gain in upturns; MOS is key, timing is irrelevant.
▫ Workouts—returns depended on corporate actions: mergers, liquidations, reorganizations, spin-offs, and so on;
much less depended on the market; expected steady returns of 10-20%; should significantly outperform in a
declining market but likely not match strongly advancing markets; resolve at a determinable timeline.
▫ Control Situations—directly control a company or build a large enough stake to actively influence operations;
focus is to push a company to unlock hidden value in assets, working capital, or operational improvements.
─ Overall goal was to use a combination of generals, workouts, and control situations to outperform the market in the long run.
 Incur smaller losses vs. the market in significantly declining markets.
 Match or slightly underperform markets that are rapidly advancing.
 Referred to building a pipeline of opportunities.
 The best investment type changes depending on market conditions and he recognized and responded to this flux to find
the most promising opportunities.
 Flexible in investment types, but inflexible in his internal hurdles.

 Management Focus.
─ Emphasis on management stayed constant.
─ Often knew the management for years before he invested.
─ Devoted considerable time to overseeing and supporting management when needed.
─ Prime focus was a history of operational success.
 Jack Ringwalt, National Indemnity—spent 25 years running the company successfully.
 Howard Clark, AXP—spent years with the company and had a proven track record.
 Roberto Goizeuta, Coca-Cola—strong focus on shareholder returns and managed through challenges.
─ Favored management with detailed and honest annual reports which gave unique insight into their businesses.
─ Strong preference for owner-managers—CEOs who are either an owner in the business or personally devoted / connected to the
business.
 Owners: Jack Ringwalt, Rose Blumkin, and Katharine Graham.
 Incented through profit-sharing or handpicked by WEB based on a personal relationship to him or the business: Harry
Bottle, Ken Chace, Stan Lipsey, and Walter Scott / David Sokol.

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Lessons Learned

Lessons Learned
─ Liked management with long and well-defined histories to their companies (often 10+ years, or in some cases 25+ years).
 Tom Murphy, Cap Cities
 Carl Reichardt, Wells Fargo
 Ronad Ferguson, General Re
 Matthew Rose, BNSF
─ Also cared about other management factors.
 Integrity
 Capital allocation ability
 Last Thought
─ Main limitation to replicating WEB is that he found on average only a handful of good investments each year, and that this was
based on expending full-time effort.

 Other
─ Handicapping
 First filter: is there ‘cat’ risk (catastrophe risk)? If yes, he passes; says no to almost everything because they don’t pass
this test; this saves him significant time and energy; always starts with what could go wrong.
 Never modeled anything—relied exclusively on historical figures with no projections (did this over and over on different
investments)
 Figures out the 1 or 2 factors that could make an investment succeed or fail; he acts like a horse handicapper.
 Takes all data, quarter by quarter, all competitor data, and studies the data.
 Main question is whether he could get a 15% return.
─ Compounding
 Wanted to compound at 15% in his early years.
 Seemingly changed his hurdle rate to 10% in his later years.
─ Margin of Safety
 Followed Graham’s prescription that: “..the function of the margin of safety is, in essence, that of rendering unnecessary
an accurate estimate of the future”; however, WEB felt more comfortable in placing a MOS in potential future earning
power vs. entirely on the historical record (Graham insisted on a MOS in demonstrated earning power and historical
margins, vs. projected earning power).
 Alice Schroeder says after having complete access to WEB’s files, she never saw anything that remotely resembled a
financial model.

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Bonus. 1950’s: Mid-Continent Tab Card Company

Investment Thesis Summary Stats

 Supernormal growth franchise.  Revenues $1M
─ Low cost, critical input to computers with significant  Revenue Growth 70%
pricing power.  Net Profit Margin 40%
─ Proved that it could compete successfully against IBM.
─ Shipping advantage in strategically locating in the
midwest.
 Attractive valuation.
─ WEB thought that he could get 15% returns even with
slower growth and half the current margins. Outcome
 WEB’s aunt Katie and her Uncle Fred invested in Control Data,
a startup to compete against IBM. Katie’s brother, Bill Norris,
was a founder; WEB advised against it—he studied IBM and
thought it was difficult to compete with given its monopoly-like
status; they invested anyway and made a lot of money.
 MTC was formed because IBM had to divest of its tab card
company.
 Once MTC proved that it could compete successfully against
IBM in tab cards, WEB got interested.
 Invested $60k of his own personal money (~20% of his net
worth) for 16% of the shares and subordinated notes; hurdle
was 15% return on $2M sales and he believed he could get
that when it already had $1M in sales and 70% growth.
 Company later changed its name to Data Documents.
 WEB owned it for 18 years, putting in another $1M over time.
 Bought out by Dictograph in 1979.
 WEB got a 33% annual return.

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Bonus. 1950’s: Mid-Continent Tab Card Company

 Makes tab cards—punch cards that were sent mechanically off a computer.

Business

 Critical input to computers.

 Trivial cost relative to overall mainframe computers—IBM got 50% profit margins in its tab card segment.
 Carroll presses,w hich made tab cards, turned over capital 7x a year.
 IBM settled with DOJ after anti-trust charges were levied against it and was required to divest its tab card business.
 Based in Midwest allowed MTC to ship faster.
Competitive Position

 Wayne Eaves and John Cleary (friends of WEB) saw that IBM would have to divest its tab card business and thought of
buying a Carroll press

Management

 Significant MOS—WEB thought he could get 15% returns even with slower growth and if margins were cut in half.

Valuation

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 “The only person really qualified to advise you as to
what you can do is yourself. You know yourself better than
anyone else does. You, and you alone, know how
determined you are to make a success of the undertaking.
And in the last analysis, about 90 percent of being
successful in business is that indefinable thing which for a
lack of a better name we call ‘guts.’”
–F.C. Minaker

F.C. Minaker was the author of One Thousand Ways to Make $1000. His book is credited for shaping Warren Buffett’s business
acumen and giving him his appreciation of compound interest.
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