Warren Buffett. Robert G. Hagstrom

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      First, the financial terms. Limited partners would receive annually the first 6 percent return of the investment partnership. Thereafter, they would receive 75 percent of the profits, with the balance going to Warren. Any annual deficiencies in performance goals would be rolled over to the next year. In other words, if the limited partners didn't get their 6 percent return in any one year, it would be extended into the next year. Warren would not receive his performance bonus until his partners were made whole.

Warren told his partners he could not promise results, but he did promise that the investments he made for the partnership would be based on the value principles he learned from Ben Graham. He went on to describe how they should think about yearly gains or losses. They should ignore the daily, weekly, and monthly gyrations of the stock market—which, in any event, were beyond his control. He suggested they not even put overly much emphasis on how well or poorly the investments performed in any one year. Better, he thought, to judge results over at least three years. Five years was even better.

      Lastly, Warren told his partners he was not in the business of forecasting the stock market or economic cycles. That meant he would not discuss or disclose what the partnership was buying, selling, or holding.

      At dinner that night, everyone signed up for the partnership. Over the years, as more partners were added, they were given the same ground rules. Lest anyone forgot, Warren included the ground rules with the performance results sent every year to each partner.

      In addition to the annual 6 percent performance bogey, Warren also believed it was helpful for the partners to judge how well he was doing compared to a broader stock index, the Dow Jones Industrial Average. Over the first five years, the results were impressive. From 1957 to 1961, the partnership achieved a cumulative return of 251 percent compared to the Dow's 74 percent.

      Hearing about Warren's success, more investors joined in. By 1961, the Buffett Partnership had $7.2 million in capital—more than Graham‐Newman managed at its peak. By the end of the year, $1 million of the Buffett Partnership belonged to Warren. He had just turned 31.

Warren was applying Graham's investment playbook for the Buffett Partnership, with stunning success. He continued to soundly beat the Dow Jones Industrial Average. After 10 years, the Buffett Partnership's assets had grown to over $53 million. Warren's share was near $10 million. In 1968, the Buffett Partnership returned 59 percent compared to the Dow's 8 percent. It was the single best performance year of the partnership. Ever the realist, Warren wrote to his partners that the results “should be treated as a freak—like picking up thirteen spades in a bridge game.”¹⁴

Despite the partnership's heroic performance returns, difficulties were mounting. Scouring the market, Warren was having great difficulty finding value. Bereft of investment ideas and more than a little fatigued with the performance derby he had been running for the past 12 years, in 1969 Warren announced that he was closing down the partnership. In a letter to his partners, Warren confessed he was out of step with the current market environment. “On one point, however, I am clear,” he said. “I will not abandon a previous approach whose logic I understand, although I find it difficult to apply, even though it may mean forgoing large and apparently easy profits to embrace an approach which I don't fully understand, have not practiced carefully and which possibly could lead to substantial permanent capital loss.”¹⁵

      In 1957, Warren had set a goal to beat the Dow Jones Industrial Average by 10 percentage points each year. Over its 13‐year period, 1957–1969, the average annual compounded rate of return for the Buffett Partnership was 29.5 percent (23.8 percent net to partners); the Dow return was 7.4 percent. In the end, Warren beat the Dow not by 10 percentage points per year but by 22! From its initial asset base of $105,000, the partnership had grown to $104 million in assets under management. For this, Warren earned $25 million.

      In shutting down the Buffett Partnership, Warren took extra care to ensure all the partners clearly understood the next steps. He outlined three different options. For those who wished to remain in the stock market, Warren recommended Bill Ruane, a former Columbia classmate. Twenty million dollars in Buffett Partnership assets were transferred to Ruane, Cunniff, & Stires and thus was born the famous Sequoia Mutual Fund.

A second option for partners was to invest in municipal bonds. To Warren's mind, the 10‐year outlook for stocks was approximately the same as for the less risky, tax‐free municipal bonds. The consummate educator, Warren sent each partner a 100‐page manifesto on the mechanics of buying tax‐free bonds.¹⁶ As a third option, partners could also allocate their assets to one of the partnership's major holdings—the common shares of Berkshire Hathaway.

Warren was, as always, upfront and plainspoken. He told his partners he was going to move his personal investment in the Buffett Partnership to Berkshire Hathaway. As Doc Angel, one of the early Buffett Partnership loyalists, said, “That's all anybody had to hear if they had any brains.”¹⁷

From Investment Partnership to a Compounding Conglomerate

      Early in the Buffett Partnership timeline, Warren bought shares in a New England textile manufacturer, a merged enterprise of Berkshire Cotton Manufacturing and Hathaway Manufacturing. It was a classic Ben Graham purchase. The stock was selling for $7.50 per share with working capital of $10.25 and a hard book value of $20.20.

Warren was well aware of the difficulties US textile manufacturers faced in competing against much cheaper foreign imports. Even so, he couldn't resist the attractiveness of “picking up a discarded cigar butt that had one puff remaining in it.”¹⁸ The “cigar‐butt” theory is the name given to Graham's emphasis on buying hard assets on the cheap even though those assets had little economic vitality. With the cash and securities on the balance sheet along with even a limited potential for business profits going forward, Warren figured there was not much downside to Berkshire Hathaway and a reasonable likelihood of making money.

By 1965, the Buffett Partnership owned 39 percent of the Berkshire Hathaway common shares outstanding. Warren was then locked in a proxy battle with the board of directors to take over the company, fire the inept management, and replace them with better capital allocators. When the dust settled, Warren won the fight but in doing so found he had allocated 25 percent of the Buffett Partnership's assets to an economically sinking ship with no exit strategy. “I became the dog who caught the car,” he said.¹⁹

      The journey from managing one of the greatest investment partnerships in history to then parlaying his net worth into owning a dying manufacturing business had all the makings of a Greek tragedy. What was Warren thinking?

It's clear what he was not thinking. He had no grand plan to engineer a complete turnaround. And even though he had Ben Graham whispering in his ear, he never intended to sell the company to a greater fool. Who would have wanted to buy a 75‐year‐old, low‐margin, capital‐intensive, labor‐dependent, nineteenth‐century New England maker of fabric liners for men's suits? No, Warren was guided by a stronger principle, a principle that in fact lies at the heart of his investing philosophy—long‐term compounding.

      From an early age, Warren was taught the benefits of compound interest. More important, he experienced the benefits of a compounding machine firsthand when he took the earnings from his various jobs and plowed them back into his little business enterprise. If one СКАЧАТЬ