The Midas Touch: The strategies that have made Warren Buffett the world's most successful investor

Publishing details

HARRIMAN HOUSE LTD

18 College Street

Petersfield

Hampshire

GU31 4AD

GREAT BRITAIN

Tel: +44 (0)1730 233870

Email: enquiries@harriman-house.com

Website: www.harriman-house.com

First published in the United States of America in 1987 by

Harper & Row Publishing

This edition published by Harriman House, 2003, reprinted in 2009

and this paperback version in 2013.

Copyright © Harriman House Ltd

The right of John Train to be identified as the author of this work has been asserted by him in accordance with the Copyright, Design and Patents Act 1988.

ISBN 9781906659929

British Library Cataloguing in Publication Data

A CIP catalogue record for this book can be obtained from the British Library.

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of the Publisher. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published without the prior written consent of the Publisher.

This publication is sold on the understanding that the publisher is not engaged in rendering legal, accountancy, financial, or other professional advice or services.

No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in this book can be accepted by the publisher, by the author, or by the employers of the author.

Foreword to the 2009 edition

Much has happened to Warren Buffett since this book first appeared. As is well known, following the same principles explained here, he has become one of the richest men in the world. Though the size and complexity of the transactions Buffett can now manage has increased since The Midas Touch was first published, his recent operations are less instructive than the ones described in this book – I would say that most of the investment principles one could acquire by studying Buffett can be learned in these pages. Nonetheless, those wishing to follow current activities at Berkshire, and Buffett’s transactions, may find a website called Warren Buffett News Watch interesting. [¹]

Buffett’s company, Berkshire Hathaway, has continued to grow and evolve, and is now considered an operational insurance company, which means that the shareholders worry somewhat less about the embedded capital gains in its positions than they would if it were essentially a holding company. At an earlier stage in the company’s development, when Buffett essentially made huge insurance bets from time to time, I asked Hank Greenberg, the then head of AIG, what he thought. "Warren hasn’t got an insurance business there," said Greenberg. That was true at the time, but that wonderful business AIG came apart after Greenberg’s departure and lost most of its value, whereas Buffett’s more ramshackle construction has prospered. One thinks of a comparison made between the Duke of Wellington and Napoleon Bonaparte. The Duke’s strategic arrangements were said to be made of string – when a piece broke, the parts could be knotted again – whereas Napoleon’s splendid constructions, once ripped, fell apart.

I need not tell the reader that Buffett has also become a showman. Berkshire’s annual meeting is a fantastic extravaganza, and wise remarks emerge from Omaha on all occasions.

Even with this success, and showmanship, Buffett remains primarily a miser; he hates to spend money. It is true that he has manifested a genial side, and has found a way to keep his fortune away from the government at the same time. He has achieved this by giving money to the Bill and Melinda Gates Foundation, where it will do good. However, even acknowledging these charitable donations, it is still hard to say whether Buffett’s whole career will have benefited humanity. There is no corresponding event to the Woodstock for Capitalists for the sellers of the stocks he bought at bargain prices, and the work of the Gates Foundation may not be more useful than anything the sellers themselves would have done with the money, nor more useful than the projects the government might have funded with the taxes it now won’t collect.

Since the last edition of this book, Charlie Munger, Buffett’s business partner and an eminent investor in his own right, expounded several Buffettesque investment principles in a speech. John Templeton sent me a summary of these points, and I have reproduced them here, slightly edited:

Specialization in the business world often produces very good business economics.

Advantages of scale are important. When Jack Welch says he’s either going to be number one or number two in a business or out, he is not crazy, just tough. Too many incompetent CEOs do not understand this. But bigger is not better if it creates bureaucracy, e.g., the federal government or AT&T.

Technology can either help you or kill you. The difference is whether the customer gets all the savings or if some of the savings go to the shareholders.

Investors should figure out where they have an edge and stay there. Stay in your circle of competence. Remember the John Train question: How do you beat Bobby Fischer? Reply: Get him to play you any game except chess.

Winners bet big when they have the odds – otherwise, they do not bet at all. Those who make a few well-calculated bets have a much greater chance. Very few investors or investment funds operate this way. So, load up on a good idea; it is hard to find a good business at a great discount.

A significant discount means more upside and a greater margin of safety. Buy shares of a good business at a significant discount to what a private buyer would pay.

Buy quality businesses even if you have to pay up. Warren Buffett claims this is the most important thing he ever learned from Charlie Munger.

Low turnover reduces taxes and increases your return. Two investors earn the same compound annual return of 15% for thirty years. If the first pays a 35% tax at the end of the thirty years and the second pays a 35% tax each year, the first investor will have over two and a half times as much money as the second.

The latest Buffett biography, The Snowball, mentions that "as a child Buffett memorized the text of Dale Carnegie’s How to Win Friends and Influence People, and his status as a seer derives from his lifelong adherence to Carnegie’s precepts for avoiding confrontation or offence." The Times Literary Supplement’s review of the biography supported this by quoting his corny general philosophy,

"The purpose of life, Buffett is said to gravely opine, is to be loved by as many people as possible among those you want to love you."

However, the validity of this approach can be disputed – one could consider Confucius: Is the good man liked by everybody? he was asked. No, the sage responded. The good man is liked by the good and disliked by the bad. Sometimes the good man must take a stand – if everybody says, The devil take the hindmost, the devil soon works his way to the head of the line.

To be fair to Buffett, it should be recognized that while his overall strategy in life may be to follow the principles espoused by Carnegie, the things he says do not invariably follow this pattern. For example, although he carefully maintains his engaging Aw, shucks manner – the frumpy clothes, the ancient house, the meals of Cherry Coke and hamburgers – he can be highly critical of corporate abuse where appropriate.

The TLS review added that another billionaire financier, George Soros, regards the Buffett cult as epitomizing the shortcoming of American society wherein there is an excessive admiration of successes – measured in monetary terms – to the detriment of more intrinsic values. This is perhaps the case, but this is a criticism to be leveled at the cult, and not at Buffett himself.

The reader will note that in 1974 Warren Buffett declared himself a buyer of stocks, which were indeed amazingly cheap at the time. An excellent call. On 16 October 2008, at 950 on the S&P, he declared that again he was a buyer, stocks being cheap because of widespread fear. It will be interesting to see how that prediction stands up. Let us hope for the best!

John Train

February 2009

Footnote

1 The Warren Buffett News Watch (www.warrenbuffett.com). [return to text]

Introduction

Warren Buffett has been one of the most successful of today’s portfolio investors. He is convenient to study, since he has written and spoken extensively on the subject. Indeed, there was for years a brisk samizdat circulation of the annual reports, which include his Letters to the Shareholders of the company Buffett controls, Berkshire Hathaway. Berkshire finally coped with this demand by collecting and republishing the series.

Buffett started out as a disciple of Benjamin Graham, the most eminent theoretician of the value (as distinct from growth) technique of investing. He has edited and introduced successive editions of Graham’s The Intelligent Investor, one of the most useful books for the nonprofessional reader, and remains generally close to Graham’s thinking - which is, however, only one of many valid techniques. But when a disciple becomes in turn a master himself and comprehends the reasons behind his former mentor’s formulations, he rises above the previous orthodoxy and breaks new ground. As we will see, Buffett is no exception.

One hopes that Warren Buffett will one day write his own book about investing; in the meantime, I trust this modest summary will be found helpful. It is based on his writings, interviews, addresses, and informal observations. Some of his views have evolved since they were first put forward and others will in the future. Nobody is right all the time, and one goes on learning. Times change and so must we.

I. A Master Investor

I’ll Take the Money

If you had put $10,000 in Buffett’s original investing partnership at its inception in 1956, you would have collected about $293,738 by the time he dissolved it at the end of 1969, minus, however, his 25 percent general partner’s share of the profits above a 6 percent return to the limited partners, or $267,691 net. He had never suffered a down year, even in the severe bear markets of 1957, 1962, 1966, and 1969. When the partnership was wound up, you could have elected to stay with Buffett as a shareholder of Berkshire Hathaway, Inc., which was spun off from the partnership and became Buffett’s investing vehicle. In that event, your $10,000 would by the end of 1986 have turned into well over $5 million.

His neighbour in Omaha, Donald Keough, once mentioned in an interview that when he was a young executive with Beech-Nut, he went off to work every day while Buffett ran his investment operation from his house. "He had a marvellous hobby, model trains, and my kids used to troop over there and play with them. One day, Warren popped over and asked if I’d thought about how I was going to educate these kids. In truth, I hadn’t given it much thought. But I told him I planned to work hard and see what happened. Warren said that if I gave him $5,000 to invest, he’d probably be able to do better. My wife and I talked it over, but we figured we didn’t know what this guy even did for a living - how could we give him $5,000? We’ve been kicking ourselves ever since. I mean, if we had given him the dough, we could have owned a college by now."[Endnote: 1]

For all his wealth – roughly $1.5 billion – Buffett’s manner has been called corn-fed; it is straightforward and genial. Professionally, he is in the vulture business, but he is a cheerful sort of vulture. He has a round face with a wide mouth, bracketed by deep smile wrinkles. His quizzical eyes peer from behind large, horn-rimmed glasses. From a high hairline, surmounted by a somewhat unruly thatch, run heavy vertical frown lines. Buffett’s clothes are rumpled Middle West, although his good friend Washington Post chairman Katherine Graham sometimes sends him colored shirts, in the hope of pushing him toward a snappier turnout.[Endnote: 2] He loves junk food, including hamburgers and fudge, and was formerly devoted to Pepsi-Cola laced with cherry syrup; he has switched to the new Cherry Coke variation. He has even been known to decline a proffered glass of wine at dinner, saying No, thanks, I’ll take the money.[Endnote: 3] In short, Warren Buffett doesn’t act rich.

In 1986, he acquired a corporate jet, but it’s a fairly elderly, modest corporate jet. Few plutocrats today can manage the marble palace in town and magnificent country seat, the 200-foot yacht and the bloodstock breeding establishment, each tended by hundreds of retainers, the vast art collections and wide benefactions of the old time tycoon. Buffett isn’t rich in that sense.

Of course, as Buffett well knows, being immensely rich (as distinct from just being rich) objectively does you more harm than good. It isn’t logical, any more than endless body building or an oversized chair. From the conspicuously rich everybody wants something. Buffett’s wife Susan, once a nightclub singer, has moved to San Francisco, in part to escape from the unending demands of worthy causes in Omaha. (The two remain on amicable terms, but Buffett now lives with housekeeper-companion Astrid Menks, a former hostess at the same French Café in Omaha that Susan once sang in.[Endnote: 4]) If you get hugely rich, most or even all of the people around you are, beneath their flattery, envious and resentful. Instead of companions they become courtiers. Wealth is a form of power, and the very powerful have few inmates. (The French say that the Rothschilds have no friends, only clients.)

Even worse than the loss of real friends is the probable ruin of one’s children. Privilege without responsibility is a formula for decadence, and enjoying rewards without having earned them, for insatiability and discontent. Buffett, who doesn’t want to subject his children to such dangers, has created trusts for each worth a few hundred thousand dollars, but does not want to give them more for fear of corrupting them. He says: My kids are going to carve out their own place in this world, and they know I’m there for them whatever they do. But he refuses to bequeath them a lifetime supply of food stamps just because they came out of the right womb.[Endnote: 5]

Buffett’s family are not altogether delighted by this delicate solicitude, however. Peter Buffett has gone to San Francisco to make musical commercials; son Howard works for an Omaha land development firm, is in the business of removing snow, with with which Omaha is copiously supplied, and farms on the side. If I was rich I would help [my kids] out more than my dad did, he grumbles.[Endnote: 6] Daughter Susan, who sold real estate in California before moving to work on the business side of magazine publishing in Washington, recounts that when she asked for a loan her father sent her to the bank. On the subject of inheritance, she says, "My dad is one of the most honest, principled, good guys I know, and I basically agree with him. But it’s sort of strange when you know most