How Warren Buffett broke American capitalism

Robin Harding in the Financial Times

Growing up, I admired nobody more than Warren Buffett, the greatest investor ever. His achievement is towering. The market is an implacable opponent but here was a man who beat it year after year, making $75bn out of nothing but wisdom and charm. There was moral purity in his modesty, his ethics and his quiet attachment to home in Omaha, Nebraska. What footballer, politician or thinker could compare?

Now 87, Mr Buffett wields huge influence over US business and finance, usually positive. He pushed companies to expense stock options, warned of danger in derivatives and taught the public to invest long term in low-cost index funds. 

But how ever much you admire the man, his influence has a dark side because the beating heart of Buffettism, celebrated in a thousand investment books, is to avoid competition and minimise capital investment in the real economy. 

 A torrent of recent studies show how exactly those forces — diminished competition, rising profits and lower investment — afflict the US. Economists Jan de Loecker and Jan Eeckhout chart a rise in corporate mark-ups, a measure linked to profit margins, from 18 per cent in 1980 to 67 per cent today. In a paper presented at the Brookings Institution last week, Germán Gutiérrez and Thomas Philippon show how investment has fallen relative to profitability. Mr Buffett did not cause these trends. However, they are central to his fortune. When you celebrate him, you celebrate them. 

If he had found a few truly unusual companies and bought them on the cheap there would be no issue. But acolytes are taking his methods economy-wide Mr Buffett is completely honest about his desire to reduce competition. He just calls it by a folksy name — “widening the moat”. “I don’t want a business that’s easy for competitors. I want a business with a moat around it with a very valuable castle in the middle,” he said in 2007. 

He tells Berkshire Hathaway managers to widen their moat every year. The Buffett definition of good management is therefore clear. If you have effective competitors, you are doing it wrong. 

As with many aspects of his career, Mr Buffett used to act more visibly. An example is his 1977 purchase of the Buffalo Evening News. He bought this newspaper for $32.5m, a high multiple of its $1.7m operating profit, then launched a Sunday edition and drove the competing Buffalo Courier-Express out of business. By 1986, the renamed Buffalo News was a local monopoly making $35m in pre-tax profit. At the time, it was Mr Buffett’s largest single investment. 

His concept of a moat is linked to his views on capital investment: the beauty of one is you do not need the other. One of his most celebrated purchases is See’s Candies, a company he bought for $25m in 1972. Every year, Mr Buffett raised prices. So strong was its brand that despite sales growing little, profits grew mightily, with barely any need for capital investment. “The ideal business is one that takes no capital, and yet grows,” he said last year. 

His statement is unquestionably true for an investor. For an economy, it produces the pattern above: low investment relative to higher profits. A line attributed to business partner Charlie Munger in Alice Schroeder’s biography of Mr Buffett, The Snowball, is revealing: “Munger had always kidded Buffett that his management technique was to take out all the cash from a company and raise prices.” That does sum it up. 

If Mr Buffett in his brilliance had found a few truly unusual companies and bought them on the cheap there would be no issue. But acolytes are taking his methods economy-wide.

These days, Mr Buffett has two main ways of putting his money to work. On one hand, he is finally investing in physical assets, although only in regulated industries such as electricity and railroads where returns are largely guaranteed. On the other, he is working with Brazilian private equity firm 3G as it slashes costs to the bone and drives up margins at Burger King and food company Kraft Heinz. 

Kraft now makes a 23 per cent operating margin and an enormous return on tangible capital. In a competitive market, those high margins ought to present an opportunity for rivals to invest and steal market share. Instead, Kraft competitors such as Unilever and Nestlé are under pressure from their owners — a mixture of index funds and Buffett-like activists — to match those sky-high margins. If rivals also cut, rather than invest and compete, Kraft can cut even more. A kind of Buffett equilibrium is taking hold. 

To be clear, this is not the only reason for declining investment and higher profits in the US. Nor is there a simple solution. Better antitrust enforcement would help, but recent proposals for a complete revamp of competition policy are not well founded. Although research linking lack of competition to cross-ownership by institutional funds is interesting, it does not capture the reality of private equity operators such as 3G. 

We can decide who to admire. Mr Buffett is brilliant at buying into monopoly profits, but he does not start companies or gamble on new ideas. America is full of entrepreneurs who do. Elon Musk is investing in two wildly risky and competitive sectors: automobiles and space. Even the much-reviled Koch brothers built most of their fortune on investment in the real economy. Celebrate that kind of business. It is the kind America needs.

The 'Buffett Formula' Will Help You Get Smarter Every Day

by Business Insider

“The best thing a human being can do is to help another human being know more.”

— Charlie Munger

“Go to bed smarter than when you woke up.”

— Charlie Munger

Most people go though life not really getting any smarter.

Why? They simply won’t do the work required.

It’s easy to come home, sit on the couch, watch TV and zone out until bed time rolls around.

But that’s not really going to help you get smarter.

Sure you can go into the office the next day and discuss the details of last night’s episode of Mad Men or Game of Thrones. And, yes, you know what happened on Survivor. But that’s not knowledge accumulation, it’s a mind-numbing sedative.

But you can acquire knowledge if you want it.

In fact there is a simple formula, which if followed is almost certain to make you smarter over time. Simple but not easy.

It involves a lot of hard work.

We’ll call it the Buffett formula, named after Warren Buffett and his longtime business partner at Berkshire Hathaway, Charlie Munger. These two are an extraordinary combination of minds. They are also learning machines.

“I can see, he can hear. We make a great combination.” —Warren Buffett, speaking of his partner and friend, Charlie Munger.

We can learn a lot from them. They didn’t get smart because they are both billionaires. No, in fact they became billionaires, in part, because they are smart. More importantly, they keep getting smarter. And it turns out that they have a lot to say on the subject.

How To Get Smarter

Read. A lot.

Warren Buffett says, “I just sit in my office and read all day.”

What does that mean? He estimates that he spends 80% of his working day reading and thinking.

“You could hardly find a partnership in which two people settle on reading more hours of the day than in ours,” Charlie Munger commented.

When asked how to get smarter, Buffett once held up stacks of paper and said “read 500 pages like this every day. That’s how knowledge builds up, like compound interest.”

All of us can build our knowledge but most of us won’t put in the effort.

One person who took Buffett’s advice, Todd Combs, now works for the legendary investor. After hearing Buffett talk he started keeping track of what he read and how many pages he was reading.

The Omaha World-Herald writes:

Eventually finding and reading productive material became second nature, a habit. As he began his investing career, he would read even more, hitting 600, 750, even 1,000 pages a day.

Combs discovered that Buffett’s formula worked, giving him more knowledge that helped him with what became his primary job — seeking the truth about potential investments.

But how you read matters too.

You need to be critical and always thinking. You need to do the mental work required to hold an opinion.

In Working tougher: Why Great Partnerships Succeed, Buffett comments to author Michael Eisner:

Look, my job is essentially just corralling more and more and more facts and information, and occasionally seeing whether that leads to some action. And Charlie — his children call him a book with legs.

Bill Pugliano/Getty Images

Continuous Learning

Eisner continues:

Maybe that’s why both men agree it’s better that they never lived in the same city, or worked in the same office. They would have wanted to talk all the time, leaving no time for the reading, which Munger describes as part of an essential continuing education program for the men who run one of the largest conglomerates in the world.

“I don’t think any other twosome in business was better at continuous learning than we were,” he says, talking in the past tense but not really meaning it. “And if we hadn’t been continuous learners, the record wouldn’t have been as good. And we were so extreme about it that we both spent the better part of our days reading, so we could learn more, which is not a common pattern in business.”

It doesn’t work how you think it works.

If you’re thinking they sit in front of a computer all day obsessing over numbers and figures? You’d be dead wrong.

“No,” says Warren. “We don’t read other people’s opinions. We want to get the facts, and then think.” And when it gets to the thinking part, for Buffett and Munger, there’s no one better to think with than their partners. “Charlie can’t encounter a problem without thinking of an answer,” posits Warren. “He has the best thirty-second mind I’ve ever seen. I’ll call him up, and within thirty seconds, he’ll grasp it. He just sees things immediately.”

Munger sees his knowledge accumulation as an acquired, rather than natural, genius. And he’d give all the credit to the studying he does.

“Neither Warren nor I is smart enough to make the decisions with no time to think,” Munger once told a reporter. “We make actual decisions very rapidly, but that’s because we’ve spent so much time preparing ourselves by quietly sitting and reading and thinking.”

How Can You Find Time To Read?

Finding the time to read is easier than you think. One way to help make that happen is to carve an hour out of your day just for yourself.

In an interview he gave for his authorized biography The Snowball, Buffett told the story:

Charlie, as a very young lawyer, was probably getting $20 an hour. He thought to himself, ‘Who’s my most valuable client?’ And he decided it was himself. So he decided to sell himself an hour each day. He did it early in the morning, working on these construction projects and real estate deals. Everybody should do this, be the client, and then work for other people, too, and sell yourself an hour a day.

It’s important to think about the opportunity cost of this hour. On one hand you can check twitter, read some online news, and reply to a few emails while pretending to finish the memo that is supposed to be the focus of your attention.

On the other hand, you can dedicate the time to improving yourself. In the short term, you’re better off with the dopamine laced rush of email and twitter while multitasking. In the long term, the investment in learning something new and improving yourself goes further.

“I have always wanted to improve what I do,“ Munger comments “even if it reduces my income in any given year. And I always set aside time so I can play my own self-amusement and improvement game.”

Reading is only part of the equation.

Lane Hickenbottom/Reuters

But reading isn’t enough. Charlie Munger offers:

We read a lot. I don’t know anyone who’s wise who doesn’t read a lot. But that’s not enough: You have to have a temperament to grab ideas and do sensible things. Most people don’t grab the right ideas or don’t know what to do with them.

Commenting on what it means to have knowledge, in How To Read A Book, Mortimer Adler writes: “The person who says he knows what he thinks but cannot express it usually does not know what he thinks.”

Can you explain what you know to someone else? Try it. Pick an idea you think you have a grasp of and write it out on a sheet of paper as if you were explaining it to someone else. (see The Feynman Technique and here, if you want to improve retention.)

Nature or Nurture?

Another way to get smarter, outside of reading, is to surround yourself with people who are not afraid to challenge your ideas.

“Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.” — Charlie Munger 

Warren Buffet - a Jaded Sage?

The jaded sage
By Chan Akya in Asia Times Online

Warren Buffett, besides being the Sage of Omaha and one of the wealthiest men to ever walk this planet, is also an American hero. A man who popularized the notion of investing your savings prudently, taking a knife to Wall Street excesses and more recently, the architect of an effective minimum tax for rich Americans. All in all, your regular billionaire next door.

Of course I can also recount all the reasons why anyone who bothered to print this article and read the first paragraph got disgusted, crumpled the paper into a little ball and threw it into the nearest waste bin.

You know, stuff like his holdings in major American scams like Moody's which he purchased due to the massive profits they were making from selling fake triple-A ratings all around. Or his rescue of such amazing firms as Goldman Sachs in the midst of the financial crisis, in effect protecting them not so much from aggressive market speculators but perhaps the major regulatory bodies as well (Mr Buffett is a known supporter of and donor to President Barack Obama).

Even that supposed act of folksy good humor ("my secretary pays a higher tax rate than I do") hides an ugly word: "legacy". Mr Buffett is old and if he had wanted to pay higher taxes, well he had the last 60 years in which to do it.

But I don't care about any of Mr Buffett's flaws any more than I lose sleep over that stupid woman who unfailingly puts mayonnaise on my sandwich despite being told not to every day. My getting upset doesn't change a thing, and just ends up spoiling my day: it's easier for me to just buy my sandwiches somewhere else. That's where I left Mr Buffett - that is, until his latest investment letter hit the web and through acts of generosity by my friends, made it into my inbox. Ten times over.

Cold on gold
I don't know why so many of them did that - but it may have something to do with his statements about irrational choices that investor make about assets. He writes:

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth - for a while.

Okay, so if I understand this right, Mr Buffett objects to the fact that gold cannot be manipulated, conjured up out of thin air and that it draws a bunch of people weary of Keynesian money printing into its fold. I am not going to suggest that Mr Buffett is thick or something, but isn't all of the above the very point about owning a store of value in the first place?

I don't know about you, but if I could travel through the centuries I would sure as hell like to have in my pocket something that would still be worth something in purchasing power that approaches its current value.

Imagine the following scenario: your grandfather leaves us some wealth but you only get it 50 years later. Now, what would you have liked that "wealth" to have been: cash in US dollars or gold coins? Of course other assets would have worked better - "shares in Apple" for example. Then again, if your grandfather had given you shares in Apple and you got them in 1998, your general feelings of gratitude towards him would have been a somewhat dimmer.

Then Mr Buffett goes on with his diatribe:

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce - gold's price as I write this - its value would be $9.6 trillion. Call this cube pile A. Let's now create a pile B costing an equal amount. For that, we could buy all US cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

... A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops - and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Yup, valid points there. Then, again Mr Buffett, I wonder how those farmers would pay for the oil to use in their harvesters and how those oil workers would pay for all the grains they would need to eat. Would they own shares in each other and pay the other party dividends in kind? Or would they transact with a common currency, like gold?

And all the analysis misses the point about corporate fraud, that uniquely American preoccupation that has seen many a top firm go completely bust because of financial and accounting shenanigans. If Mr Buffett had mentioned BP instead of Exxon (and written this article two years ago rather than now) he would have had egg on his face. (See also "BP, Bhopal and Karma", Asia Times Online, June 19, 2010, one of my past articles on the subject of corporate responsibility.

Mr Buffett misses the point entirely about what gold is and what it is supposed to do. In a world where investors have ample reason to lose faith in governments and the financial system, the position of a common store of value that is recognizable and usable across all humanity and is itself beyond religion and politics in terms of being manipulated around (besides being no mean feat by itself) is made stronger, not weaker.

That is not to say that I am recommending you folks to buy gold and nothing else; my view has always been that a building up a little hedge for your financial assets with physical gold is no bad thing. I don't speculate in gold nor do I believe you should.

Of course, he clarifies similar points later on his spiel as follows:

My own preference - and you knew this was coming - is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See's Candy meet that double-barreled test. Certain other companies - think of our regulated utilities, for example - fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets. Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the US population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Really? The best that Mr Buffett can conjure up as stores of "productive" assets are those that generate software consulting services, sugared water with noxious chemicals and over-sweet artificially flavored foodstuffs? Is it possible that all of these companies will even exist 200 years from now, or will a bunch of lawsuits or corporate fraud take one or more of them down as they have many an American corporation?

This is neither about questioning his investment choices nor indeed to taunt a proud American on that country's potential failings. The investor letter though is emblematic of the core ill plaguing the West now; namely a failure to question the current logic of organization underpinning the economy.

On the other end of the scale, it is not immediately apparent that a deleveraging America would need as many cans of sugared water with noxious chemicals as it does now; nor indeed that the current system of savings through stocks could survive a Japan-style lost decade when the locus of the economy shifts from consumption to production.

In a different way of thinking, it is a good thing that Mr Buffett writes his letters the way he does now. Two decades from now, economists and students of finance may ponder the madness of our times that made a man like him the foremost investing genius in the world.