Berkshire Hathaway Part I

gonna need some of that um you know running like the the goo that you eat oh man i should have brought a snack well great thing about not being alive we could always just take a break if need be it's true on the warren and charlie don't take a break it's true yeah oh my god what are we doing we should have brought peanut brittle and cherry oh snap well for part two peanut brittle and cherry cokes are yeah mandatory mandatory oh well that's okay because we're not really talking about berkshire today that's right it was intentional yeah welcome to season eight episode five of acquired the podcast about great technology companies and the stories and playbooks behind them i'm ben gilbert and i am the co-founder and managing

director of seattle-based pioneer square labs and our venture fund psl ventures and i'm david rosenthal and i am an angel investor based in san francisco and we are your hosts let's talk about the 10 most valuable companies in the world the first nine are tech companies there's of course the big five in the u.s plus tesla of course because it's 2021 of course and then you have tencent and alibaba from china the ninth tsmc the taiwan semiconductor manufacturer and the 10th the only non-tech company it's a 182 year old company that started as a textile mill in new england berkshire hathaway as most listeners know berkshire is far from a textile mill today it is a holding company unique in every way in by far the most successful in history a few of the

companies that they own outright include dairy queen duracell fruit of the loom geico net jets sees candies and even brooks running shoes seattle company right oh yeah oh yeah and i'm super loyal i i ran up mount si wearing them the other morning nice they also own large pieces of many of your favorite publicly traded companies including amazon johnson and johnson coca-cola american express kraft heinz verizon gm mastercard snowflake and now they even own over a hundred billion dollars of apple stock and somehow the man behind it all warren buffett has claimed that purchasing berkshire hathaway was the biggest investment mistake he had ever made and for many of you you're probably learning that warren buffett purchased berkshire hathaway and it was not something that he founded

which is the first takeaway from this episode he claims we will cover this again much later in the episode but he claims that purchasing berkshire hathaway cost him 200 billion dollars in opportunity cost well when you compound something over 50 years you you can uh you can come up with some large numbers so what the heck is this company how did it come to be and why is it that even at an all-time high for the stock so many analysts think it is underpriced today well to do this right we are going to need more than one episode even an acquired sized episode so welcome to our first part of our two-part series on berkshire hathaway and in this first part most of it won't even be about berkshire the company

it's about the man warren buffett and his mental iterations and learnings that would shape what berkshire would come to be people always try and reduce what buffett does to a simple strategy or even a few pithy quotes in reality warren has learned adapted and reinvented his strategy at least four distinct times over the decades in doing the months of research to prepare for these episodes david and i both learned just how much warren's thinking evolved to create the absolutely unreplicatable juggernaut that berkshire hathaway is today so on this episode we bring you the story of warren buffett the learning machine are you an acquired slack member if not what have you been waiting for it is a stellar community discussing all things acquired recent episodes but more importantly it is just a genuine smart group of

people having a thoughtful nuanced and respectful discussion about the tech and investing news of the day you can join at acquired.fm slash slack all right listeners now is a great time to talk about a new partner of ours here on acquired lagora the agentic operating system that is redefining how the world's best legal teams work yep it's sort of obvious that ai is going to completely change the legal industry i bet most of you listening have dropped a contract into some sort of ai chat bot out there lagora took that insight and asked the question what if you really built something with that power from the ground up for the legal industry so the founders did exactly what great founders do operate with

obsessive customer focus they embedded inside a massive law firm for months they sat with the lawyers just watching how the work really gets done and that's how you get features that customers love like tabular review where you drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with lagora's bet here is interesting since it lets each lawyer handle more complexity any given person can increase the quality of their work and do higher value work and this means that the pie can grow even as each individual task takes less time and they recently launched lagora agent offering greater intelligence and performance the agent lets lawyers set an objective then it can

handle the planning and the execution and delivery of the final product legal teams get to maintain full control and transparency since they're still involved where judgment is required and lagora works where you already work you can use it within microsoft word while redlining or drafting the early lagora numbers essentially speak for themselves when they have a head-to-head pilot with their top competitor they win 70 percent of the time lagora now has over a hundred thousand lawyers on the platform from 1200 legal teams in 50 countries and crazily they went from 1 million to 100 million in arr in about 18 months truly insane numbers and that is the real test plenty of things demo well but the question is whether a busy associate actually reaches for it during crunch time or whether a partner trusts it

before going into a conversation with a major client if your legal team wants to check it out whether you're a law firm or you're in-house at a company you can learn more at lagora.com acquired and just tell them that ben and david sent you all right lastly to keep this short and sweet if you are not an acquired lp you really should just become one and aside from all the things that we tell you every episode about the lp program we just did a really cool new thing we called it a community q a with the founder of levels josh clemente after we had him on on the show and we thought wouldn't it be cool to let all the

lps pepper him with questions and interact with him that was super fun if you missed it you can check out the recording in the lp google drive and if you are not already a limited partner you can click the link in the show notes or go to acquired.fm slash lp cannot wait to see you in there all right david i think we are ready to do it listeners as always this show is not investment advice and you know like warren buffett we would never profess to give you investment advice all of our best ideas we will keep a deep dark secret maybe until long after we've executed them so we can sort of tell the world about our wonderful investments but david and i may have investments in the companies that we

discuss the show is educational definitely do entertainment purposes only we hope you enjoy it and without further ado david rosenthal where are we starting this story i have been a proud berkshire hathaway shareholder of the b not the a for pretty much my entire life the greatest things that really gifts that my parents and grandparents gave me was a few shares of berkshire b when i was a little tyke never sold them very smart investment on their part what's your sell date on them what's your uh where are you exiting the position uh never as as it should be as it should be okay before we dive into history and facts we owe a big big big thank you to alice schroeder and her wonderful book

the snowball which i at least used as my main source for this episode ben you read uh yeah buffett the making of an american capitalist uh a great book by roger lowenstein i thought this book was awesome people talk about snowball all the time as the one as the sort of more popular uh buffett biography i thoroughly enjoyed this book so i think you can't go wrong yeah well we'll get to compare and contrast as we go here but alice's own story is pretty amazing i didn't realize to looking this up she was an equity research analyst on wall street covering insurance companies and she wrote to warren in 1998 asking to talk to him and warren had never talked to wall street research analysts before but for

some reason he takes her call and uh she was the first research analyst to initiate coverage on berkshire kind of amazing and then in 2003 another author approached her about writing a book together on buffett she talks to buffett and he says well why don't you just write it instead and i'll give you full access like thousands of hours with him oh family everybody it's amazing amazing story so definitely go check out both the snowball and buffett great books highly highly recommend and listeners we'll have to see how this goes this is the second time i think the new york times would have been the first one but where david and i both just read separate books and i think we both

read them cover to cover obviously we've got a few dozen other sources that we use for this as well but we may have stories that uh one another does not know about yeah we shall see okay so i'll go first and start appropriately enough back in 1867 with a journey from new york to omaha undertaken by a young gentleman named sydney buffett who was working for his father's farm in long island but he quits because he feels like he's not getting paid enough and like so many young people young men of his generation he decides to go west to seek his fortune and he ends up in omaha nebraska he got part of the way west part of the way west i think his maternal grandmother grandfather was already there

in omaha that might have been why he headed there but the other reason was that omaha was a boomtown at the time so it had existed for a long time it was a kind of pit stop on the uh the trail west the the oregon trail or the california trail for gold prospectors heading out west but after the civil war the u.s civil war lincoln decrees that omaha is going to be the headquarters of the new union pacific railroad and uh which is going to connect up the west coast of the united states with the rest of the country and the town takes off now interestingly union pacific is still around and operating today ironically as the second largest rail company in america after of course burlington northern being

the first northern santa fe owned by bruxia hathaway but that won't come until part two so sydney gets to town he decides he doesn't want to be a farmer anymore he instead wants to sell products from the farm he opens up the first grocery store in omaha and um he runs it and then effectively passes it on to his son his son ernest buffett um i think actually technically sets up a different store but it's like the family business so ernest his son is running the legacy of the grocery store in omaha and as alice points out in the snowball earnest was very very aptly named as uh as we'll see under earnest management of the store his quote that he likes to use is the hours are long

the pay is low the opinions cast in iron and the foolishness is zero oof hardcore yeah oof hardcore so typical of this sort of uh new entrepreneurial middle class ernest and his wife henrietta you know they they're fine with their children working in the store but they want them to get a good education and become professionals so most of their children go to the university of nebraska including their third son howard who majors in journalism and works at the daily nebraskan school newspaper while he's working there he meets a freshman who comes in and is applying for a job layla stall whose father owned a local newspaper in nebraska and they meet they hit it off they marry of course these are warren's parents that

we're talking about and amazingly you know they meet at the college newspaper the uh very fitting the newspaper business is going to play a large part in uh young warren's life to come so howard graduates in 1925 he and layla marry and as was typical at the time unfortunately she drops out of school by all accounts she was like an incredibly promising student very good at math uh her professors were very disappointed when she drops out to mary howard and and become a housewife howard of course he wants to go into journalism and eventually politics but earnest is having none of it his son needs a respectable professional career uh the no nonsense earnest so he instead uh suggests that howard might want to do

something you know more more useful something more like selling insurance so the just ironies continue to mount here boy we've got newspapers already we've got insurance already it's like either berkshire hathaway basically has an index on the american economy or the forces that would then shape war in forever are sort of already playing a role in his life they're already stacking here probably some of both probably some of both maybe more the latter because there's one more chip to stack which is howard for two years he's a insurance agent selling insurance but we're in the late 1920s now and it's the roaring 20s and it's go-go time and howard after a couple years decides you know maybe this insurance stuff is pretty boring uh you know my my customers here in omaha they don't want

insurance anymore they want stocks baby so he switches careers two years out of school and goes from selling insurance to being a stockbroker in omaha i had to like look this up thinking about this like well you know you hear about stockbrokers like what does it mean to be a stockbroker in omaha in 1927 so you got to remember it's like there's no charles schwab uh for one i mean schwab was hugely innovative right so how are you brokering stocks if you're not on the floor right like so there's the exchange the new york stock exchange in new york but then for all the rest of the retail public in america how do they get stocks you've got a local broker who is your sort of like combination

financial advisor plus you know exchange access you know your you call your broker or more often he calls and it was always a he at the time uh he called you and would say hey you know i've got this great stock that you might want to think about getting into you know i i know you and your portfolio your investment objectives and you would chat on the phone with him for a while or you go to his office and then you would sign up and you would buy shares he would then call the exchange back in new york get a trader on the line and then buy in your name some shares oh so they would get a trader on like it wasn't

like the brokerages bought these big blocks and then they would sort of like sub it was like your broker would like call a trader on the floor to execute your trade well i think it was kind of both i think that was if you wanted a specific trade to happen but more often what would happen was the big banks and financial firms and trading houses in new york they had like product that they needed to move you know they had issuances that they needed to move they had trades that they were doing they needed counter parties to the trades and so all these local stock brokers distributed throughout the country they were like the distribution and sales force like you know people talk about sales and trading back in the day

and as part of investment banks the sales part of it was sales to these you know an effort to educate all these local brokers to then recommend and push stocks to the clients yeah pretty fascinating i mean and at this point in history investing isn't really like a profession with a lot of sort of science behind it it's kind of looked at as gambling right like buying stocks totally fundamental analysis does not exist yet it's like people think about stocks as exactly gambling is the right word kind of like you know tickets to bed on a horse like oh i like the name of this company or i like what they're doing but nobody's thinking about what's the capital structure of this company what are its revenues what is growth prospects

that's that's not how this works so warren would later in life as we shall see uh he would do a brief interlude working for his father at the firm as a stockbroker himself he called what they did equivalent to being a quote-unquote prescriptionist versus being a doctor it would be like if you were you know a medical professional and you got paid based on the type and amount of pills that you prescribed to your patients versus the actual like outcomes because you're just getting paid by the on every every stock that you sell like the incentives are totally misaligned oh you're making me pull forward my first playbook theme already like this is one of war i mean we're he's

not even born yet in the story but this will ultimately be one of his very first realizations is what is the point of me researching the crap out of these companies and picking stocks when all i'm getting paid for is just to move product you know it's like a total like you said total incentive misalignment total instead of misalignment but but let's let's stick on warren's father like father howard yep yeah okay so howard 1927 he switches over to becoming a stockbroker things are really great they're humming the family's doing great for two years and then october 29th 1929 amazing i don't think we've talked about this on this show yet amazingly no we've made it 150 plus episodes without

talking about black friday black tuesday black tuesday black friday is a much happier uh event a real capitalism fest america has not a capitalism fest on uh black tuesday mark on me yeah yeah all right so black tuesday black tuesday of course we're talking about the stock market crash on black tuesday over i think it actually wasn't that bad by modern standards i think the dow dropped like in the low teens maybe percentages on black tuesday but it was still shocking to people the real problem is over the next three years after black tuesday the market loses 90 percent of its value could you imagine that like that's unbelievable i mean during the in 2008 i think the market lost like close to 50 percent maybe but 90 people are just wiped out like it's carnage yeah

like the way that it's described in in loenstein's book is that what was unique and remarkable about the great depression was that even the smart money got wiped out because the people who sort of realized oh things are cheap now the the crash is over would buy in and then even they lost all their money and of course that is the thing um to fear when everyone's screaming buy the dip uh and of course that hasn't happened to this level as you're saying since 1929 but just crushed everyone well to grossly oversimplify you know what at least i think happened and why it hasn't fortunately happened since is so the stock market crashed and that led people to panic and that led to runs on

banks people wanted their cash out of banks banks were you know not nearly as institutionalized as they are now and there was no fdic insurance that was put in place after the crash so when there runs on the banks that led to bank failures so when the when all these local banks failed the fed had to i think raise interest rates because it was like borrowing was so hard now there was so much less like capital base available to borrow so the interest rates had to go up so you've got an economic shock oh wow and then interest rates are going up like imagine like when coronavirus you want to be able to lower them right like when coronavirus hit the fed slashed it to you know less than zero and same

during 2008 so no it was a double whammy of like economic shock plus major interest rate hikes and that just like that led to it was a decade of you know more than a decade really until world war ii the stock market the dow wouldn't return to its high before the crash until 1954 that's 25 years that's a quarter century just lost like crazy crazy crazy okay so back to howard and the buffets howard does something pretty crazy right so like it's you know it's bad warren is born uh less than a year after black tuesday on august 30th 1930 warren edward buffett is born the next year it wasn't until 31 howard was working as a stock broker for union state bank and the bank fails so not only is howard out

of a job but all the family's money is at the bank so they got no money they got no job and howard and layla now have two kids so what does howard do he does the 100 total contrarian move first he does try to go to his father to earnest and and get a job at the family grocery store earnest is like i can't i don't have any money to pay you like i can't employ you so howard sets up his own stock brokerage firm so we're in the middle of the great depression really after the crash and he's just like well i know i want to be a stock broker oh he's not totally crazy because you know the world is belting down

but for anyone who does still have some wealth left they need something to do with it like they're not going to put it in the stocks that they were in before the crash so howard has this sort of business plan he starts going around omaha to anyone who still has any wealth left and he advises them on hyper conservative investments that they can use their capital for so like utility companies municipal bonds that kind of stuff and it works like there's actually demand for this kind of service so he's placing all these hyper conservative securities uh he ends up making i think pretty quickly like way more money than he was making at the old job wow i didn't realize that he sort of

broke out of his own there and started his own brokerage yeah started his own brokerage uh it would eventually come to be known as buffett and fock and so the family actually you know warren has no memory of this of these two years of really hard times but kind of skates through the depression fairly well off his dad bought the dip his dad bought the dip exactly so warren unsurprisingly to anyone who's heard of him which is probably everybody listening to this podcast turns out to be an extremely mathematical kid so he's like always counting things this is things counting bottle caps he's counting his weight he's running all sorts of analysis even as a little kid did you see he like

was counting the occurrences of letters in like newspaper articles and then he and his friend would like tally them up and make bets on which letters were gonna appear more often than others like he was he was counting completely arbitrary things just to count them you might say that uh he has some budding ocd developing in his personality he was writing down license plates that went by i mean it was hardcore it was hardcore so then famously as the story goes there's actually a picture of this for christmas when warren is six years old he receives one of those money coin changers like that you wear on your belt like the old oh yeah style uh i actually had one of these two i got one from my grandpa

ah amazing with the little like dude that we crank that you push down the little like lever yep and then it spits out you know one coin at a time and there's the separate slot for quarters and dimes and nickels and pennies i mean that thing was so cool so warren gets this and he becomes obsessed with it this is like you know the combination of counting and collecting things and analyzing and and money he's just like he wants to get as many coins as he possibly can to stuff into this thing and then he starts keeping jars in his drawers of all the all the buddy it's amazing so he starts to think like how can i get more money he goes i assume to his

grandfather to the grocery store and he buys packs of gum like in bulk and then he starts going around door to door in the neighborhood and selling individual packs of gum to mothers in the neighborhood for five cents a pop amazing uh then he starts you know he kind of gets this racket going then he starts selling soda door to door he starts selling magazine didn't he like on a vacation he like goes and buys some cokes and he's like wandering around the edge of a lake selling cokes for like twice as much as he bought them for i don't think this was in the snowball what uh yeah it's it's exactly that and it was cokes i remember that despite his soon-to-come pepsi addiction his earliest

childhood sales came from cokes amazing so he's starting to accumulate the beginnings of the warren buffett wealth when he's 10 years old howard takes him on one of his trips to new york and to wall street and this is amazing you probably read this too warren actually gets to meet the legendary sydney weinberg who was the head of goldman sachs at the time he's 10 years old warren buffett's 10 years old and his dad takes him to meet sydney weinberg and uh supposedly as they're you know warren's sitting there starstruck the whole time and uh as they're leaving sydney supposedly turns to him and says what stock do you like warren and unfortunately in the snowball like alice doesn't say what warren responds like i want to know what the hot pick is

uh but he's totally starstruck this makes a huge impression on him and uh before they come home after the weinberg meeting his dad takes him to the stock exchange in the new york stock exchange to the building for lunch and uh they have this great like amazing lunch in this you know gilded building and after lunch a waiter comes up to the table with a tray that has all of these different types of tobacco on it and rolling papers for cigars and warren realizes that like oh after lunch at the exchange you get like a custom cigar made for you like you choose the tobacco and uh or it says he's like he you know he has no interest then or ever in smoking a cigar or even in any of these trappings

of wealth but he realizes like if this is how they roll at the new york stock exchange every day there must be so much money here i gotta find a way to get me some of this do you know if he got to like see the trading floor as a 10 year old i i think so i think so have you ever been no have you yeah so i went when i was 16 or something as part of a high school trip where there was a someone who had taken a class that i had previously taken who who worked at the stock exchange and sort of got us in and we went on the balcony and all that and um it leaves a mark i mean looking out at this this would

have been 2005 or 6 something like that so it was mostly already computers and the people that are there are you know you don't have people making every trade live on the floor the way that you did would have in those days but even then it it leaves that impression especially as a teenager how much gravitas there is there that that's sort of the central clearinghouse of equities in our nation yeah it's a impactful experience yeah it's like it's capitalism there incarnate so warren says this trip and the wealth that he saw at the stock exchange and at goldman he says he didn't want he didn't have any desire to have any of the fancy stuff but he says he did want independence he said i

realized wealth could make me independent then i could do what i wanted with my life and the biggest thing i wanted was to work for myself i didn't want other people directing me the idea of doing what i wanted to do every day was important to me yeah that that certainly happened it certainly happened i just like resonates so much i feel exactly the same way so when he gets home he decides that he's going to set a goal to amass this wealth that's going to get him the independence that he wants he tells all of his family and friends that his goal is he's going to be a millionaire by the age of 35 being a millionaire in those days would be equivalent to about 15 to 20 million dollars

in net worth today so you know gosh today i mean like like anybody can do it and it's great and doing our entrepreneurial startup friendly you know ecosystem it's probably not totally crazy if a little kid said that they wanted to amass a 20 million dollar fortune by the time they were 35 in omaha in 1940 this was like totally nuts yeah i'll bet i mean the other thing it reminds me so much too of the you know he would say several times throughout his life and i'm going to paraphrase that he doesn't want to be rich to be rich he wants to you know have a lot of money because it's fun to have a lot of money and it's fun to watch it grow and you can sort of already see

that and like his ambition here is not to make some specific impact or to get to do a certain thing because he has passion for it it's like no no i want to be a rich person and it's fascinating how even so early in his life he's just unabashed about that i mean there's so many like i think we're talking to every founder right now that's going out and like 50 wants to be rich and 50 wants to accomplish the mission that they're on and they're like i'm here to accomplish the mission that we're on because we've all had it browbeaten into us that like yeah it is it is not virtuous to want to be and he's like no no no no like i want to be a rich person and later in his life he

would also decide like i want to be likable i want to be you know an icon in america i want to be a platform for learning i want to teach but at this point he's like i want to be a rich person i just want to be rich yeah it's kind of amazing even the 50 of you know people and founders out there who like do just want to be rich so you would never say that right it's a very buffett uh sort of singular focus and frankly like not caring about what other people think of him to just have that yeah just come out with it so this is pretty amazing he's 10 years old he has this goal and he figures something

out at the age of 10 that just drives the entire rest of his life and i think it's something that like 99.9 percent of people out there in the world never figure out which is this concept that money can create more money which is obviously compounding which will spend most of the rest of you know the next several hours here and several hours on the next episode talking about but he figures this out like it just simply reduced to that money can create more money and the way he figures it out the story goes he had gone to the library and taken out a book called 1000 ways to make 1000 dollars uh one of those like books that could only exist in like the 40s and 50s yep and um one of the 1000 schemes that

it describes in the book is that you could buy a penny weighing machine so these things used to exist they're like scales in public that would be on like street corners and in drug stores and stuff and um you would weigh yourself on it i guess because like home scales oh i've seen these in like grocery stores yeah and uh and so you'd pay a penny you put a put a penny in the slot and then you'd get to weigh yourself and um and so the scheme in the book is that oh you just go buy a penny weighing machine and then you collect the money over time and eventually you'll get a thousand dollars out of it so warren reads this and he's like wait a minute what if i buy one weighing machine

and then once i earn enough money from it i use that money to go buy another weighing machine and then i'll put it in a different spot and then i've got these two weighing machines both earning pennies every day well the rate at which i'll earn enough to buy my third weighing machine is going to be half as much time and then i can buy my fourth weighing machine and you know another third is less time and so he figures this out he apparently literally starts writing out you know essentially compound interest tables in his bedroom in his notebook dreaming about all these weighing machines that he's gonna have oh it's so crazy amazing other kids would be like thinking about using all this

money to buy bubble gum or baseball cards or something and he's 10 like i i knew that later as he gets into his teenage years he's um you know he's got a little pinball servicing business but like at he's 10 that's crazy he's 10 so yeah so you alluded to he never does do the weighing machines but when he's in high school yeah he doesn't actually end up buying he just like does the formulas to see what it would be no he he just does the formulas yeah oh wow but he does buy used pinball machines in high school and like he makes a ton of money off these things he puts them in barber shops it's great do you know

why he got out of that business the pinball no i assume just because he graduated high school no this is a call back to our uh nolan bushnell episode warren found out that this was a business that if you get too powerful in it then you start having to contend with the mafia for uh you know who's getting a cut of doing that servicing and he basically was like well i don't want anything to do with that and he his friend got out of that business wasn't nolan saying something about um that pinball machines were linked to like bootlegging to during prohibition and like bootlegging money laundering yeah they've got sort of a storied history there that would then bleed

into arcade games too because i think one it was an outcropping of the other that's right these are these are doing warren's uh less scrupulous early years well and he he had this whole game too that he was running where um he and his friend would basically pretend that they weren't the guys in charge that they worked for some bigger company and so whenever they'd get like you know harassed for something or they would complain about prices or something like that they would say like look we're just a you know we're the hired hands like we're not the guys in charge we gotta we don't set the prices it's such a good bit oh warren so great so the other thing he does when he gets back from the new york

trip is uh of course he starts buying stocks he's got his dad the stock broker right there so he's got the line he can go buy stocks so he um he convinces his big sister doris to pool all of their money together they're about like 200 250 bucks between them and uh and he decides he's gonna buy shares uh preferred shares in a company called cities service so they together you know he's he's the sort of managing partner in this partnership uh they buy six shares for 38 bucks a share and immediately the stock goes down to 27 bucks a share so not a not an auspicious beginning doris is like freaking out about this and warren feels horrible it's like eating him up so the stock

does recover to 40 a share and warren just unloads it he's like great get the money back give doris her money back but it keeps going like pretty quickly the stock goes to over 200 a share but warren had already unloaded this is like me and bitcoin in 2015 like this is exactly what 10 year old warren if only ben if only you'd learn these lessons at age 10 blew it so i'd say the incident makes an impression on him he says he learns three lessons from this i think he actually only learns one but the first that he says he learns is don't fixate on the price you paid for something it's irrelevant the second is don't rush to grab a small profit stay focused on

the big long-term wins the irony is he would violate rules one and two like many many many times until he was about 40 years old so as we shall see but the third lesson he does learn which is that you can't control other people's emotions around money so if you're gonna take money from anybody you need to make sure one that you're not gonna lose it and he's talking about his sister here he's talking about his sister yeah and two that you need to do something to manage their emotions or their ability to affect you so that they don't freak out and cause you to do uneconomic things you know warren might have sold at 40 anyway but certainly that his sister was breathing down his neck to sell it you

know it reminds me of um sequoia days yeah an apple warren decides it's best if the clients don't see how the sausage is made so to speak which would absolutely inform his uh you know his his perspective on some of the partnerships he would do in the near future where he would not tell people the stocks he was buying on their behalf which like i remember reading those words and being like what this is like a blind undisclosed pool that he's running but it's so easy to see how uh you know these early experiences make him realize yeah like if you want to be you know the completely independent free thinker that you are doing your own fundamental analysis and not moved not only by the current price that things are

trading at but of the emotions of your investors or the demands of your investors for their tax consideration or for whatever reason they want to withdraw funds then you better figure out how to hold and manage money on your own terms totally totally so meanwhile shortly after the new york trip howard's career takes another turn pearl harbor happens and the u.s of course enters world war ii uh howard is a like staunch isolationist and very and define that for us like like xenophobic like anti-trade anti it's unclear to me if he was xenophobic i mean he probably was i i wouldn't imagine he was the kind of person who loved foreigners but he was certainly very against america entering the war uh and he hated fdr and roosevelt he was like a die-hard republican

as apparently were many people in nebraska at the time because he runs for congress inspired by the u.s entry into world war ii which he thinks is the worst thing that has ever happened uh and he wins so the family moves to washington and howard becomes a u.s congressman warren though he hates it he wants nothing to do with washington he loves omaha he wants to go back so he campaigns his family to let him go live with the grandfather with earnest back in omaha and warren's like this is gonna be great you know me and gramps we're gonna become industrialists we're gonna be partners buddy buddy we're gonna be like you know the rockefellers and the morgans it's gonna be great he moves back

lives with his grandfather and earnest puts him to work in the store as a stock boy and warren's like wait a minute i thought we were partners here yeah i like the business you're running i don't so much like the work that i have to do inside of it yep so manual labor stock in the shelves extremely low pay warren's like this sucks i gotta get out of here did you read too that like his grandpa was withholding a penny or two each day to simulate social security to like show warren what it was like to have to pay different levels of taxes oh so great so great ironically somebody else would feel this exact same way about working for earnest buffett a few years earlier though they

would not intersect one charles thomas munger so crazy like how nuts is it that charlie munger worked for warren's grandfather in the same job that warren did a few years later and they never met until what their 30s something like that yeah until 1959 they never met wild crazy so after this summer that uh warren thought would be his future industrialist summer he's like all right take me to washington i gotta get out of here get out of the store he goes with the family to dc where he devises a new way for making money to earn his fortune he gets a paper route delivering the washington post amazing like beautiful foreshadowing and uh when he can profess that i rose all the way

from paper boy to chairman albeit with some you know leaving the and coming back in between yep it's an amazing journey an amazing journey and of course yes he would later become the chairman of the washington post and partner to kay graham what was martin the chairman he i think he was the chairman yeah and kay was the ceo i think that's right i mean he got a board seat commensurate with his investment i think she gave him the chairman role because she had so much sort of respect for his counsel well we'll hear more about that in part two to come but he's got this paper route now and remember he was selling gum and soda door-to-door back in omas like this is great now i've got the way that literally my foot in

the door to all of the housewives in washington dc you know i deliver them the paper but i can sell them magazine subscriptions i can sell them calendars i could sell them all sorts of stuff so he starts an empire in the streets of the suburbs of washington dc and he's doing crazy stuff like he's ripping off the labels on subscriptions that i think people had like put out to throw away so he was basically understanding when subscriptions would expire so he knew who to go sell what subscriptions to at what time it was a brilliant strategy warren loves digging in the dirt for stuff yep so by the time he's in high school in washington he's earning 175 bucks a month which is more than what his high school

teachers are making and almost as much as the average u.s workers salary at that point in time wow and warren's in high school totally crazy he's amassed okay he's not spending any of it of course he's amassed over two thousand dollars in savings which you know is the equivalent of like i don't know forty fifty thousand dollars today like how many high schoolers do you know that have amassed self-made almost a full bitcoin in savings and and how many high schoolers do you know that firmly understand what the value of that is compounded seven percent every year for another 80 years like you know that warren is looking at that stack imagining its future potential totally so now he's got like some real actual capital to invest what does he do he's still buying individual stocks still

playing the stock market but he really you know he wants to be this like industrialist businessman he's decides he's gonna buy an actual business he's 15 years old so he buys a tenant farm in nebraska back home no way twelve hundred dollars uh so a tenant farm he buys a farm an active farm with a tenant on it that is working the farm because warren's not going to work the farm like no way and the deal is with tenant farmers is the tenant farms the land and the profits from the crops get split 50 50 between the tenant and the owner of the farm half the returns to capital half the returns to labor yep and of course if the tenant also gets to live there in addition to getting half the profits right indeed

indeed wow it's like warren's first yielding asset it's his first cash flow business huh so warren graduates high school in 1947 at age 16 i don't he might have skipped a grade or maybe he was just young it certainly sounded that way sounded that way and he goes to where else the university of pennsylvania's wharton business school which then as probably now i still sort of think of it as like the preeminent you want to be an undergrad business major you know in the u.s or anywhere in the world like wharton is the place to go but it's really his dad who makes him go he doesn't want to go to school at all he's like i already know all this stuff i just want to go get to work and he wants to stay in

nebraska i mean he doesn't like going east it's never been a great experience for him and he's only comfortable doing it because he's like my dad's in washington so you know i have some family sort of close i'll do it sure so he does it he doesn't study you know he like aces all the tests you know it's sort of ridiculous uh after two years his dad loses his congressional seat and the family moves back to nebraska and warren uses this excuse to say hey why don't i transfer to the university of nebraska at lincoln be back closer to home he also has something else in mind which is he knows if he goes to nebraska he can take a lot more courses accelerate and graduate in three years and just get

out of there yeah i don't think he was like loving the social scene of college i mean he wasn't a drinker he wasn't going on lots of dates he had his eye on the prize and uh for him that was making money and he frankly thought he was smarter than all of his college professors at wharton so i think i mean he probably was with warren buffett it's uh you know it's he's not wrong he was probably pretty obnoxious about it so at lincoln he goes to the lincoln journal newspaper and he gets a job managing the country circulation which means he now has 50 paper boys reporting to him all across the countryside in nebraska uh so he's that's his side hustle he loads up on courses he finished his degree

a year early so he's 19 now he's just graduated college he's ready to start his business career for real but unlike when he went to undergrad he actually does see some value in some further education he decides there is a graduate school that he wants to go to that would actually be worth it and that is to go to the prestigious harvard business school and he's so sure he's gonna get he's gonna like look i you know i bought my first business at age 15 i met sydney weinberg when i was 10 like there's no doubt i'm gonna get in he writes his application it's all about being an investor and he goes and he does his interview he's sure he's gonna get in and he gets rejected which harvard

business school would forever forever be regretting totally now i mean i don't know i don't know exactly what harvard business school was looking for in uh in uh 1947 at the time but i think kind of sort of either notest or unbeknownst to warren i don't think he cared either way i think this idea of like being an investor was sort of de classe you know like what you wanted to do i mean because investing you know people were still still hangover from the depression and it was wartime i think what you wanted to do is you wanted to be like madmen you wanted to work for you know a big firm you wanted to climb the ladder you wanted the stability like this idea of like being an investor and on your own

that was not what was proper at the time well and ben graham is only really starting to publish the intelligent investor like this notion of how to analytically and and from fundamentals do investing you know this still very much looked at as investing equals casino like we're still not quite in the era of that being respected and and frankly most people that are doing it are pretty much hucksters are looking for their their uh just to make their commissions on the trades and the people who were not who were good and professionals and fantastic at their craft at this point in time most of them are jewish uh which you know i i assume there were probably some jews at harvard

business school but not a lot uh and it's kind of viewed as a jewish profession this is going to come up in a big way in a minute ben graham's jewish the anti-semitism that was running rampant at the time can't have helped things totally you know sydney weinberg jewish like goldman's ex it's a jewish firm and uh it was very much you know they were outsiders they were not the establishment so uh warren uh is shocked by his rejection from hbs he starts looking at the course catalogs for other business schools just to like oh man well what am i going to do and he happens to see in the columbia uh graduate school of business course catalog that there is a course taught by his hero benjamin graham

and david dodd of course and he's like holy crap he would joke later i assume this is a joke he said either he would write a letter to them to plead his case to get into columbia saying i thought you guys were dead i didn't realize you were alive and teaching classes because he had like just picked up their book and was like this is that you know he had what the intelligent investor i think is the one he probably read and was like this is incredible so graham's book the intelligent investor had just come out and warren was obsessed with it now graham and dodd together had written published security analysis back in 1934 but that was a textbook that was like an academic you know i haven't read it but

like it's super thick dense it's it's not meant to be readable the intelligent investor is like the danny kahneman thinking fast and slow you know version of like uh you know it's case studies it's like distilled down for public consumption and and for listeners out there who have read the uh intelligent investor you're probably thinking wait that was supposed to be the not dense one different era different era yeah so warren's read you know the intelligent investor and he's he loves it he's like this is amazing and and what the intelligent investor and security analysis in a even more dry way before it what they did was they espoused they were like hey you should think about stocks and investing in stocks systematically and based on the fundamentals of the companies that they

represent and as pieces of a business not like tickets on you know horse race betting here and they basically introduced the idea of the discounted cash flow like this is the first notion that like stocks are you know the market cap of a company is representative of the sum of all future positive cash flows or i guess all cash flows uh discounted at a certain rate back to today and you know this sort of um forcing you to look and say does the price of the stock today reconcile with what you actually believe the business will yield or produce in its full lifetime you know that that was frankly novel it was and so dodd is the chair of the finance department at columbia but graham he's an adjunct

he's a practitioner so warren is just so gaga here because not only is he like you know a professor apparently but he wrote this book graham runs essentially like the first hedge fund in the world uh he runs the graham newman partnership with jerry newman they are a partnership that invests in stocks on wall street like there's nothing warren wants to do more than be like these guys right i can literally go take a class from a guy who is actively employing at a real investment strategy on wall street mind blown totally so the deadline for columbia has passed by the time he gets figures this out so he writes a letter to dodd and graham he's basically just like begging them to let him in

well lo and behold guess who at the time was chairing the admissions committee at columbia business school it was dodd so dodd like gets this and uh you know reads it and is like all right well i'm just gonna unilaterally let this kid in no interview no discussion no formal application they just send warren on a note and be like all right you're in you're starting in the fall because this is like hey we we basically see ourself in you like no one is writing us about this thing that we're doing and here you are crazy excited about this super dry relatively unrespected thing that we're doing in the world yes come join us come join us so the fall of 1950 warren arrives in new york city

at this point he's compounded his net worth up to ten thousand dollars which is a lot of money uh five x what it was in high school five years earlier but he still can't stand apart with any of his money so rather than staying in the dorms at columbia or renting an apartment he rents a room at the ymca for a dollar a day oh my god this guy is truly cursed with having a firm grasp of the future value of his money compounded in the way that he feels he can get a get a return on it i mean we can we can talk all we want about the virtue of compounding and the eighth wonder of the world and

frankly i feel like i have a new understanding for it based on doing all this research it's only like now that i'm feeling the heft of truly like what if i just put a thousand dollars in a savings account not a savings account but in an index fund and accessed it 50 to 70 years from now and you're like oh my god it turns into like a real big amount of money almost no matter what and it's like you all know this but when you're warren and you've actually done all these calculations and all you're thinking about all the time with singular focus is the future compounded value of this money how could you ever spend a dime i mean it truly is cursing to your lifestyle yeah i mean alice writes

about that that every time he looked at spending money he would not see the sticker price for things he would see it times eight or ten or twenty of what that money would be worth in the future and just to come back and say it so we all have a firm understanding here if you took that thousand dollars and you want to invest it for 70 years say getting a 10 per year return on it which would be good like that would be a very good return i think it's a little bit outpacing public markets that's eight hundred thousand dollars 70 years from now and like you know 70 years from now my money has a lot less utility to me than it does today because i will have not had it my whole life which is the curse

but if you're warren and all you're seeing all the time is that money in the future my gosh well i think that's the difference between warren and most normal people too is that money in the future probably has about the same utility to him because it's not about what he can buy with the money it's just about the stack of money yep for warren it is a scoreboard game not a utility of the cash game yep totally all right listeners now is a great time to tell you about a longtime friend of the show vanta ai has scrambled the whole security picture it used to be that you proved that you were secure once a year on audit or a static pdf then everyone would nod and you're done but in an ai first world that

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signs up right away for ben graham's seminar uh which is in the spring semester so he's already read the intelligent investor cover to cover you know he's wearing out the pages so many times he knows everything but he really like he's such a go-getter for this he like he really wants to impress graham in the seminar in the spring so he sees i guess in um moody's and s&p put out like stock manuals at the time that was the main thing that uh people like warren and and ben graham and and newman and everybody browsed through looking for stocks he sees that the graham-newman partnership owns 55 percent of and graham is on the board of this little company in washington called the government employees

insurance company interesting sounds familiar i mean if ben graham's the chairman like surely warren wants to know more yeah well surely he wants to know more but the government employees insurance company isn't mentioned anywhere in the intelligent investor and you know the rest of the intelligent investor is full of case studies and talking about different stocks and but they don't talk about this company there why is that warren decides i want to go investigate i'm going to find out more about this company this uh geico if you will uh for short i'm going to go pay them a visit so he hops on the train from penn station goes down to washington on a saturday morning and uh he just

shows up at the office and he knocks on the door and he persuades a security guard at geico to see if anyone's who around who could talk to him uh warren sort of presumptuously at this time although i guess he was signed up for the seminar says uh that he's a student of ben graham's and ben graham is the chairman of the board so you know might want to let me in have somebody talk to me uh eventually the company's head of finance lorimer davidson is there that saturday morning and he he's like all right kid come on in my office i'm gonna he's figures i'm gonna do like a a good samaritan deed give this kid 10 minutes of my time here well it turns out that uh lorimer or davy as everyone called him

he wasn't just like a finance dude at at geico not that there's anything wrong with being a finance dude i guess he was a finance dude in a certain respect he had been an investor and a bond salesman before joining geico so he was like he was a lot more like ben graham than uh just an employee at geico the story of geico the founders had thought that they could make auto insurance cheaper by having commercials with geckos and no by selling the auto insurance direct to customers without using agents and to be as cheap as possible and have the best underwriting profiles possible they also needed very responsible drivers so they borrowed an idea from usaa which targeted military families for insurance

they target government employees for insurance hence the government employees insurance company it's also amazing that their hunch that like government employees are going to be less prone to accidents than the general public was right that they could actually underwrite to you know we can give these people cheaper premiums because they're going to be less expensive to us like that that worked out for them i mean i guess seemed like a reasonable assumption yeah that if you work for the government you're maybe more less conservative less likely to drive under the influence of alcohol or you know who knows either way it worked so one of the two founders after a bunch of years wanted to sell the family wanted to sell and uh their stake and hired davy to help find

a buyer davy brings it to graham which is how graham at the company he ends up negotiating a deal to buy at a discount to the asking price of course because it was fully privately owned right it was not a fully privately owned company yeah so he buys out the 55 percent stake the family owned for a million dollars and then he turns around and puts lorimer in charge of managing geico's own investments so warren happened on the mother load beating this guy here like you know he's like a graham disciple he runs all the investments at geico so warren just starts peppering him with questions lorimer's super impressed he's like who is this 19 year old kid they talk for four hours that saturday

morning and davy tells warren all about how geico works how the insurance industry works tells him about this magical thing called float and uh warren is like he has seen like the revelation of uh you know god has handed down the 10 commandments on the mount and you mean you have other people's money that they're loaning you for free that you can do stuff with until you need it huh and you may not even ever need it well that's an interesting idea yeah so what is this float idea and how does geico and all insurance companies work the premiums that the customers pay geico for their audio insurance that cash comes in the door on day one and geico's expenses they have to pay out

claims on insurance claims later so you pay the policy premiums up front but then when there are accidents and stuff and then they go through court and blah blah blah it could take years before you have to actually pay out any money if you pay out any money at all right right yeah supposing you have a good government employee that never wrecks their car you might just make money you might just make a lot of money and never have that you sit on and you never have to pay it up and if you manage it well you can make investments with it and that's what lorimer is doing at geico he's using all this float to make investments and he's doing a pretty damn good job of it there's sort of like two things that

that warren realizes this that like i never fully put together before about insurance premiums the first is this is a loan that someone is making you at zero percent interest you're like well that's a pretty good loan like i don't i don't have to disservice the debt well like that means that i basically can make more profits because i don't have to take a cut of my profits every month to pay down the debt awesome it's an interest-free debt the second amazing thing is wait it's not one person that loaned me money it's a gigantic set of thousands or tens of thousands or hundreds of thousands of people that are paying me money well then what that means is they're predictable

because that's not just somebody wakes up on the wrong side of the bed and says that they want their money back like the worst thing that can happen save for some hurricanes to force out of the future a little bit is that like one person wrecks their car and maybe another person's car but nobody's wrecking all my customers cars at the same time so that's the second thing that's amazing and the third thing that's amazing is it's not a collateralized loan so you don't have to have something in your business that sort of like warrants you being able to take on this big debt load it's just a big uncollateralized interest-free distributed loan to you that you get to do something

with until you need to pay it out and especially back then there was much less regulation about capital requirements for insurance companies and well all financial institutions so they really didn't have to keep any cash reserves i mean they could kind of do whatever they wanted with the money speaking of do whatever they want with the money i think what was happening back then is that as you would sort of imagine in the early days of insurance you would want your premiums to basically equal the amount of money that you would need to pay out in the future what happens now is it's assumed that you can do interesting things to earn money on the float so and i didn't know this till doing the research

when you pay for your car insurance they're actually collecting less in premiums than in total they will owe out to everyone so you need to do something interesting with the float in order to make it so that the insurance company doesn't go under which i never i i never realized that it's kind of like a i suppose that probably happens with competition where everybody's just lowering and lowering their premiums until they realize gosh we effectively can sell our insurance below cost because we can invest the float yep and geico's got the additional advantage which it still has to this day of they don't employ agents so they just have a fundamentally better cost structure than all of their competitors which means more money they get to play with i bet if you call these guys by going

direct they can save you some money in like 15 minutes or less on your car insurance how much money do you think they could save you like 15 percent should you get an acquired i would imagine i can't imagine what the cost of customer acquisition is through an agent but it seems like they could at least rebate that to you yep one one final flash forward here before we go back to the story everyone should go to berkshire hathaway.com one to bask in the full glory of this beautiful website uh but secondly please observe that there is a banner to purchase geico insurance on the berkshire website it is the one thing that they do on that website other than a series of blue links to

a shareholder documents and it is an ad for geico it's like the most hilarious use of of web real estate hey we have our car insurance through geico it's cheap it's great all right all right enough of this uh so that the next monday this is on saturday on monday warren goes back to new york city and immediately liquidates 75 of his portfolio and loads up on geico like he's 75 concentrated in geico he's like in love and he thinks i'm gonna show up at graham's seminar i'm gonna tell him about this i'm just he's just gonna go gaga like this is amazing i'm gonna be his boy it's gonna be like you know his dreams of earnest back in the day well he shows up at the seminar and

he tells graham what he's done graham is not that impressed he's like you put 75 of your portfolio into geico what are you nuts yeah because graham first of all is not a one-stock guy he's a distributed you know portfolio approach guy and second of all i'm sure his next question was yeah and what'd you pay for it what'd you pay for it so geico was not a typical investment for the graham newman partnership they probably only did it because he was able to wheedle a deal out of lormer and the family and there's a reason why it wasn't in the intelligent investor so graham's whole strategy his whole mantra like he you know basically like he and dad you know basically invent discounted

free cash flow discounted cash flow evaluation you know fundamental analysis all that and what comes to be known as value investing but there's like a major problem with what they're doing which honestly like this conflation that graham had of what between fundamentals and value investing persists to this day and is still why there's like religious wars about value versus growth investing and that's that he thought there was a very specific way to practice fundamental investing what he and others called cigar butt investing and what does he mean by cigar butts this is crude but the analogy is that like you could be walking along the street in those days in new york and you might see smoked cigar butts laying in the street in the gutter and some of them might still have a little bit of cigar on it and so you

could pick it up for free not pay anything for the cigar light it up and maybe still be able to get a puff or two out of these cigar butts for free uh and the analogy the reason why this analogy is used is that graham's whole like thing that he looked for in companies of stocks that he bought was he wanted companies that were quote unquote worth more dead than alive and he actually writes an article by this name and what this meant was he looked for companies where like the book value of the assets so like the cash on hand the value of their you know land property buildings their equipment like if you shut the company down today stop taking money from customers paid out all your liabilities stop the business and you just sell

off in a fire sale everything in the building would you make more money from what you're selling off than what the market cap of the company is trading at that was what he looked for which in that era i mean you could find those because you didn't have tons and tons and tons of people whose eyes were always on these stocks trying to figure out hey is anything trading below the book value that it should be trading below and you know you could find them pretty often you could find them and not only there were far fewer people participating in the market and far less data available but the people who were participating they were mostly you know handicapping horse races they weren't thinking like this so

stocks that weren't hot there were a lot of them out there and so graham referred to he had he had kind of three big insights he and dodd that revolutionized investing one was this concept that a stock is a piece of a business uh with cash flow profiles and going concerns and you should value it as such two was that price and value are two very different things and the price of a stock at any given day may or may not reflect the actual value price is what you pay value is what you get exactly and you can and that you can use this to your advantage he had this concept of mr market and mr market comes to you every day and

quotes prices for what you own and what you're looking what you're contemplating owning but he's schizophrenic and one day i'll quote high one day i'll quote low but the value stays the same right it's uh it is the notion that it's he's your business partner in the venture and every single day he comes to you offering to buy out your stake at a price that is either too high or too low almost never exactly reflecting the the actual intrinsic value and uh every single day you have the option to decide to sell or buy more yep very true so points one and two great i totally agree with point three i also agree with but i disagree with the interpretation and that's this concept of a margin

of safety the famous ben graham warren buffett charlie munger margin of safety and of course the way that graham wanted to apply that is by companies that are so cheap they are literally free of risk yep yep and so you know it makes sense like investing involves risk as every disclaimer in history has told you and involves uncertainty uh you don't know what's going to happen so ideally you want enough downside protection built in that you'll do okay no matter what that makes sense and yes you do want that but graham's way of looking at this as we said was i'm only going to buy things where if we literally shut down the business and sold off everything on hand we would get our money

back or more there's two problems with that both on a downside and on the upside on the downside as we shall see sometimes the liquidation value of the assets of a corporation aren't worth as much as you think they are so you can try to sell off the property plant equipment but if there are no buyers or no buyers at the price that you want well just because it says it's worth something on the books doesn't mean it's actually worth that uh so that's one problem the bigger problem though is that like this is the ultimate small ball way of making money like your upside is so fundamentally capped when this is how you're looking at the world like you could go to a hundred of these cigar butts or you could buy

one geico and just hold it for 20 years and make way more money yeah it's fascinating the way that i have been thinking about this i think the closest analog is basically to gross margin in an operating business where if you're running a tech business with super high gross margin and high fixed costs like yeah you got to spend on the fixed costs but then you get that gross margin forever without having to change what business you're in but if you're in the business of selling lattes then every single time you need to go and pull a new espresso and so for graham this is the like stock equivalent of that analogy yeah he's in a high velocity business of constantly needing to go and

buy a new security sell it for more than it's worth go buy another one sell it for more than it's worth and you're gonna make you know his notion is never count on making a good sale have the purchase price be so attractive that even a mediocre sale gives good results but you're gonna incur transaction costs every time you're gonna need to pay taxes every time like you're gonna have to do the work of actually identifying what you want to buy and sell every time it's a high cogs business yep and it takes a long time so sadly tragically by the next year warren has succumbed to graham's exhortations here and uh warren sells all of his geico stock in 1952 early 1952 for 15 259 he makes over a 50

irr on it which is amazing but if he just held on to the damn thing he would have made you know hundreds of times more of his money but of course the graham way to analyze that business is like hey it's actually trading at a high price right yeah that its price is at or above its value so it's time to get out yep it's so interesting i just want to take a step back for a second here and just reflect on that for a minute because this whole growth versus value thing if you think about value in this narrowly defined concept of like let's just keep using the cigar butt analogy you you pick up the cigar butt you smoke it and it's done and now you throw it away like there's all the

work we talked about of identifying the cigar butt the transaction cost of picking it up of puffing it of paying the tax on your gain of the puff and then discarding it and having to go through that whole process again but the whole notion of growth investing is well wouldn't it be nice if that cigar actually got larger and larger and larger faster than you could smoke it and like not only do you have to not incur all those transaction costs there but if you're willing to take some risk and be smart about analyzing what risks you're going to take the business could sort of grow the value of the business could even grow faster than the way that it's being priced in the market that's sort of this

like completely novel concept that exists outside the universe of what ben graham was willing to consider an investment totally now to be fair to graham you know he was doing all this through the depression like if you live 25 years and the stock market is flat to down for 25 years of course you're gonna think this way yeah and of course we are all a product of our environment and i think one of the phrases that is a buffettism that sort of applies to this is you know we've talked about is the market a weighing machine that where the market basically if you think about a weighing machine then it effectively equates value to price whatever you are spending is what it's worth or is it a voting machine where people

are sort of setting price and voting on the price independent of the weight or the value of the actual underlying security and this is where the realization sort of comes in that in the long run it is a weighing machine but in the short run it's a voting machine the stock market totally and sometimes the short run last longer than you would think yep so all that said cigar butt investing was still a sound strategy in the 1950s uh you're kind of like in the land of the blind you know the one-eyed person is is king or queen or whatever so uh you know the the graham approach works and warren is just like lapping it up so he takes the seminar warren becomes the first and only student to ever receive an a plus in the

class from graham side note also in that same class with warren is one bill ruane who was a stock broker at the time at kidder peabody and was auditing the class and he realizes he's like man this buffett guy like he's going places i'm gonna become friends with him that would pay off handsomely as we will see at the end of the episode so after graduation warren he wants more graham he can't get enough so he goes to ben and to jerry newman and says hey can i get a job at graham newman can i can i work for you guys and it was a pretty small place i think there were only like six or seven people working there they talk about it and uh graham though turns him down and says you know i'd love to hire you

you're the best student i've ever had but um jerry and i have a have a pretty strict policy here and that is that we only hire jews and uh he would later recant on this and would hire buffett in a couple years but it makes sense like you know graham was british i think and this is effectively like an affirmative action type comment right where he's saying totally we want to make an opportunity here for those who have been sort of persecuted and discriminated against exactly and this is you know 1952 world war ii ended four years ago and graham was i believe british european i was born in europe you know this is like it's a small firm but they're like hey you know we're pretty committed to

giving jews an opportunity here so warren is heartbroken but not deterred he goes back home to omaha decides okay well if i can't join the graham newman partnership i'm just gonna set up my own partnership i'm gonna do it myself but both graham and howard warren's dad talk him out of it they both say hey you need some experience first working for someone else before you go and do your own thing and the natural thing to do is why don't you go work for your dad's old brokerage firm buffett fog so warren does and he becomes the dreaded prescriptionist working for his dad and he just hates it hates it hates it hates it he's getting paid on commission selling stocks the whole

idea of there's a room full of people who are tasked with moving a stock and calling all their customers to say you should buy this thing it's about the most anti-warren buffett thing i can possibly imagine totally he's just like it's like organ rejection so he's you know he's making his calls he's doing what he has to do he's moving the trying to move the product but he gets on the phone with people and he's like you know he'll do whatever he has to do but then he's like hey but there's this company called geico they're a agentless insurance company you should really consider buying that as well and people think he's nuts they're like an insurance company that doesn't have agents i want to

talk to my agent like that's weird so he doesn't have a lot of success d to c baby they got this great website yeah uh so there are two good things though that come out of his two-year interlude actually i am curious how did geico work back then without is it by mail is it by phone presumably the whole thing's done by phone that's actually a good question i assume phone there might have been some tie-in with the government agencies that you know maybe there was like marketing that went out to agency employees i don't know exactly all right well we'll have to we'll have to do a spin out geico episode at some point yeah we will well it'll come up again in part two don't worry uh warren gets

another bite at the apple so to speak so two good things that come out of this little interlude back in omaha one he reconnects with one susie thompson whose father doc thompson was a dean at the university of omaha and had managed howard's political campaigns and warren somehow persuades susie to marry him which shocking given uh what warren buffett was uh his personality and what he was like back then and two he also after dutifully you know working for a while at the brokerage persuades his dad to set up the first of the warren buffett partnerships with him called buffett and buffett and basically warren puts you know some of his money in and his dad puts some of you know the family's money in

and warren just gets like some more capital under management to invest here so it's his first sort of taste of being uh being a principal yep and just to add a little more color to that comment you made on on sort of what buffett was like back then and got susie to marry him you know he was and is a person of singular focus in his life and he sort of in his old age started to do more things but he was never a socialite he was never someone that was you know deeply diving into other people's interests and you know socializing to be social he he was a person that has always wanted to invest and make money and so of course he did set his eyes on hey you know i want to marry susie and i'm gonna

make that happen well there are all these stories about it like family dinners even like they'd have friends over and he warren would just wander off upstairs and start go reading annual reports in the middle of like a dinner party yeah he was like a like a wild man who uh all he did was invest in stocks however uh the flip side of this these personality uh quirks of warren are he is very singularly focused and he's very persistent so despite the rejection from graham newman warren continues to write letters to ben and jerry constantly talking about his ideas talking about stocks he's looking at he travels to new york frequently just to go see them and drop in after two years of this jerry finally sits down with ben and is like you know we've got this

anti-anti-semitism uh rule here but um maybe we should make an exception and and hire this kid he's pretty special so ben relents he uh he calls up warren he's like all right you really want to come work here fine we can make it happen well you don't need to ask warren twice he accepts on the spot i don't think he even talks to suzy about it even though they have their daughter little suzy at this point uh and they're living in omaha he just accepts on the spot he moves them back to new york at a moment's notice he literally shows up at the graham newman office a month before his initial start date he's just like yeah you're not paying me this month that's fine i'm like i'm here i'm working

that's awesome uh once again he doesn't want to pay new york city housing prices so he moves the family into a crappy apartment in white plains even though you know he's like pretty rich already from everything he's been doing and he's now working at like the most prestigious hedge fund in the world and you know he's paying like you know god knows how much like 50 bucks a month for an apartment way outside the city that's crazy is it fair to call it a hedge fund like what differentiates a hedge fund versus just like a institutional money manager that's a good question i mean i don't think really i mean i don't think they're taking like huge short positions or anything

like that at this point in history i don't think so i think they would sometimes short stocks and warren would actually famously i wasn't gonna put this in the script but um he was a real pain in the ass in in high school uh arguably real pain in the ass for his whole life and uh in high school he hated his teachers so much that uh he knew that they all had the teacher's pension was mainly invested in at&t stock and so warren went out and shorted at&t stock and brought the short the slips in and like put them on his teacher's desk just to show he was betting against their retirement funds oh and in high school they would have like he was already sort of seen as sort of a savant so that probably would freak

people out yeah uh what like what does he know that i don't yeah he was he didn't really care about people's uh feelings at least when he was in high school so he lands he's he's at graham newman unsurprisingly he just like crushes it pretty quickly within another two years you know ben and jerry are consulting him on everything that they do warren's coming up with most of the investing ideas that they're doing he's involved in every decision that the firm makes and he's really hitting his stride so much so that ben at this you know ben is a we're not going to get super into it he's he's a very colorful character shall we say uh had uh three wives i think and then the story goes i think he

he started up a relationship after his last marriage with the girlfriend of this is at the end of his life with the girlfriend of his son after his son died anyway he's a character so he is ready to retire he wants to move to california live the good life so he and newman is also getting old jerry's getting old he's thinking about the same they offer to make warren a general partner at the firm and have him essentially continue graham newman i assume they would sort of stay as like you know partner emeritus or something like that but this time warren shocks them and he's like yeah no remember that whole on my terms thing that i really care a lot about yep he's like i don't know i don't want to run your firm if i'm gonna run a firm

i'm gonna run my firm and you know i'm just here in new york to work with you guys i don't actually like it in new york susie wants to be back in omaha i would do it in omaha so they end up winding down the firm and warren and susie and little susie uh their their daughter moved back to omaha in 1956 this time for good so here's the plan tell me how how well you think this is going to work warren's net worth is about 175 000 at this point after working at graham newman for two years so it's like a few million dollars by today's yeah so the average yearly salary for a worker in the united states at that point is four thousand eight hundred dollars and he has 175 000 saved up

in the bank account and he's 26 years old so the plan is uh and they have two kids now uh how he's been born so the plan is he's gonna retire and he says you know made my fortune uh susie really wants me to like you know be a father and all that uh be involved at home you know just small requests all right i think i can retire and um if i set a budget that we can live on in omaha you know i'm gonna enjoy the good life this is so not warren he says i think we can we'll set a budget of twelve thousand dollars a year remember the annual average income three x that's yeah like close to three x that he would be

spending every year we'll buy a nice house in omaha this is huge we'll live like kings and then you know i'll still have the rest of the money that'll be compounding it'll grow great it'll all be fun and how much does he have in the bank again 175k so that's uh what 6.8 so that's probably about what he thinks he can generate passively by just leaving in an index fund and so he's he's effectively i'm sure he thinks he can generate more right you know because he's he's still gonna dabble a little he's gonna do a little bit active management just on you know his own capital why why do i feel like this didn't happen i don't remember this part of the book this did not happen so he's uh despite his uh

retirement you know he's hanging out with family and friends and stuff and they're talking to him and all he can talk about is money and so eventually some of these people are like well you want to manage my money and uh and warren's like oh okay twist my arm i don't even know i got some ideas yeah i got some ideas so he starts setting up these little vehicles around omaha with family first like immediate family and then a few close friends to manage their money in addition to his own money that he's managing and uh he structures these things actually really i really like the way he structures these so he says remember these aren't these are people he really cares about you know in

his own warren way he structures them as partnerships where there's a four percent annual return hurdle and any returns that he generates above four percent he is the general partner in these partnerships keeps half of the upside of those returns half i thought it was 25 percent uh no it was half uh at least according to the snowball wow so that's pretty huge i mean that's like 50 carry effectively but but there's the four percent benchmark return so if it underperforms four percent then he gets no no money and he's not paying there's no fees right he's not paying himself there's no management fee but it's even better this is why i think it's actually pretty fair and i really like this structure

he personally puts himself on the hook for a quarter of the downside so any money lost i think between zero and four percent return it's like a neutral zone where nothing happens i think if there's any capital lost he will personally cover 25 of the losses of his partners which is these are pretty good incentives yeah he's so good at incentive alignment totally and he hadn't even met charlie yet so he's finally living the dream he's fully independent he doesn't work for anyone else he's got the you know he sort of has a partnership like graham newman but it's it's all part-time you know he has no employees they're all separate partnerships it's all friends and family it's a little over a

hundred thousand dollars total in outside money so not not that much money and he does everything everything himself so the investing the accounting he he files all the taxes himself for the partnerships he has no employees um no outside services his total expenses for doing all of this in 1956 you ready for this ben lay it on me amount to 22 and 71 cents that's like our accounting at acquired where all the labor's free yeah totally and that's between all of the gains that he generates and taking in some more money by the end of the year he's managing over half a million dollars for less than 23 dollars in cost that's pretty good uh pretty good fee load on that so word starts going around omaha that like

hey warren's back in town and so wait let me understand real quick here so this 25 of the downside is that like gp commit where he was putting his own money in and that money was just at risk or was he sort of like additionally on top of that saying i will reimburse you for 25 of your losses wow like a club yeah so he actually at this point in time at first i thought this was weird but then i understood it later he does not really put in any of his own money he only puts in a hundred dollars into each partnership huh he's keeping his own money separate which at first i was like well that's weird but i think he did that because these are friends and family the goal is to make returns for

friends and family he's essentially making the same investments separately with his own pool of capital i see and then later when he consolidates it all he puts in all of his family's money as well so i don't think he really thought of it as like oh this is a fee generating scheme right it's just that yeah each one of these is the pool of capital for my friends yep yep so word starts going around omaha that warren's back in town he's taking on money if you want to invest with him so he can't help himself he starts he's loving this he's going around town he's meeting with everybody he can't stop pitching he's raising money for his uh retirement activities one family he gets introduced to is the

davis family in omaha the husband of which is a prominent doctor in town they decide to invest a hundred thousand dollars in this venture after discussing amongst the family uh while warren is there saying you know warren you really remind us of a really bright young man who actually grew up uh next door to us uh now lives out in los angeles you guys are like the spitting image of one another uh it's really bright guy we remember he was the smartest kid we ever knew he's left omaha now he lives out in los angeles we'll have to we have to introduce you when he's back in town sometime uh charlie munger is his name more more on that to come in the next episode it was a while right like

this was yeah the seed was planted but they wouldn't meet for years so that was in 1956 and the dinner that the davises would organize would not happen until 1959 so yeah three more years before uh warren and charlie would meet so this all goes pretty well and a couple years later do you know the one other term that he asked of the davises and then he would ask for everyone else going forward after that oh no so this gets to his desire for doing business his way and not having other people sort of influence when he does distributions or anything like that he is open for business one day of the year to his clients and that day is december 31st and on that day they can either take money out or

put money in but other than that it is managed by warren and secret and so he does not have to disclose what he is buying or selling nor can they take money out ah interesting i knew that he obviously didn't disclose what the holdings of the partnerships were but uh i didn't know that it was only that one day that uh yep that you could take money in or out interesting so um this goes pretty well pretty quickly warren's rounded up uh nearly a million dollars across seven different partnerships and after the first year or so of running this his stake so his intention with this effectively carried interest that he sets up the half 50 of the profits above the four percent benchmark threshold is um he wants

to essentially grow his equity ownership of these pools he's not going to like take that money out in cash of course he's not there's transaction costs there's taxes there's warren buffett he's warren buffett so um he does so well within the first year or so that his fees are on paper 83 000 which is what like almost half of what his net worth was when he started this thing and due to that he owns 9.5 percent of the combined partnership uh starting from you know essentially zero his hundred dollars that he put in he now owns wow almost 10 of these pools and that's of course because in that very first year when the dow finished the year down eight and a half percent buffett made ten and a half percent that

year for his his partners pretty good pretty good so he now has enough capital under with the million dollars at his control that he can start to do the kind of things that graham newman used to do so we didn't really talk about this but there was another aspect to the cigar butt style of investing it wasn't just that ben and jerry and then warren when he joined would look for companies with book value above trading value they would then amass big positions in those companies try and get themselves on the board like graham did with geico although he didn't need to be agitate with geico but with the other with the cigar butt companies they would then like agitate actively to get the

companies to liquidate assets and distribute the cash out to shareholders oh it does sound like a hedge fund after all yeah these guys are like uh uh they're like bobby axelrod out there like corporate raiders so now with a million bucks at his disposal warren can start to do this so the first of uh the companies he does this with is a company called sanborn map he puts 35 percent of the capital of the partnerships into it gets control of the company forces it to split itself in two and makes a quick 50 profit on the spinoff boom like he's shooting fish in a barrel he can do this all day by the end of 1960 total capital is up to two million and warren's share is worth a cool quarter of a million dollars

or 13 percent of the partnership in 1961 and let me pause before you go into 1961 just to recap a few of the returns here year over year the second year he made 41 percent the third year he made 26 percent the fourth year 1960 he made 23 percent all well the dow is having some good years some bad years so it's losing money sometimes it's making money sometimes warren hasn't lost a dollar he's outperformed every single year he stayed positive every year in fact the partnership results as a whole so far if you compound over those four years are 141 percent compared to the dow's 43 percent so uh you know whatever warren is doing is working wow so then 1961 i don't have the dow numbers in 1961 so i don't know relatively how good this performance was

the the dow numbers in 1961 are 22.4 percent 22.4 pretty good year pretty good warren does 46 percent in 61 which not only you know generates a bunch of returns compounds the capital the partners are like please take more of our money bunch more money flows in the partnerships are managing over seven million dollars in total which is larger than graham newman ever was wow and let me start uh quoting from some buffett annual letters here because this is an interesting phenomena he was a wonderful writer he he had sort of trained himself both in public speaking um and and taken some classes in that and in writing and he wrote these uh as i'm sure many people would guess some prolific shareholder letters to

his partnership every year that actually is not something that he did in the early berkshire years it took him years to start doing that again but he really felt like it was incumbent upon him to do this when he was running these investment partnerships so let me just read from you a few of these 1962 if my performance is poor i expect the partners to withdraw 1963 it is a certainty that we will have years when we deserve the tomatoes 1964 i believe our margin over the dow cannot be maintained 1965 we do not consider it possible on an extended basis to maintain the 16.6 point advantage we had over the dow this goes on and on and on where warren continues to caution i don't think this is sustainable i don't

think we can keep crushing it as hard as we are and he does this to this day every year in the berkshire letter 50 years later oh amazing more than 60 years later unreal yep so at this point in 1962 when he's now bigger than graham newman ever was he finally gets an office he'd been working out of their spare bedroom at the omaha house all these years doing everything himself he gets an office he hires a couple people he consolidates all these various vehicles into just one vehicle the buffett partnership limited and this is when he puts all of his own money in as well so he's got a single vehicle he's now you know i don't know if he ever said he officially unretired but like he's in business

he's in business um he also codifies in these letters he's sending out a few official quote unquote ground rules for the partnership uh just like don valentine did back uh in sequoia in the early days to their limited partners and uh there are a few rules in there uh the the last one kind of like you were saying ben hallmark of the buffett style for years to come i cannot promise results to our partners what i can and do promise is that a our investments will be chosen on the basis of value not popularity b we will attempt to bring risk of permanent capital loss not short-term quotational loss to an absolute minimum by maintaining a wide margin of safety and c my wife children and i

have virtually our entire net worth invested in the partnership pretty good ground rules by halfway halfway through that year uh 1962 when he consolidates everything warren is 31 years old and his net worth crosses the million dollar mark so he's achieved his dream ah he made it he made it four years early the next year in 1963 buffett finds the second great investment of his lifetime and also the second great mistake that he would make on the back end of it uh the first of course being geico american express so this is great some listeners probably already know this story here and before we dive into this story i think the framework that i would use for if you're listening

to this and hearing a lot of this for the first time you know you heard about geico you know you're sort of hearing these puzzle pieces where there's a lesson learned from each of these companies that buffett was sort of the first to figure out that these businesses are each interesting in a puzzle piece way that fits in with other businesses that in the sum of its whole could create this kind of unbelievable capital efficient flywheel uh and i don't know if flywheel is the right term puzzle pieces put together into a beautiful puzzle or mosaic might be the right term but it really is like him understanding all these unique types of businesses that have these characteristics that he can then use in the

future and american express i feel is sort of like the second big lesson for him after he learns about the insurance business with the first one well i think you're totally right about the puzzle piece fitting together aspect he learns that in his third great investment which will be the last one we'll cover on this episode so that's that's coming up okay so back to american express in 1963 you know buffett is he's still under the gram spell here like he's looking for cigar butts that's what he's doing uh he's looking for deals and amex is no cigar or as as charlie munger would later put it he's looking for fair businesses at good prices great prices yeah fair businesses at great prices

not great businesses at fair prices yep exactly which is the charlie way of doing things that buffett would later wisely adopt so you wouldn't think that amex you know amex is at this point it's still widely respected today but back then american express is like the most trusted financial services company in america uh it had been around already for close to 100 years the travelers checks business uh some many listeners are probably not familiar with travelers checks but was it just an absolute juggernaut and an amazing business the idea was if you were traveling and this is before i did this growing up yeah me too even when i was in college when i studied abroad my parents got me amex travelers

checks the idea was you would go to your local american express office give them money cash they would in return give you travelers checks which were essentially like a guaranteed paper for that amount of value backed by amex and then you could take those checks anywhere where you traveled and if you like lost them you could go to amex but more importantly when you're traveling internationally you could use this as a way to get funds in whatever the local currency was right because wherever you're traveling doesn't know about your hometown bank and may not even know about your home country bank and so this is the way to have your credit accepted everywhere right there are no atms and credit cards are still

early early early days although amex was a pioneer there and had the american express credit card anyway it's this gilded institution in 1963 they have a small subsidiary of the company that issued operated warehouses and issued warehouse receipts uh so what does this mean it's like the equivalent of a traveler's check for warehouses you would have warehouses full of a commodity of something say salad oil in this case soybean oil to be exact and you would get amex to come in inspect the warehouse and issue paper that says like oh yes there are xyz tons of soybean oil in this warehouse and then you could take that paper and you could collateralize it you could borrow against it you could trade against it you're essentially

financializing this product it was pretty brilliant business that amex was in but it was small this was much smaller than their consumer business so all this is great until a pretty uh shady commodities trader named anthony tino de angelis in new jersey of course of all places decides that he's going to pull one over on amex he has his warehouses with them he decides to fill his tanks which were supposedly filled with soybean oil with seawater instead and defraud the inspectors and then collateralize it and borrow against it and uh you know run a ponzi scheme essentially didn't he like try and bet with it like he then took it and made some risky investment with his check that said hey this is worth so many tons of

salad oil and then he ended up like basically losing it all yeah there was something about like had to do with the futures market and like it was crazy i mean you can't make this stuff up it was something with like russia and the soviet union their soybean crop failed that year and people thought they were gonna have to buy u.s soybean oil and then they didn't and so the price collapsed anyway ridiculous stuff but anyway suffice to say he's now got a piece of paper that someone's coming and saying okay give me what that piece of paper is worth and of course not only does he not have it but there's nothing in the warehouse to back it up either so the piece of paper is worth zero uh so all

in it comes to over 150 million dollars worth of fraud that happens and theoretically amex is on the hook for this now legally it's debatable like tino defrauded them so you know whether they should actually be on the hook or not is debatable but like they're american express they're the ceo says like we're gonna you know settle we're gonna with the creditors we're gonna we're gonna cover this this scandal like rocks amex stock on wall street so the share price drops by over 50 percent and analysts and people out there think the company's not gonna survive buffett though thinks otherwise he sees an opportunity so he and his new employees they go around omaha and new york and a bunch of other places and they just start like interviewing consumers and talking to them at

banks and saying like hey what do you think of amex have you heard about the soybean oil scandal the salad oil scandal are you still using the travelers checks are you using the credit card and consumers are like i haven't heard of this scandal what are you talking about of course i trust the travelers checks um so and buffett figures that amex can easily absorb all of these losses even if they covered the whole thing out of cash on hand they have over 200 million dollars of cash on hand plus over 500 million dollars of float from the travelers checks business yeah and this is a similar lesson that he learns from geico which is look all of this debt that the company has that they owe out to

these people with travelers checks as long as there's not a scandal they're not going to have a run on us they're not going to come at us all at once it's a sort of portfolio distributed liability and so as long as i do my diligence and i assume that there's that consumer confidence hasn't been rocked and there's not going to be a run on amex then hey we're actually in good shape so he makes a huge bet on amex at this point in time the partnership bpl buffett partnership limited has over 17 million in capital buffett puts 3 million into amex right away like a huge position at this time and eventually he puts 13 million in total into amex and owns five percent of the company amex ends up settling the case the

next year for 60 million dollars the stock goes through the roof and they make two and a half times their money on the 13 million dollars invested so amazing win second great investment you know of his career and similarly second incredibly stupid decision once he gets up two and a half x he sells it brutal brutal brutal brutal he did not listen to our sequoia capital part one episode he did not and this is something that he sort of saw too that is a departure from graham and wouldn't really come about until later with like coca-cola but this is the first sort of twinkle of it of buffett really recognizing the defensibility the moat that comes from brand because brand doesn't show up on a balance sheet

but it's a huge asset and so it's one of these things where i think buffett's starting to you know flex a little bit and say hey i actually can analyze these businesses a little bit beyond the black and white numbers that are showing up on the financial statements by doing a little bit of a different form of diligence and assigning value to things that are a little bit less tangible than than previous value investors have in the past yeah i mean there's ben graham i could you imagine talking to ben graham about brand and the value of brand he would like kick you out of his office ben graham wouldn't even talk to you about product like he's he's like if you're talking to me about i'm not interested in

hearing your opinion on the how the company's product blah blah blah show me that it's underpriced relative to book value i can't imagine taking that to brand i want to know how many machines they have in the factory and what i can sell them for yep totally uh so that's the amx story right around the same time in parallel buffett finds another cigar butt that he is just over the moon excited about and this one he hears about from a friend i think in new york dan cowan it's a failing new england textile manufacturer whose stock was selling for well less than the book value of assets i think about 50 yeah i think the i have the numbers here yes so the book value of all the property plant and

equipment and cash on hand at this company is 20 a share and the stock is trading at 750 so warren is just like his eyes get real big real real big here so what is the company we are talking about we are talking about berkshire hathaway so berkshire the company was really hathaway had its origins way back in new england wailing times like like moby dick style which side note i tried to read that book once and i was like oh this will be cool it's like a whaling adventure it's an american classic that is the most difficult book i've ever tried to read i got like 50 pages in and i was like no it's your intelligent investor yeah totally it was it was the

uh security analysis if i needed the intelligent investor version of it there you go yeah i mean i think the the way to think about new bedford was like they were an industry town and their industry was whaling and whaling oil and then when they sort of pivoted as a town and needed a second industry textiles sort of cropped up based on all the competency and talent and labor and stuff that they had in the town the business leaders in town sort of collectively decided that textiles was going to be the thing and you know we think about whaling now and it seems barbaric and it totally was but it was the biggest industry in america so new bedford massachusetts was the wealthiest town in america

during the whaling years i did not realize that yeah this was not like some little thing there's a reason why melville wrote his novel about whaling so in 1888 after the whaling business was in decline thankfully because it was horrible horatio hathaway and joseph knolls found hathaway manufacturing company which would then go on to acquire and merge with a bunch of other mills over the years um there's just sort of one problem with this business plan that the elders of new bedford come up with which is that building textile mills in new england was a really really dumb idea really dumb idea why is that because you know if you think about it like what what do textile mills do they take cotton raw cotton

from the south you know from the south and they turn it into you know yarn finished products etc uh berkshire hathaway eventually would become i think the largest or one of the largest producers of men's suit linings yep synthetics too like polyester yeah synthetic so you're importing this cotton from the south right that means that like the cotton's got to get on ships and come up to new england well if you're going to put a bunch of cotton on ships you could also send it to places that have a cheaper cost than the former wealthiest town in america or just not put it on ships well not not in the beginning in the 1880s you had to put it on ships because the climate in the south the humidity

was such that you couldn't like there were problems with with producing that so they needed to send it to some cooler climate you needed to send it to a cooler climate but you didn't need to send it to new bedford massachusetts it's so like okay it's not great off the bat but then in the early 20th century industrial air conditioning is invented and now you don't need to put it in ships at all like just build the factories the textile mills there which people did so the business is kind of limping along but it's been operating for a long time so there's like a lot of mills a lot of plant and equipment there is a decent amount of cash on hand by this time in the 60s it's run by a descendant of

knolls named seabury stanton and stanton he's like the don quixote figure of like the new england textile business industry he is all he sees himself as like preserving the legacy the wonderful institution of great textile manufacturing in new england and he is going to do everything he can to protect and bring the industry back to his glory days so he is every year just spending millions of dollars outfitting all the mills with all the latest technology doing everything he can to like bring back the glory days yes he he has not once heard of the sort of like buffett-esque notion of you know what's your return on invested capital in the business no no no no if we have capital

spend it just pour it into the business pour it and he's he's like a noblesse oblige so warren hears about this from cowan and he's just like oh this is gonna be amazing i'm gonna make so much money here he starts buying the stock seabury once he finds out that buffett is is buying the stock he starts buying the stock himself uh he's like oh i don't want anybody taking my baby away from me and let alone you know these guys that have a reputation of being corporate raiders and at first buffett is happy about this because he doesn't really want to own this company he's like oh good the price is going up once it gets to a certain point i'll sell and if i sell to seabury like all

the better i don't really care so he goes and he meets with stanton they discuss the company making a tender offer to buy outstanding shares in particular warren's shares and they have according to warren they have a handshake deal at 11 and 50 cents a share and warren says great if you launch a tender offer at that price i will sell my shares he goes back to omaha gets a letter in the mail tender offer is announced at 11 and three eighths it's 11 and three eighths dollars so what's that 11.3738 something like that yep so 12 and a half cents a share less than what they talked about and this is like i still don't understand i've read a lot about this nobody including warren can really

seem to explain why warren gets so worked up about this because that's not in his personality like he cares a lot about money but it's not in his personality to get worked up about things or to get emotional about stocks but he goes off the deep end he is like pissed the best explanation i've seen is sadly his father howard was was dying around this time and passed away right around this time and must have been affecting warren well and and buffett is also uh you know he's he's built a lifetime reputation on doing right by his word and in dealing in good faith and i have to imagine that you know facing off against someone who is not dealing in good faith and is sort of reneging on an agreement

that can't sit well totally although you know the monger version of what to do here would be when somebody deals in bad faith you just don't deal with them warren you know it would have been completely understandable to say like all right fine whatever i'm just gonna sell my stock at 11 and three-eighths get out of this be done with it still make a lot of money if you want to you know fight it would be also totally rational to just hold the stock and say i'm not selling instead warren says screw you i'm gonna launch a tender offer for your shares which is so uncharacteristic for him he starts canvassing the entire shareholder base trying to get anybody to sell him shares he is on a mission like a man possessed that he wants to get control

of berkshire hathaway and kick stanton out of his company and this is like a big ish company at this point i think it's something like 15 000 people work in the mills yeah it's it is not a small company it would become a small company but it is currently a large company it's now a non-existent company except in name so by april 1965 warren gets enough shares to get himself elected to the board the next month he stages a boardroom coup essentially also very uncharacteristic of him he forces stanton out and installs himself as chairman he's won and his prize is this super crappy company and it's not like like what's he gonna do he could shut down the mills but then he's

got to lay off like 15 000 people and have the whole town of new bedford hate him but then what's he gonna do with the buildings he's gonna sell the buildings to whom he's gonna sell the equipment to whom right the whaling industry is done every other textile manufacturer is also not doing great at this point like it's a pretty terrible asset to own other than if he really could have liquidated it for book value then awesome but frankly he couldn't have and he's got this reputational thing which i think we're seeing come into play here and we'll definitely see more of it in the the second episode in the series which is buffett deeply cares about his reputation and will ultimately derive a tremendous

amount of value from his reputation and so he doesn't want to be seen as this raider who comes in and destroys the local economy and shuts down the mills and so he basically doesn't like he makes a deal with himself with the rest of the company with others and he's like look we're just gonna i think like you probably know better than i do but basically not continue to invest like crazy only make very smart investments eventually make no additional investments into the company but at least keep it running yes so um he would say to alice in the snowball about this about berkshire quote so i bought my cigar butt and i tried to smoke it this is amazing you walk down the street and you see a cigar butt

and it's kind of soggy and disgusting and repels you but it's free and there may be one puff left in it berkshire didn't have any more puffs so so all you had was a soggy cigar butt in your mouth that was berkshire hathaway in 1965 i had a lot of money tied up in that cigar butt i would have been better off if i'd never heard of it in the first place oof what did you say at the top of the show it cost him in terms of compounded opportunity capital so yeah in 2010 he did the math and claimed that not only was purchasing berkshire the worst biggest mistake of his investing career but had he taken the money that he put into berkshire and instead just invested it directly in an insurance

company by 2010 he he figures he would have made about 200 billion dollars in incremental returns but like steve jobs said you can only connect the dots looking backwards not looking forwards and now there's an energy company that bears its name and a real estate brokerage that bears its name and on and on and on so not only that but i do think if he hadn't bought berkshire i don't think he would have figured made his third great investment or at least wouldn't have made it in the same way and figured out the same lesson from it that really drove the entire rest of his career and what berkshire hathaway would become so the next couple years despite all this berkshire nonsense things go

great thanks to american express at the end of 65 the partnership has 37 million dollars in assets buffett's net worth is about seven million dollars and that year 1965 the dow did 14 and of course buffett's partnership did 47 so still uh not only beating the dow but positive every year of its existence so far crazy so all this success is sort of building up and weighing on on warren so in january of 66 thanks to now knowing from you that on december 31st was the day that partners could take money out or put money in on december 31st of 65 partners invest another 6.8 million dollars in the partnership wouldn't you yeah all in baby so for the first time warren doesn't know what to do

with all the money he starts setting aside some cash reserves like he's never done this before he's always been 100 invested and he starts to worry that he might not be able to find enough good investments for all the capital he now needs to play as he is cautioning in his letters every year yep so he closes the partnership to new capital at that point says not going to take any more capital continue to invest this and compounding but like there's danger in getting too big i might not be able to perform in the same way this is like a disciplined seed stage venture capitalist saying no i don't want to grow my fund size i don't want to have to change my strategy and invest in different

things i want to stay true to the the thing that i'm good at yep so this is uh before we get to his third grade investment i think maybe in part because of this mindset of like i'm gonna stay true to do what i'm good at he makes like the biggest missed opportunity ever maybe in history this is i was teasing ben over the last couple days texting him saying i've got something in this episode that i don't know if you know but is just the most unbelievable thing that you will never imagine lay it on me in 1967 he writes his partners saying that he's introducing a new ground rule to the partnership and this one is quite literally the opposite of don valentine he says we will not go into businesses

where technology which is way over my head is crucial to the investment decision i know about as much about semiconductors or integrated circuits as i do about the mating habits of the it's a polish word it means beetle in polish typical you know warren way with words here this is very unfortunate very uh what was the company very unfortunate decision to let's see 1967 it predates microsoft by seven years predates apple uh it's way after ibm what's around this time deck or no it's post deck oh no you'll get it if you think about it enough i mean is it in value origins we've talked about it a lot early sequoia investment uh just pre-sequoia sequoia was started in 72 but this is all the the crew that don's an arthur rock investment it is an

arthur rock investment is it intel we're talking about intel here oh no way get this so buffett at this point is on the board of grinnell college in iowa he's a trustee of grinnell college which by the way he was introduced to by susie uh susie became an incredible civil rights activist and grinnell college was involved in the civil rights movement and uh martin luther king spoke at grinnell college six months before he was killed and susie brings warren to the college to listen to king speak and like warren is like wow incredibly moved by dr king and so he decides after that to join the board though they were trying to recruit him to to join the board and um so he does do you know who

else was on the board one of grinnell college's most famous alumni alongside warren buffett uh noise or more or bingo robert noise wow alumni of grinnell college inventor of the integrated circuit part of the traitorous eight who left shockley semiconductor to start fairchild and then co-founder of intel with gordon moore and andy grove is on the board of grinnell with warren not only that but warren of course chairs the endowment investment committee at grinnell right of course that would make sense um when noise leaves to start intel and arthur rock is putting the deal together to finance intel noise brings it to the investment committee at grinnell college oh man says hey there's a hundred thousand dollar piece i think grinnell should invest in this company i think this is really

gonna be big i know what i'm doing he saw the deal warren approves the investment and grinnell does invest a hundred thousand dollars in the intel seed round effectively but warren never goes near it for the partnership for himself and in fact says i will never invest in technology companies unreal this is unreal and basically held to that for another 45 plus years totally not until apple and i think well i haven't done the research yet i think apple bubbles up within berkshire from todd coombs yeah not from warren i mean talk about wow sins of omission like this is before sequoia imagine if warren had financed intel warren buffett could have been warren buffett plus sequoia capital wow and what realistically what would he have done with it if he did invest in it like he's never invested

in business so first of all he's never invested in technology business to this point he's never invested in something that early right everything he's bought has been yeah these public you know they're they're pieces of public companies yep established on good cash flow businesses yep the buffett partnership doesn't wholly own any businesses so it's it's it doesn't even own anything private right every single thing is a sec registered well berkshire is now private at this point okay i'm just trying to do a little bit of math on like would he have held it how long would he have held it you know all of these things but here's the thing like this this whole like warren always justifies not doing technology investments by you know his whole circle of competence thing that really is a charlie

munger thing but that warren adoptively i stay within what i know my circle of competence i know the boundaries of my competence this doesn't make any sense to me because he invests in plenty of businesses that he doesn't know anything about at the beginning like textiles like uh insurance you know like retail yeah and the question is like are the dynamics in those businesses more closely related to each other than they are to technology businesses like our our high growth pre-product market fit or like pre-scale technology businesses just so completely different yeah i think that's maybe what warren thinks but he's got some kind of mental block here because like with intel you got noise and more and andy grove coming from fairchild like you know what fairchild is it's a staff like

it's an amazing business and they've like we've got the thing we're gonna basically dethrone i don't know anyway i just read this and i was like jaw on the floor it also goes along with his notion of independence of thought that like he doesn't really care what other people think about a company that if he doesn't understand it from first principles in a way that he's sort of gonna build it up from fundamentals then it's not his cup of tea and he's not investing i mean that is a very all this sounds like warren buffett to me but it turned out to be a bad decision it does i mean that's warren for you so anyway back to the story i just thought that was so amazing yeah so berkshire

meanwhile unlike intel is quickly becoming a major problem buffett of course stops stanton's you know investing in the business but once you stop investing like they were already uncompetitive now they're wholly uncompetitive and they're just you know losing money so he says like gosh i gotta do something like berkshire is gonna burn through all of its millions of dollars of cash reserves if i don't do something here and i don't want to shut the business down as we were saying right so he starts thinking about like well could i just buy something else within berkshire use the money that's sitting there and essentially just kind of transform the business around it so he starts looking around and there's a company right there in omaha that he's been eyeing for a while called

national indemnity and this is the third great investment and where we're essentially going to leave the investing portion of this story and national indemnity david to me sounds like an insurance company would that be right that would be right it is run by jet jack ringwalt all right listeners now is a great time to thank our longtime friend of the show service now if you are running a large enterprise ai agents are likely spread across every team and deploying them is uh no longer the hard part yeah the hard part is knowing what permissions they have what employees are using them for or what decisions ai is making ai security for an enterprise at scale is not a small concern like the risks are real

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different than geico indemnity national they ensure super esoteric risks like you know geico wants the boring safe driver you know low risk wide aggregate insurance these guys want like the hole-in-one policies right like what we were talking about on the uh the virgin galactic episode with the x prize they would be ensuring the x prize they want the riskiest craziest wildest stuff out there as jet jack was famous for saying there's no such thing as a bad risk only bad rates and of course he's right you could price anything as long as you price it right so and they were very good at pricing risks and and jack famously like he would personally go dig into they once there's some story about they were once

insuring like a settlement on a murder case or something like that and maybe it was a murder case or maybe it was something and uh like he went personally and like did a bunch of detective work to figure out like how likely it was that the case was gonna go one way or the other and then he raised the risk so and they happen to be like right down the street from warren's office in omaha i feel like half of like the berkshire orbit companies are like oh warren happened upon them in omaha and they happen to be these like best in class businesses it's like it's unbelievable a little nexus it's so folksy yeah it's hilarious and differently in how they did this thing geico but

similar to geico national got to use its float for a super long time because most of the policies they were writing never cashed in like they were the type of things they were insuring where like it was long tail stuff like stuff that was very unlikely to happen so they just got used to the money for a long long long time jack though he's getting older he's considering selling the business but it's his baby he's super super fickle about it like you know he wants to sell but he doesn't really want to sell uh and you make noises about it every now and then warren knows all this so in february 1967 he catches him in sort of a dour mood uh they're like having lunch or something at some point warren's

courting him and they work out a deal in 15 minutes 15 minutes or less to sell your company and warren's like i'm gonna buy this company for berkshire not the partnership this is it i'm gonna transform berkshire into insurance company so they hammer out a one-page deal at the price ringwall wanted no audited financials uh promise to keep the company in omaha promise not to fire any employees every literally gives jet jack everything he wanted like no reason to say no and they do it and jack even sticks around and continues running the business because he can't like disengage uh he's obsessed which warren wanted anyway so it's great puzzle piece that's like a little little learning warren's gonna employ later yep yep he's just adding to his uh adding to his quiver of tricks of the trade here

so it becomes part of berkshire and in doing this deal it's unclear how much warren thought about this ahead of time or more like he was just looking for something to buy for berkshire but he sort of stumbles upon this is probably like the single greatest insight that buffett has across his entire career of marrying an insurance business with first one in berkshire but then many operating companies and so how it works is so he knows he already knows going back to geico that within the insurance business you have float you can invest the float that's great and then you can compound your capital for free essentially the problem though not that it's a problem but the limiter on this is that you do need to keep some cash on hand as an insurance company because like

you got to pay out some policies like you know at any given month you might need to pay some stuff out so you can't just go invest all of your capital into other things but if you actually combine an insurance operation with other you know non-insurance operating businesses you can invest all of your capital all of your float because an operating business both consumes capital but also spits off cash also produces the capital and so you can keep the capital from the float tied up in the operations of operating businesses and then buying more operating businesses to attach and then if you ever need to pay off claims well you just pull a little capital over from the cash flow every month that's coming out

of say a railroad or say like you know anything that's very predictable like a candy store or a dairy queen or you know what have you this is brilliant because this now enables but warren through this insight to start building up a a two-sided flywheel of more and more insurance businesses and operations that generate more and more float that he can then invest that capital in more operating businesses which generate more monthly cash flow which enables him to take on more and more float and you can start to see how this ping pongs back and forth he actually writes a paper after the national acquisition where he talks about the capital requirements for insurance companies in this insight he says by most standards national indemnity is pushing its capital quite hard it is the availability

of additional resources in berkshire hathaway that enables us to follow the policy of aggressively using our capital which on a long-range basis should result in the greatest profitability within national indemnity berkshire could put additional capital into national should underwriting turn sour berkshire so boom berkshire is still a dog but the insight was huge like he can go out and just run this playbook all day long it's amazing right so this is the beginning of berkshire morphing from a series of textile mills into a holding company that has all these incredible cash flow flywheels happening inside of it yep and it's not just a holding company unlike the you know nifty 50 conglomerates of the 60s which were just like holding companies for the sake of being holding companies right it's a holding company with

a purpose right like these companies actually benefit each other rather than just hey we have a whole bunch of capital so we're going to roll up companies that never really interact at all yep yep and i should say it's not like the products interact it's not like the managers meaningfully interact the way that and this is a little foreshadowing here but the way that berkshire will eventually run is capital is managed by the central head office and when a business you know needs cash or produces cash it goes to the head office and the capital allocation is done there but all the actual operations of the businesses are done inside the business and so it's this insight that the synergies or the flywheels or the

connectivity whatever you want to call it don't have to happen from the managers of the businesses actually dealing with each other it can happen at the capital allocation level yeah and it also gives you know look warren is already a once in a generation talent when it comes to capital allocation but it gives him this huge margin of safety because back to the ben graham you know concept he doesn't have to chase cigar butts anymore because his cost of capital is way lower than anybody else out there he's got all these policyholders lending him money for free in a non-dilutive way like it's not really dead it's not really equity it's just free cash that he gets to play with yep so he can go buy

businesses and graft them onto this flywheel and he has this margin of safety where like even if he doesn't you know he does make great investments and great purchases but even when he doesn't it's he's still benefiting from it because he's adding on to this capital flywheel yep yep and it's this national indemnity is such a good pickup for buffett too because he's the master of probability i mean if we go back and look at amex you know the market was scared off because there could have been a run on amex but warren looked at it probabilistically figured out the probability of it actually happening was low assess the expected value multiplying the probability by the sort of potential outcome and was

like oh this is an expected value positive bet with a margin of safety and he's just a genius probabilistic thinker and so when you apply someone like that to owning an insurance company not only is he a brilliant probabilistic thinker an individualistic decision maker who doesn't need third parties to give him social proof that something is a good idea now there's this third leg of the stool also which is sort of this um master capital allocator so the capital allocation the probabilistic thinking and the individualistic decision making he's now got these like three crazy tools at his disposal and owning an insurance company is awesome for someone like that yeah it's like and he's playing with a stacked deck here like he can't lose you know so no wonder he becomes the

best investor of all time well so we're about to see some pretty excellent returns here through 1967 and 1968 the dow does well in 67 it's at 19 19 return that year we're starting to kind of see some go go action going on in the market 1968 it's a little cooler but it's 7.7 percent across those years uh warren did 36 in the buffett partnerships in 67 then had its best year ever with a 59 return in 1968 like he's untouchable he's just like he's like steph curry he's just draining threes here it's i mean if if we look all the way from 57 through 69 the dow the compounded results of the dow were 153 the compounded results of the partnership were 2795 that's a 28x that warren did over the 12 years

of the buffett partnership he's just like playing out of his mind yeah unreal wow but as hopefully we've painted on this episode you know there's um probably the best quote uh i don't think we said this at the top of the episode but probably the best quote about buffett that has ever most apt quote that has ever been said about him was in a forbes piece that came out i think right around this time which and it says buffett is not a simple person but he has simple tastes and so hopefully we painted the picture here of like he's a really complex dude like you know he comes across folksy he drinks his coke he eats his peanut brittle but uh he doesn't use a computer for his analysis but like there is deep

deep analysis yeah and there's a lot of there's a lot of psychology going on in his head so you think like i mean this insight this whole thing about insurance and the float the flywheel and the operating businesses this insight should have and did drive the entire rest of his career like the next five decades is this but he doesn't see it like he's really worried at this time you know what started a few years ago of i don't know that i can invest all this capital in the partnership i don't know that i can keep generating these returns close the partnership to new capital i'd have to go buy really big businesses or buy businesses outright to deploy this much capital and

i don't have access to that you know these are the types of businesses we can buy and we buy smaller shares of them yep so in 67 he writes a letter to the partners saying quote i am out of step with present conditions on one point however i am clear i will not abandon a previous approach the cigar butt investing strategy whose logic i understand although i find it difficult to apply in the current environment even though it may mean for going large and apparently easy profits to embrace an approach which i don't fully understand have not practiced successfully and which possibly could lead to substantial permanent loss of capital you'd like he's he's like mentally struggling here with this

dichotomy like times have never been better and he's never been more worried yeah his i mean he is ben graham through and through at this point in his life it's rule number one don't lose money rule number two see rule number one and then you also have this thing going on where because everything is so tied to the purchase price rather than the betting that you'll be able to generate a positive outcome his mood is tied to purchase prices so even though everything's going up he's looking at it like this sucks like i can't find anything attractive to buy and it's all you know he's almost his mood is very much inverse of the market and he's feeling i think like i've got so much to lose now yeah i've

got all these gains you know he's not playing like he's got nothing to lose anymore he's playing like he's got everything to lose yep so he's in such a bad place that even after this brilliant national indemnity pickup for berkshire in 1968 he tries to unload berkshire he tries to wholesale sell it to munger and david goddessman who was an investor in the partnership and um fortunately for warren they're either too smart or too dumb to take him up on it they put in typical charlie fashion charlie's looks at it just like you're telling me you want to sell this thing and you want me to buy it knowing that you want to sell why on earth would i buy something knowing that you want to sell

and warren's like the mutual admiration and respect there is so telling so telling so telling so by mid 1969 warren's like he's done uh he starts making plans to wind down the partnership he's he's like dejected he's gonna hang up his spurs after his greatest year ever after his greatest year ever you know definitely there was some tension with suzy as well where suzy was like we're worth like many many millions of dollars like what are you doing here and interestingly many millions of dollars but he's still kind of an unknown person like wall street doesn't yet know the name warren buffett the way that they would in the next couple decades and he's not sort of being called on he's not

a celebrity investor he's not informing the public on investing this is very much just about staying private and making money yep yep so on memorial day 1969 he writes a letter to the partners and he says if i am going to participate in the investment business publicly i can't help being competitive i know i don't want to be totally occupied without pacing an investment rabbit all my life the only way to slow down is to stop and then he says he's giving notice of his formal retirement at the end of the year he's going to wind up the partnership distribute out all the securities to the partners in the beginning of 1970 that's it he's done he's walking away he's like jordan he's going to play minor league

baseball that's a very apt analogy that's exact this is the last dance except it's not really the last dance the partners are shocked they rightly never thought warren could give up the game of course he can't give up the game as we'll see next time they ask warren what to do he thinks about recommending them to charlie but charlie at this point is like i don't know i don't want a bunch of new investors either i'm worried about the market too so he sends the big investors to david gaddisman at first manhattan bank in new york his big farm can manage big clients and the small one the small investors he ships over to bill ruane uh who had back from his class yeah ben graham bill had just

left kidder peabody and was setting up his own fund the sequoia fund not to be confused with sequoia capital but equally incredible performance over the last 60 years and that's kind of where he leaves it so january 1970 he liquidates all the public securities he unwinds the partnership at this point he owns 26 of the partnership he gets 16 million in cash 18 of berkshire 20 of diversified retail company which was a joint venture he had with charlie owning department stores ill-advised place to invest and we keep mentioning charlie here do not worry stay tuned we will have the full monger story in part two in part two and uh two percent of blue chip stamps which was another charlie jv and that's it he also owns the omaha sun which was like a vanity purchase uh to get back to

his newspaper roots and the partners have to decide with these private companies berkshire diversified blue chip and the sun whether they want to sell their stake and buffett says he's happy to buy their stakes from them if they want to sell or they want to keep them so he writes a long faq to the partners including should i hold my stock in the private companies to which he writes all i can say is that i'm going to do so hold the stock and i plan to buy more so with that cryptic statement he drops the mic he's out out of the game and he owns how much of berkshire hathaway at this point 18 percent as he rides into the sunset and i think that little cliffhanger is probably a great place to

leave it on history and facts for this first half of berkshire hathaway i don't know we're at about three hours do you think that's enough should we go another hour we could talk about the part after this where he tries to figure out what to do with his life well the market is doing crazy things or you know the little bit of warm water that he gets into with charlie and the feds um but maybe maybe let's hold on that and and we'll uh we'll start part two off with some of that wandering pre going all in on berkshire hathaway uh back lake jordan wearing the four five yep well boy do we have some fun playbook things to dive into this episode the first one that i have i actually i decided to leave

berkshire land for a moment to illustrate the point so the point that i wanted to make is sure warren buffett is really into compounding like i think that would be an understatement and everyone in the audience is probably chuckling if they've made it with us that far another fascinating thing is david you just mentioned he took this distribution in cash at the end of the wind down um and what i'm thinking is ah that's got to kill him to have to take these transaction costs these taxes like he must have really wanted to wind down the partnership to make that happen and to illustrate the point of how much transaction costs and taxes can interrupt the beautiful thing that is compounding i went to a paper that was written in may of 2020 from the

yale school of management by aj wasserstein mark agnew and brian o'connor who are uh collaborators with someone that we have had on the lp show david do you know who that person is hamilton will thorndyke will thorndyke i should have gotten that author of the outsiders who came on on our book club and they did some awesome great analysis in this paper called on the nature of long-term holds where they basically ran a little simulation and showed what would happen if you held something that had continuous compounding for 25 years and you paid taxes once in year 25 or if you had continuous compounding happening where you paid taxes every five years basically if you withdrew in cash and then

reinvested in the exact same or an equally producing asset and is this assuming taxes are all long-term capital gains yep yep it's assuming 25 which would be some combination of federal capital gains and some state tax as well so if you invested one dollar and just let compounding do its thing for 25 years you would end up with 24.9 at the end and this is uh assuming a compounding rate of 15 so you you know you take your dollar 25 years later it's worth 25 now if you pay taxes every five years that same dollar is worth 16.8 so it's a 50 increase in the amount that you are left with at the end if you just don't interrupt compounding by doing the thing that all humans want to do which is manage the money do

stuff be active and i think that it's this brilliant insight that warren has sort of like begun to have here i think in the buffett partnership he moves stuff around much more than he later would in berkshire hathaway but this sort of uninterrupted power of compounding you know taxes transaction costs whatever the things are if you can find yourself betting on a winner and just let it ride that is the very best strategy you can possibly employ and i it feels to me at the end of this story he's like he's really starting to grasp that yeah well it's kind of like um so there's this great this is we go way out there in left field but you know hey we're three hours into this episode so

who knows how many people are still listening there's this great book called transitions by william bridges and it's wonderful and it's about psychologically dealing with transitions in your life even if it's like a good transition like getting married or or having a kid or you know um and bad transitions too like big changes in your life and the whole theme of it is that when you have a transition like the old you needs to die before the new you can arise and to my i kept thinking about this through this story here in this part one of like warren was so successful he was the most successful ben graham disciple that there was more successful than ben himself but that wasn't gonna work anymore

and he needed to get to start to understand these things that you're talking about and he needed to symbolically you know die the old warren to have the new warren arrive and i think that's what happened here with the closing down of the partnership whether he knew it or not almost assuredly he did not he needed to close the chapter on like that part of his life to start to embrace some of these very different philosophies yeah it's fascinating that's a really good point i've never thought about that sort of like literal let the old you die think that way it's a really good book recommend it to anyone well speaking of ben graham this notion of independence of thought there's a ben graham

quote that the stock investor is neither right nor wrong because others agreed or disagreed with him he is right because his facts and analysis are right and this is something that i think as a venture investor is so difficult because so much of the success of a company when you're investing in it depends on its ability to in the near term raise future capital uh from someone who is not you so it encourages this sort of herd mentality of do other people perceive this to be a you know hot company in the in the same way whereas what ben graham is looking at is the complete opposite side of the spectrum no growth at all exclusively looking at cigar butts it's like you have to hang your hat exclusively on your independent

analysis which is way easier to do when you have a book value staring you in a face and you're only going to do basically a one-time transaction on it but it is i think a thing this sort of independence of thought and is something that we can all bring a little bit of ben graham into our lives and it's funny because the positive and the negative hit you in different ways when other people are telling you you are right it's very easy to accept the idea that you are right when other people are telling you you are wrong you know that hey maybe what i'm supposed to do is be contrarian here and trust my gut and it's funny how you want to say well look just because other people are telling me i'm

wrong it doesn't mean i'm wrong but if other people are telling me i'm right i'm definitely right uh totally i think you raise a really good point in there too two good points one yeah we could all use a little more ben graham in our lives but people talk about value investing in venture and blah blah blah and like you know some people try to do it other people bemoan why it doesn't happen you raise a really really good point which is that it kind of can't because you need other people to believe too and unless you're going to be willing to just wholly finance a company yourself but even then like that's a slippery slope but but b the company needs to recruit employees it needs to

recruit partners it needs to recruit customers like you can't just be you got to be bringing people into the fold you got to be a missionary to succeed in the startup world right yeah it's funny how uh basically in in a growth company and in a very small growth company especially you cannot be the only believer otherwise it won't work yeah which maybe is a reason why as painful as it is to go back and talk about it maybe is why buffett investing in intel and technology never would have worked in the first place he just wasn't in a mindset to be able to think like that yeah it is a completely different way of thinking well speaking of uh not being in the right mindset you know buffett spinning down

the partnership in its very best year ever or after its very best year ever this is sort of like there's a boom time going on and that's a terrible time for warren to be buying and i think that the classic warren buffett aphorism be fearful when others are greedy and greedy when others are fearful springs to mind where it's easy to say this guy shut down his investment partnership when everyone else was being greedy you know like he did not when he returned 50 plus percent right it's crazy like what what most people would say let's go raise so much more capital to deploy and it is like a really adherent to principles approach of uh you know if you truly do believe the fearful when others are greedy

and vice versa comment there is no better illustration than that yeah and interestingly though i bet he would probably also say it was the wrong decision you know i mean like the right decision in the long run because it enabled berkshire but like in a vacuum like he was crazy he should have kept going yeah maybe i mean that's the whole sort of bill girly uh enjoy every last minute of the upside you never know when the downturn is going to happen so you have to invest through all cycles that's true unless you're warren buffett and you can actually pick the cycles like so far he has proven and we will see in future years too he is remarkably good at having a lot of cash when he needs a lot of cash

and being fully invested when he needs to be fully invested yep that is true that is true don't time the market unless you're the oracle of omaha i think is the second part of that phrase well he does have a saying that uh i actually first heard from chamath of all people very different approach than than warren although great and in his own way but um the quote from him it's not timing the market it's time in market which to your point would be like uh do as i say not as i do he also says invest in index funds and goes out and is incredibly concentrated himself right yeah i mean it's it's funny listening i was watching the i'm gonna flash forward here a little bit but i was

watching the first recorded annual meeting the 94 annual meeting with he and charlie and he's remarking on um well sure if you have no conviction then you're any better than any fool at picking stocks you should go own as many stocks as possible you got to be diversified you got to you know uh be covered in case of downturns if you feel like you're investing in managers who are excellent and have fortified their businesses so that they'll be excellent through all cycles then you should own as few businesses as you possibly can i own one i trust the managers implicitly it's just a very warren buffett quip but for all of us who are taught diversification that's another way of saying that we

should all be reverting to the mean and uh if you believe you actually have a gift and or have an edge then you know bet on your ability to perform superiorly which he has done incredibly well yeah a couple others here that i think are worth highlighting and i'll save a lot of these that are better illustrated in part two i think the one that i really want to harp on here is buffett's singular life focus and obsession is getting as much money as possible and watching it grow and doing it in the most ethical stand-up way possible on his own terms and what we're witnessing is just the result of that singular focus of that complete maniacal singular focus when applied by someone

who is a genius savant at that and also has trained himself to become a master communicator and i think there's just very few examples in the world where someone truly is world-class at something and is singularly focused on it and i think that when you have that that is when you have these you know 10 sigma events or i don't know how many standard deviations from the mean this is but it is this performance is remarkable and enduring and we'll talk about this in grading but this is a 29.5 percent compounded return every year for 12 years partnerships it is you know you mentioned michael jordan i don't think that's a ridiculous analogy and i i think jordan's singular focus on winning i think is a very uh a very reasonable comparison he's naturally the best

in the world he is the hardest working and he's singularly focused on it so i think that's very apt totally there's a um i just pulled up there's a wonderful quote from uh mike moritz that uh i love that uh was in uh the book leading that he wrote with sir alex ferguson and it says the great ones eliminate all distractions and focus only on what matters shut out the things that don't matter and don't let their time get stolen away people forget how few hours there are in a year you must focus on what's important and not do what's not i mean we haven't talked about his work habits but like warren is the singular embodiment of that like he sits in his office all day and he reads annual reports

period right like six plus hours a day he's just reading and the other hours he's talking to charlie right and there's massive life trade-offs to that like if you've decided that that's the thing you want to do and that's what makes you happy great but do not pretend that it doesn't come without trade-offs because like for someone who wants a well-rounded life yeah that's not it you're not gonna get it totally uh the last one that i'll highlight here and then i'll save the rest for part two because there's so many other things here worth discussing but i think they'll be better illustrated by the full embodiment of berkshire hathaway as it is today is the secrecy of his ideas not to get too much into power but i think he was actually counter-positioned to every other

stock picker who got paid to look smart in the short term warren did not care about looking smart in the short term his business was not that he wanted to make the most money long term so he stayed quiet about his ideas to like a religious extent and he never ever wanted to move the market or cannibalize that rare really good idea that he had by sort of showing his hand too early and trying to appear smart and he didn't have that national brand he was never paid on commission or transactions he aligned the business model with his long-term goal and that was totally counter-positioned to the market yep totally agree aligning the business model yep huge only one i throw in there which will

probably also come up in part two but uh but i think it really came out here in part one is just like the i say this all the time it's the sequoia capital let your winners run like selling geico selling amex those were massive mistakes and as brilliant as all the things that warren did and as brilliant as his performance was in this first part of his career it's just impossible for me to look at it and i think man it could have been 10 times better had he not made two very simple mistakes and when you're saying just like sequoia you're talking about like the hard learned lesson of selling apple and making a six million dollar profit on it yep yep so true all right listeners

now is a great time to talk about one of our favorite companies statzig yes long time acquired partner there is a reason why the best product teams at companies like open ai and notion atlassian figma rippling bricks and more rely on statzig whether they are iterating on their core product features or shipping ai powered experiences at scale yep in the crazy speed of today's ai world shipping fast is just table stakes now it's basically trivial to build and deploy your app constantly the real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you ship next whether it's a feature tweak a pricing change a performance

improvement or an ai update like a model change or prompt adjustment they're not relying on instinct they're measuring what actually moved engagement retention and ultimately revenue and as more teams build with ai that learning loop becomes even more important building with llms introduces non-determinism into your product experience the same input doesn't always produce the same output and behavior can shift in subtle ways in real world use so doing offline evals will give you part of the picture but you can really only understand the impact once your product is live with real users and then you can measure how their behavior actually changes it's very different than the way that you would ship features in a pre-ai world where you knew exactly what the software was going to do in

production yeah exactly so this is where statzig comes in it brings experimentation feature flags and product analytics into one unified system so teams can ship safely test rigorously and directly link what they changed to how users actually behaved the result is a tighter feedback loop and learning that compounds over time so you don't just ship more you ship better so if you want to make learning your competitive advantage whether you're building new ai experiences or just evolving your existing core product go to statzig.com slash acquired to get started well all right as a little precursor to grading here let's do a quick value creation value capture on these episodes we always compare how does the value that they create compare to the value that they actually capture you know is it very little like wikipedia

do they capture a lot like google does and then of course a second part how does the value created for the world not just for shareholders compare to any value destruction so sort of talking from like an ethical moral perspective well on the first one david you might say well warren buffett he's a pure play investor so that by default means he's just capturing as much value as he's creating like he's not out there innovating and creating a new product for the world he's not a value creation type person so i'm curious your thought on that like on part two that will definitely not be true like i think berkshire hathaway from this point forward will have lots of value creation to talk about but what about

up to this point to 1970 you know what companies created value for the world that otherwise wouldn't have created net new value because warren was involved yeah well i mean and even stepping back and looking at the whole ben graham entourage and cigar butt investing like you could make a super real argument that it's all that is value destructive investing totally after companies and breaking them up and liquidating them like there was a going concern providing value to customers that is no longer going and not employing people and like yeah there was definitely some value destruction here now i think you could also argue about the cigar butt investing in ben graham that before him and them there was just rampant speculation that was happening and that's ultimately value destructive for everybody too so

he did lay the groundwork for fundamental investing value based investing in the purest sense of the word value not as anti-growth but as like true investing in value as opposed to speculating so that's all great for the world right if you think about all the like pensions that invested from the graham era through today that you know generated money for their the the people whose pensions they support like that's awesome to the extent that they had access to public equities that were no longer sort of just treated as lotteries yep so yeah and then warren you know gosh i don't know it was probably neutral to berkshire hathaway his involvement like he stopped investing in the business but the business was gonna die die any

faster that's a good question it is interesting because i the the least charitable view that you can take on investors like pure investors is that you're just reallocating piles of money so you're not creating new value for the world and that's like the least charitable in lots of ways i mean if you think about the ways that great venture investors are value add like yes there's something there to bringing a lot more than capital if you think that some of the things we'll talk about in part two where someone with a really strong reputation can sort of come in and save a business who you know has has is sort of in the midst of blowing up like a solomon brothers or something like that like that is

much more than reallocating money from one pile to another so you are legitimately creating new value for the world it's interesting though in up to 1970 where we've sort of covered here i'm not really sure you could make an argument that what the buffett partnerships were doing was in any type of value creation yeah i don't really think so it laid the groundwork for a lot of value creation but yeah yep it's actually very interesting to examine like in the financial sector pure play investors what else is value creative well you can if you increase liquidity in markets that's value creative if you come up with more innovative instruments that allow for i guess it's again companies to get funded faster

or companies to get funded with fewer fees that provides value warren's not really doing any of this at this point though no no not at all yeah not at all it's just coming at it from the other side because normally when we're talking about a new tech product that's created we start from a place of well they created all this value did they capture it and with pure investing and pure finance you starting from this place of like well all right they definitely were moving value from one place to another but where did they grow the pie yeah i don't think they really did at this point nope okay so grading the buffett partnerships returned 30 for 12 years compounded so that's a 28x david

how do you think about that yeah is that an a is that a c well it's interesting right we were talking before the show about how we're gonna approach this question and i think it depends like everything the lens through which you look at it if you look at the buffett partnerships like a fund which they essentially are it's essentially a hedge fund any fund that returns 28x over uh you know 12 year standard-ish lifetime of a fund that's incredible that's one of the greatest of all time you know the i there may be some sequoia and benchmark funds that are approaching that but i don't think any of them hit that number no i think the super fantastic recent benchmark fund was like a 25x right so even that

and that had what like uber and we were we work and snap in the same fund i think yep yep so yeah from a fund grading it through that lens a plus no doubt now interestingly though if you were to look at it relative to a individual company investment which i think would be a stretch i think it is much more like a fund it is a fund total company it's not that impressive these days you know that you would return 28x on an individual investment over 12 years i mean they're individual investments in crypto these days that are returning 28x in six months like well i mean it's been 12 years since bitcoin was invented and it's returned 62 no i'm sorry 6.2 million x so crypto is a whole different right

so that just blows it out of the water it's really interesting though like i don't back in these times there probably wasn't anything that was returning on this level an individual style i mean intel for sure but like the concept of you know venture investing or investing in private companies we're talking about like maybe 15 people in the world that did that yeah that's a great point yeah so it's i hadn't thought about normalizing for the time period because i mean i thought about when i looked at this the numbers sort of jump out at me of like oh i have an irr number on a 12-year fund like cool let's compare it to venture oh i have a cash on cash on a 12-year fund so like a 28x

on a 10-year fund with a two-year extension like this is a top 0.1 venture fund you know this is like people say i want to be top decile i want a 3x i want a 5x like funds don't 28x especially with the inflation adjusted millions that buffett was investing then so it's a it's a crazy impressive feat i mean i to like just to assign a letter this is an a plus and frankly the fact that a they never lost money they they not only beat the dow but they had a positive return every single year crazy impressive and a positive return with the option to take your money out so the there's not an illiquidity premium unlike venture you know it's just crazy and actually beats the now granted

berkshire hathaway has been around a lot longer and it uh today and they're managing way more money than the buffett partnerships ever were but you know this 30 or 29.5 definitely beats the pants off of berkshire's uh returns you know ever since warren went full-time which we'll talk about in the next uh next episode what is full-time i think warren was just a man ahead of his time yeah a plus we're dancing around trying to figure but it's an a plus no doubt yep all right carve-outs carve-outs mine is a very very very different way of thinking investing looking at the world but fascinating balaji srinivasan on the tim ferris show another three-hour podcast that came out a few weeks ago wildly fascinating balaji is a very interesting character that many people in tech

know he was a partner at andreason horowitz for a while he founded council he was a founder of a company called earn.com i think that coinbase acquired then he became the cto of coinbase he's a crypto evangelist transhuman evangelist transnational you know anyway very interesting podcast lots of seemingly out there ideas discussed but uh always worth considering these things i really enjoyed it yeah i gotta it's like next on my queue to check out i it's like right after all the stuff that i was listening to to do the berkshire research yeah we haven't had a lot of time for uh other carve-outs recently i will say this is the first time i've started research like months in advance just

like giddy to do this episode so i know this was so fun all right mine is also something that i listen to via audio you can read it via text as well but since i'm such a big audio consumer i chose to listen and uh hearing it straight from the horse's mouth i much prefer it to reading especially in this case packy mccormick wrote a wonderful piece called not boring one year in and i can't recommend reading it and especially the narration and hearing it in his voice enough i don't know if it just particularly resonated with me because you know we're friends with packy and we've been watching his journey or if his journey is just like remarkably similar to acquired so just reading it i'm like just

screaming in my car while listening to it yes like at certain moments uh but it is the most awesome open book cathartic telling of his first year i can't believe it's only been a year what a crazy crazy thing he's accomplished and the biggest thing that resonated with me is that like there's both a process and not a process and he's like i have certain things that i do because i need to get the content out once a week or twice a week and so i i have a set schedule that i need to follow but i don't i never actually know like what the content's going to be and i need these lightning bolts of creativity and i would say that david and i aren't quite as wide in the gamut that we

run of like where the you know a not boring piece can look quite different than the sort of what acquired's mold is although recently who knows but i definitely know that thing of like okay there's a set of activities that i need to do to go generate ideas and then i can at some point i need to narrow and pick one and then i need to run with one of those ideas and i think that's a for a person who is creating on any sort of regular schedule be it creating in products you're making creating in the blog stuff you're writing creating in podcast whatever it is like that is such a real emotion to identify with and um package does such a great job writing about it i think anyone who makes stuff should go read

not boring one year in yeah it was so good i loved that piece packing my friend you are gifted indeed well as we wind down here we should say there is a uh a berkshire hathaway 2021 annual shareholder meeting that will be coming up on may 1st so if you like david and i are becoming sort of a converted buffet head that is a great thing to tune into and watch on uh that lovely saturday on yahoo finance uh we will have part two coming out here in the near future we definitely look forward to talking about all things berkshire with you both past as we've covered on this show up to the present as we'll do on part two and looking into the future with the berkshire annual meeting so um tune into that

if uh if it sounds interesting it's warren and charlie on stage just fielding questions for hours and hours and hours on end so it should be pretty good we should totally in post covet times a go go next year b be like all you know artists and steal and just do the same thing we should like we should totally do this we should just like get up on stage and then we should have all of our sponsors all of our partners oh my gosh out in the concourse out in the concourse uh we'll have bronze bus of warren and charlie thank you to our good friends at tiny yeah and uh we'll just have a we'll have a big acquired fest

i'm in let's do it all right i'm gonna keep the wind down brief everyone if you like this episode share it with your friends um if you have a friend who's a value investor or not a value investor or you talk about this stuff with share it feel free to share it from social media if you're getting excited about the annual meeting coming up for berkshire feel free to point people to this as a resource and uh it's definitely one of the things that inspired david and i to do it become an lp we love our lps we love everyone but we love our lps the most join the slack it's a great conversation there and i'm sure there'll be much discussion of this episode there i think that's all i got

listeners thank you so much and we will see you next time we'll see you next time you