WARREN BUFFETT

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PART ONE

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The First Partnership

Following the
the my last ten part series on the life and career of Charlie Munger, Vice-Chairman of Berkshire Hathaway
Corporation and Warren Buffett’s right hand man, in this series I’m taking a look at Warren Buffett’s early career.

Before Warren Buffett became well-known, and before he acquired Berkshire Hathaway Inc. (NYSE:BRK.A)
(NYSE:BRK.B), he ran a number of partnerships, investing the money of family
family,, friends and outside investors. It’s
It’s
these partnerships that helped build his reputation and provided the funds for him to ultimately acquire Berkshire
Hathaway.

 This is the story of Warren Buffett’

Buffett’ss early career, the years that laid the foundations for him to become the world’s
greatest investor
investor..

Warren Buffett -- Part one: The First Partnership

In 1952, Warren
Warren Buffett went to work with the godfather of value investing, Benjamin Graham at the Graham-
Newman partnership. Here, Warren Buffett put his education from the Columbia University to work and learnt his
trade as a value investor.

Unfortunately, Graham-Newman partnership closed its doors during 1956 so Buffett, took his savings (around
$174,000) and started the rst Buffett Partnership Ltd in Omaha.

 When he rst set out to invest money for others, Warren

Warren Buffett knew that he wouldn’
wouldn’tt be able to stand criticism from
from
his partners if stocks he selected started to fall. As Buffett was going to be the sole manager of the partnerships run
by Buffett Partnership Ltd., there was nowhere to hide if he failed. With this being the case, Buffett only invited family
and friends to invest in his rst partnership -- Buffett Associates, Ltd.

In total, six other partners, plus Warren Buffett invested in Buffett Associates, Ltd. raising $105,100 in capital.
 Two
 Tw o more partnerships were set up in the months after Buffett Associates, Ltd. started trading bringing the total
number of partnerships controlled by Buffett to three by the end of 1956.

• On September 1st, 1956, he raised $120,000 from Homer Dodge, a physics professor who had attended Har
 vard University.
University. With it, Buffett setup Buffett Fund, Ltd.

• Then, on October 1, 1956, Warren founded another partnership for a friend of his, John Cleary, who was
his father’s secretary in Congress. (Buffett’s father served in the House of Representatives
Representatives.)
.) It had $55,000
in capital.
 These partnerships immediately
i mmediately made money for investors in their rst full year of trading. As Warren
Warren Buffett wrote
in his second annual letter to limited partners at the end of 1957:
“In 1957 the three partnerships which we formed in 1956 did substantially better than the
general market. At the beginning of the year, the Dow-Jones
Dow-Jones Industrials stood at 499 and at
the end of the year it was at 435 for a loss of 64 points. If one had owned the Averages,
Averages, he
 would have
have received 22 points in dividends reducing the overall loss to 42 points or 8.470%...

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 All three of the 1956 partnerships showed a gaing ain during the year amounting to about
6.2%, 7.8% and 25% on year end 1956 net worth. Naturally a question is created as to
the vastly superior performance of the last partnership, particularly in the mind of the
partners of the rst two.
two. This performance emphasizes the importance of luck in the
short run, particularly in regard to when funds are received. The third partnership was
started [in late] 1956 when the market was at a lower level and when several securities
 were particularly
par ticularly attractive. Because of the availability of funds, large positions were
taken in these issues. Whereas the two partnerships formed earlier were already sub-
stantially invested so that they could only take relatively small positions in these issues.”
-- Warren
Warren Buffett annual letter to partners
 All three partnerships held the same securities with similar weightings. I’ll cover the stocks Warren was buying later
in the series.

Three types of trade

It’ss here that I should introduce

It’ i ntroduce Warren Buffett’s
Buffett’s early trading
tradi ng strategies.

Buffett had three main strategies: Firstly, Buffett has his “generals”, which were usually undervalued securities where
he had nothing to say about corporate
cor porate policies. Typical
Typical value plays in other words. Generals made up the bulk of Buf-
fett’s portfolio.

 Then there were the “work-outs”, undervalued securities where

wher e corporate action was required for the market
mar ket imbal-
ance to correct itself. And nally the “control” situations where Buffett
Buffett aimed to inuence policies of the company
in order to unlock value. In a number of cases, Buffett’s
Buffett’s generals and work-outs quickly turned into control situations
 when Buffett either ran out of patience or decided that management had to go.

“At the end of 1956, we had a ratio of about 70-30 between general issues and work-
outs. Now it is about 85-15. During the past year we have taken positions in two situ-
situ-
ations which have reached a size where we may expect to take some part in corporate
decisions. One of these positions accounts for between 10%
10% and 20% of the portfolio
por tfolio
of the various partnerships and the other accounts for about 5%. Both of these
thes e will
probably take in the neighborhood of three to ve years of work but they presently
appear to have potential for a high average
average annual rate of return with a minimum of

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risk. While not in the classication of work-outs, they have very little dependence on
the general action of the stock market. Should the general market have a substantial
rise, of course, I would expect this section of our portfolio to lag behind the action
of the market.” -- Warren Buffett 1957 annual letter to partners.

 The compensation structure for Warren Buffett’s partnerships was fairly simple. Investors received 6% interest on
their money from the partnership and 75% of prots above this threshold. If there were a loss, Buffett took 25% of
it himself. That means that even if Buffet broke even; he lost money.

 What’s more, Buffett’s obligation to pay back losses was not limited to his capital; it was unlimited.

Buffett also had a little partnership with his father, called Buffett & Buffett. Warren charged no fee for the manage-
ment of this partnership.

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PART TWO

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Expanding

 Warren Buffett’s rst three partnerships, set up during, 1956 outperformed the market signicantly during their early
years and attracted plenty of attention. As a result, more potential investors began to approach Warren and ask him
to manage their money.

So, to meet demand during June of 1957, Buffett started another partnership calledUnderwood, with one of the
original partners of Buffett Associates, Ltd., Elizabeth Peters, with $85,000. Then, on August 5, 1957, Warren Buffett
started his fth partnership, which was called Dacee. Eddie Davis and his wife Dorothy Davis had Buffett manage
$100,000 for themselves and their three children. The year after, on May 5, 1958, Dan Monen and his wife, Mary El-
len, formed the basis of Warren’s next partnership, called Mo-Buff. They put in $70,000.

 The ve partnerships that were in operation during 1958 posted returns of 36.7% to 46.2%. As Buffett wrote in his
annual letter to partners at the end of 1958:

“The latter sentence describes the type of year we had in 1958 and my forecast
 worked out. The Dow-Jones Industrial average advanced from 435 to 583 which,
after adding back dividends of about 20 points, gave an overall gain of 38.5% from
the Dow-Jones unit. The ve partnerships that operated throughout the entire year
obtained results averaging slightly better than this 38.5%. Based on market values at
the end of both years, their gains ranged from 36.7% to 46.2%. Considering the fact
that a substantial portion of assets has been and still is invested in securities, which
benet very little from a fast-rising market, I believe these results are reasonably
good. I will continue to forecast that our results will be above average in a declining or
level market, but it will be all we can do to keep pace with a rising market.” -- Warren
Buffett 1958 annual letter to partners.

 Warren Buffett

However, with the market rising, Warren Buffett was struggling to nd opportunities, and it’s at this point that his
investing methods started to take on an activist style.

“THE CURRENT SITUATION

 The higher the level of the market, the fewer the undervalued securities and I am
nding some difculty in securing an adequate number of attractive investments. I
 would prefer to increase the percentage of our assets in work-outs, but these are very
difcult to nd on the right terms.

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Unlocking Value
 “So that you may better understand our method of operation, I think it would be
 well to review a specic activity of 1958. Last year I referred to our largest holding
 which comprised 10% to 20% of the assets of the various partnerships.” Warren
Buffett letter to partners 1958

 There’s a stark contrast between Warren Buffett’s early investments and those of later years. It was in 1972 that Warren
Buffett’s strategy really started to change, from a deep value activist approach to that of long-term quality and value.
 This change was inspired by the $25 million purchase of See’s Candies. A deal Buffett was pushed into by Charlie
Munger, as the two investors started to become friends and build a strong working relationship.

Still, it’s Warren Buffett’s early investments that are really interesting. Indeed, many view Warren Buffett as a passive
deep value investor, who’s incredible skill (and possibly some luck) at picking investments helped him to g et to where
he is today.

But that is not the case. Many of Buffett’s early successes were driven by activist tactics. Buffett would devote most of
his partners’ assets to one company, buy a controlling stake and then push for change. Granted, most of the compa-
nies he targeted were trading below their net asset value and were deep value opportunities anyway. But Buffett wasn’t
prepared to wait for the market to correct the valuation gap.

Commonwealth Bank 

One of the rst investments Warren Buffett wrote about wasn’t an activist situation. This situation was Common-
 wealth Bank, which Buffett started buying during 1958. At $50 per share, Commonwealth was trading at a measly
ve times earnings and had had an intrinsic value $125 per share computed on a conser vative basis.

Over time, approximately ten years, Buffett computed that the bank’s intrinsic value could rise to $250 per share. So,
this was both a deep value and growth play.

Over a period of 12 months, Buffett acquired around 12% of the bank at a price of $51 per share, which made
Buffett and his partners the bank’s second largest shareholder. The bank only had around 300 shareholders in total,
the shares traded only around two times per month.

However, during the latter half of 1958, Warren Buffett sold his entire commonwealth holding.

“Late in the year we were successful in nding a special situation where we could
become the largest holder at an attractive price, so we sold our block of Com-
monwealth obtaining $80 per share although the quoted market was about 20%
lower at the time.

It is obvious that we could still be sitting with $50 stock patiently buying in dribs
and drabs, and I would be quite happy with such a program although our perfor-
mance relative to the market last year would have looked poor. The year when a
situation such at Commonwealth results in a realized prot is, to a great extent,

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fortuitous. Thus, our performance for any single year has serious limita-
tions as a basis for estimating long term results. However, I believe that a
program of investing in such undervalued well protected securities offers
the surest means of long term prots in securities.”

In other words, Buffett took his near 60% return -- in under a year -- and started to gobble up the stock of another
deep value opportunity.

Clearly, Buffett’s involvement in Commonwealth did have some impact on the bank’s stock price. It’s here that it starts
to become clear that Buffett’s success has not been wholly down to his stock selection strategies. The ve Buffett
partnerships that were operating throughout the year gained between 36.7% to 46.2%, outperforming the Dow-Jones
Industrial Average, which returned 38.5%. Buffett was paying close attention to the index at the time. He wanted to
outperform, the reason he took his gains in Commonwealth and snapped up another opportunity.

Sanborn Map

 The other opportunity was a company called Sanborn Map and at the end of 1959, Warren Buffett had ploughed a
total of 35% of partnership assets into Sanborn stock.

 Warren Buffett’s Sanborn trade (I consider Sanborn to be a shor t-term trade rather than the long-term investments
Buffett has become known for) is well documented. Buffett hoped the situation would work out within a few years,
and during 1960 he was proved right.

 As I said above, the trade is well documented so I won’t go into too much detail here. Sanborn was a mapping com-
pany that had, over the years, built a sizeable equity and bond portfolio with excess cash. At the time Warren Buffett
started buying Sanborn stock, during 1958, the map business was evaluated at a minus $20 with the stock portfolio
trading at only $0.70 on the dollar. Sanborn had a sales volume of about $2 million per year and owned about $7
million worth of marketable securities.

 Warren Buffett managed to get his hands on a large chunk of 15,000 Sanborn shares from the widow of a deceased
president of the company. Her son had tried and failed, to instigate change at the company. Through open market
purchases, Buffett increased his holding to 24,000 shares and pushed for change. To avoid a proxy ght, manage-
ment caved, and Buffett got his way. The company was separated, and value was unlocked.

“About 72% of the Sanborn stock, involving 50% of the 1,600 stockholders, was exchanged
for portfolio securities at fair value. The map business was left with over $l,25 million in
government and municipal bonds as a reserve fund, and a potential corporate capital gains
tax of over $1 million was eliminated. The remaining stockholders were left with a slightly
improved asset value, substantially higher earnings per share, and an increased dividend
rate.”
 A great example of Warren Buffett’s early activist activities.

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PART FIVE

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A retreat
So, an increasing number of investors chasing a dwindling number of securities, coupled with increasing short-
termism, a rising value of asset under management and request for more personal time were the key reasons behind
Buffett’s decision to retreat from the deep-value game. At the same time, Buffett reduced his yardstick performance
 water mark.

“...I am likely to limit myself to things which are reasonably easy, safe, protable
and pleasant...The long-term downside risk will not be less; the upside potential will
merely be less.”

“...out longer term goal will be to achieve the lesser of 9% per annum or a ve per-
centage point advantage over the Dow. Thus, if the Dow averages -2% over the next
ve years, I would hope to average +3% but if the Dow averages +12%, I will hope
of achieve an average of only +9%.”

Deteriorating
On May 29 1969, Buffett followed up his rst letter, issued at the beginning of October 1967. Buffett noted that the
situation in the markets had deteriorated further:

“...opportunities for investment...have virtually disappeared, after rather steadily dry-

ing up over the past twenty years...our $100 million of assets further eliminates a
large portion of this seemingly barren investment world, since commitments of
less than about $3 million cannot have a real impact on our overall performance...
this virtually rules out companies with less than about $100 million common stock
at market value…”

 Along with these factors, Buffett noted once again that the markets were becoming increasingly shor t-term focused,
and he was struggling to devote 100% of his time to the running of the Partnership interests. With these problems
laid out, Buffett revealed to his partners that he intended to announce formally his resignation before the end of 1969.

 This was the end of the Buffett Partnerships and the beginning of Berkshire Hathaway as we know today.

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PART ELEVEN

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The End Of An Era

 “About eighteen months ago I wrote to you regarding changed environmental
and personal factors causing me to modify our future performance objectives.

 The investing environment I discussed at that time (and on which I have com-
mented in various other letters has generally become more negative and frustrat-
ing as time has passed…”

“The October 9th, 1967 letter stated that personal considerations were the most
important factor among those causing me to modify our objectives...publishing
a regular record and assuming responsibility for management of what amounts
to virtually 100% of the net worth of many partners, I will never be able to put
sustained effort into any non-BPL activity.”

“Therefore, before yearend. I intend to give all limited partners the required for-
mal notice of my intention to retire...” -- Warren Buffett May 29th, 1969 letter to
partners.

During November of 1969, Warren Buffett formally announced his intention to wind up his investment partnerships.
He made this decision for several reasons. Firstly, as mentioned above, undervalued securities were becoming harder
to nd. Secondly, the size of the partnership was becoming a problem.

 At the time he announced his retirement, the partnerships were managing over $100 million in assets, with gains of
over $40 million during 1968 alone. And thirdly, managing Berkshire alone with its subsidiaries as well as partnership
assets, become too much for Buffett.

But for those that wanted to keep their money in the market, Buffett offered a replacement; Bill Ruane. Bill Ruane’s
managed his own set of partnerships and in the years to the handover achieved returns of 40% on average per annum
for shareholders. If you want to nd out more about Bill Ruane, his investment process and returns for partners, head
over the ValueWalk Bill Ruane resource page.

Outsized returns
 There has always been plenty of talk about Warren Buffett’s ability to compound shareholder equity at Berkshire,
although it’s the returns that he achieved during his years running the partnerships that are really impressive.

Over ten years, Buffett turned less than $1 million into more than $100 million, achieving a compound annual return
of 31.6% during the period.

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 This record eclipses Berkshire’s growth.

Buffett summed up the performance of the Buffett Partnerships in one of his nal letters to partners.

“Buffett Associates, Ltd., the initial predecessor partnership, was formed May 5,
1956 with seven limited partners (four family, three close friends), contributing
$105,000, and the General Partner putting his money where his mouth was by in-
 vesting $100. Two additional single-family limited partnerships were for med dur-
ing 1956, so that on January 1, 1957 combined net assets were $303,726. During
1957, we had a gain of $31,615.97, leading to the 10.4% gure shown on page
one. During 1968 I would guess that the New York Stock Exchange 127 was open
around 1,200 hours, giving us a gain of about $33,000 per hour (sort of makes
you wish they had stayed with the 5-1/2 hour, 5 day week, doesn’t it), or roughly
the same as the full year gain in 1957. On January 1, 1962 we consolidated the
predecessor limited partnerships moved out of the bedroom and hired our rst

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full-time employees. Net assets at that time were $7,178,500. From that point to
our present net assets of $104,429,431 we have added one person to the pay-
roll. Since 1963 (Assets $9,405,400) rent has gone from $3,947 to $5,823 (Ben
Rosner would never have forgiven me if I had signed a percentage lease) travel
from $3,206 to $3,603, and dues and subscriptions from $900 to $994. If one of
Parkinson’s Laws is operating, at least the situation hasn’t gotten completely out
of control.”

Buffett takes the helm at Berkshire

 As the Buffett Partnerships controlled the majority of Berkshire Hathaway, it wasn’t until the partnerships were dis-
solved that Buffett began to manage Berkshire himself.

Berkshire’s 1970 letter to shareholders was written and signed by Kenneth V. Chace, President. Berkshire’s 1971 letter
to investors was signed by Warren E. Buffett Chairman of the Board.

Even though Buffett had wound down his partnerships citing the lack of opportunities and scope for return in the
market, he was immediately able to achieve an outsized return at Berkshire.

Berkshire’s 1971 operating earnings, excluding capital gains amounted to more than 14% of shareholders equity. Con-
siderably above the average of American industry. Below are Warren Buffett’s rst three letters to Berkshire stocks
holders as the company’s Chairman.
• To the Stockholders of Berkshire Hathaway Inc. 1971
• To the Stockholders of Berkshire Hathaway Inc.1972
• To the Stockholders of Berkshire Hathaway Inc.1973
 That’s the end of this series on Warren Buffett’s early years. Stay tuned for the next exclusive ValueWalk famous inves-
tor series.

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