. Buffett did it for ten years in a row during the
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EXHIBIT 17.1Year
195719581959196019611962196319641965196619671968Total ReturnAverage Annual
Returns of Buffett PartnershipBuffett Partners
Dow
Value Added
9.3%32.220.918.635.911.930.522.336.916.828.445.61403.525.3
(8.4%)38.520.0(6.2)22.4(7.6)20.618.714.2(15.6)19.07.7185.79.1
17.7(6.3).924.813.519.59.93.622.732.49.437.91217.816.2
Source: Warren Buffett Wealth, Robert Miles, © 2004 by Robert P. Miles. Reprintedwith permission of John Wiley & Sons, Inc.
last ten years of his partnership. The odds of that happening are 1 in 1,024.This does not take into account the fact that he beat the Dow, on average,by 15 percentage points a year. Nor does it take into account the fact thathe continued to beat the Dow for the next 30 years. The odds head into theone-in-billions range very quickly.Let’s give the skeptics the benefit of the doubt. Let’s say that the oddsagainst Buffett’s success are one in a billion and that of the six billion people on the planet, one billion of them like to play in the sandbox andinvest. So the odds are that someone with Buffett’s track record wouldexist eventually, and lo and behold, here he is in the middle of Nebraska.Who’d have thought?On a qualitative level, it is definitely true that we create our own luck.Having a methodology, sticking to it with discipline, and working day andnight towards identifying stocks and opportunities that fit specific criteriaare all part of creating that luck.I’m not jealous of Buffett because of the money. In fact, I would probably jump off the carousel well before I had earned $42 billion. However, Iam jealous of the fact that he clearly has fun day in and day out. As he hasstated, “I tap dance to work every day.”
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Warren Buffett has built up friendships over the last fifty years. In a cutthroat environment like the business world this seems like a difficult thingto do. You could argue that he is everybody’s friend because he helped somany people make money. But I have found that even helping people makemoney doesn’t necessarily make them your friend. In many cases, it makesthem the exact opposite.Also, we can see from his many admirers (some of whom are interviewed in this book) that they, too, have succeeded by following Buffett’svarious methods. It is this community of mentor and students that is veryinspirational as well.I must admit that I started this book as a skeptic. The primary thing Iwas skeptical of was that Buffett’s homespun “Buffett-isms” seemed perhaps for show. For instance, he does not buy and hold forever. There aremany, many examples where he actively trades, and only a few exceptions.But so what? His point remains the same. Not everyone is going to go outand do risk arbitrage or find the latest liquidations or have the opportunityto play the PIPEs that he plays. If you can find 20 stocks that are like CocaCola, then all the better. Also, he plainly admits that his biggest mistakeswere mistakes of omission. Why didn’t he chase Wal-Mart up a few points?Or hold onto his Disney stock in the 1960s? Or keep McDonald’s? Maybe hewould have $90 billion if he had done that instead of $42 billion. And I’m notbeing facetious.I was a bit upset at him when, shortly after the terrorist attacks of September 11, 2001, he stated that there was an almost near certainty of anuclear attack on American soil within the next 50 years. From a man whoseldom likes to predict the future, this is a bold statement—particularlyconsidering that there are no relevant statistics or historical events onwhich to base this claim. It is just a guess. Meanwhile, we all had a horribleexperience on 9/11. I lived a few blocks away from the World Trade Centerand was right outside the North Tower when I watched the first plane crashinto it. I was unhappy with Buffett’s claim that something similar wouldhappen again.But, again, this is my problem. From Buffett’s perspective, he had toprotect the fact that he has billions of dollars on the line insuring againstthe mega-catastrophe of a nuclear attack on American soil. And his pointwas purely mathematical. Even if there were a 1 in 10,000 chance for there
Jealousy
239
to be a nuclear attack in any given year, the odds do quickly add up to nearcertainty by the time fifty years elapse. So why not charge for that statistic?Another big criticism of Buffett is that he doesn’t invest in new technology. Why not invest in the growth engine of the United States? Why notinvest in the vehicle that has driven this economy for 200 years, whether itis the cotton gin, railroads, computers, the Internet, or biotech? However,history is our guide. The Dow Jones Railroad Index was flat from 1846to 1910. The computer craze that swept the market in the 1960s saw computer companies like Xerox lose 80 percent of their market value whenthe Nifty 50 turned into the “Iffy” 50 in the early 1970s. And the results of theInternet boom do not have to be repeated here. The reality is that mosttechnologies that spur the economy do not necessarily result in investmentsuccess. Hundreds of automobile companies that went public in the early1920s ended up in bankruptcy. Only the big three remained. If you had theskill set (and the luck) to pick General Motors, you would have done quitewell. But most other companies that were around then are gone today. Anexcellent book that covers this topic is Tomorrow’s Gold by Marc Faber. Hewrites that the U.S. market during technology booms behaves very similarlyto Third World markets that enjoy their boom and bust periods—they go upmultiples of 100 percent and then have a tendency to go straight to zero.This doesn’t mean that it is bad to invest in technology. But the luckfactor plays a larger role. Who could have known that Yahoo! would be thesuccessful company and that Excite (which was older than Yahoo!) wouldfile for bankruptcy? The same can be said for my favorite search engine in1993—the World Wide Web Worm.In Technical Analysis of Stocks & Commodities, a monthly magazineabout trading, there was a recent article about a man in the late 1990s whoturned $10,000 into $40 million in just a few years. In the resulting bearmarket he gave a lot of it back, but he still has a fair amount of money.He proved his results by showing audited returns to the magazine. Hisapproach for years had been to buy breakouts with leverage and options,and perhaps add to his positions as they went up. Ninety-five percent of thetime this approach failed, but he was able to capitalize on the dot-comboom of the late 1990s and really multiply his money.Is he a better investor or trader than Warren Buffett? Maybe. Certainlyduring the years he went from $10,000 to $40 million he was, and I don’t
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think Buffett would disagree. But there are a lot of reasons why onewould prefer the Buffett approach to investing and trading. And I don’tmean the advice of buying great companies and holding them forever, butrather the idea of looking for a margin of safety in many different types ofinvestments, then trading around that idea. Why would one prefer this togoing from $10,000 to $40 million in a few years? Who knows? But maybemaking $40 million in a few years requires a little too much luck.
Index
3COM (COMS)market valuation, 121market-implied value, 124Palm spin-off, 11, 121–124AAcquirers, involvement, 83ACTV, Inc. (IATV), 24, 33OPTV bid, 101Advance PCS, Caremark acquisition, 107Aetna Insurance, 35All-cash deals, preference, 118Allied Crude Vegetable OilRefining, 43Allied Irish Banks, acquisition, 70All-stock deal, 85preference, 118Altucher, James, 21Ambassadors International(AMIE), 24, 26American Express, 185audit, 43bankruptcy, fears, 44card, usage, 236float value, analysis, 236holdings, 54scandal, 43–44, 80, 236shares, Buffett purchase,44–45turnaround, 76American Standard (ASD),holdings, 55–56Annualized value (AV),calculation, 84Anti-trust action, 80, 87Anti-trust problems, 94AOL Time Warner, 22Apollo Investment Corporation,166Arbitrageanalysis, 23deal, failure (reasons), 101example, 87, 93fund, leverage (usage), 96
opportunities, noncorrelation,86situations, 6–9evaluation, 87spreads, narrowing, 9Arbitrage Fund, 102–119Arbitrageurs, 83deal, 84involvement, 96Arcata Corp., 38deal, 87–93debentures, 93purchase, 91–93Artisan, 23Ashton, Zeke (interview),169–179background, 169–170role, 169–170Asset-backed securities, spreadtrades, 224Assets, sell-off, 38Atrion (ATRI), 175–176Automatic Data Processing(ADP), holdings, 51Avista, 232BBaker Fentress, 155, 160Bank One, 108–109trading, 110Bankruptcy, 23, 132, 187declaration, 21risk, 67Bear market, 200, 216Bell Industries, personalholdings, 154–158Berkshire Hathawayallocation, 149annual meetings, 2, 59, 82annual reports, 79, 196book value, 8conference (1999), 11holding period, 3–4investment, 19purchases, 1, 64
rating, 143shares, increase, 7trades, 3undervaluation, 171Biotech sector, 107–109BKF Capital Group, 160Black, Fischer, 225Blue Chips Stamps shares,Buffett/Munger purchase,163Bondsinvestment, 11selling, 143Bottle, Harry, 38Bovende, Jack, 66Brand strength, 44Brand value, 81Breakup fee, payment, 83Buffett, Warrenannual letters, 6arbitrage style, relationship,100–102buy-and-hold investing/investments, 2, 45deal flow, 9disasters, 203due diligence, 65–66early years, 5–6equity holdings, examination,140evaluation. See Stockshedge fund years, 5, 9history, 5–8holding period saying, Pabrai(opinion), 185–186investment. See Silver;Technologycareer, stages, 5–8investor letters, 80–81, 87, 122jealousy, 235later years, 8letters, 36, 100–101, 144–147market returns, 43merger arbitrage, relationship,79
241
242Buffett, Warren, continuedmiddle years, 6–8Pabrai, contact, 182–183partnership, 80personal holdings, 149personal portfolioactivities, 15selection, 150portfoliosuccess (1987), 87switching, 11purchases, 64, 220. See alsoAmerican Express;Gilette Co.; Nextelattempt. See DempsterMiningsimplicity, 46speeches/statements, 94,194–195, 197–198stocks, selection, 12studies. See Merger arbitragetrading, 1size, importance, 10style, 8–10value investing, principles.See CommoditiesVC style, 45visit. See Geicovoting block, 37Buffett Foundation, holdings,155–158Buffett Partnership, 37–38Bull market, 212, 216Burn rate, 23Burnham Pacific Properties,personal holdings,153–154Businessdepression, 36liquidation, managementimpact, 34liquidity, 44model, failure, 21risk, 42setback, 47turnaround, 22. See alsoTSCMBuy-and-hold investors, 184–185Buy-and-hold strategy, 193, 217Byrne, Jack, 223CCAMZ, cash levels, 23Canadian National Railway, 231Capitalallocation, 169deployment, 174–175pool, 185Capital & Income StrategiesFund, 167Capital Cities, 195purchases, 164Capitalism, advantage, 57–58
INDEX
Cardinal Health, acquisition.See Syncor InternationalCaremarkacquisition. See Advance PCSmerger, 107Carr, Fred, 162Cascade Investmentsportfolio, 234proposal, 233Schedule 13-H forms, 230Schedule 13-HR forms, 231Cash, 20commitments, 21deal, 84flow, 171generation, 144index, 21development, 22limit, 22trades, futures trades(contrast), 224Cash on hand, inaccuracy, 21Cash/stock, mixture, 85Cash/stock/debt, mixture, 85Centaur Capital, 167Champion Internationalanalysis, 136–137ROE, 136CHI Research, 16Cigar butt companies, 129Cigar butt stock, 74, 80Cigar butt technique, 5Cipirico (CPCI), 24, 32Clarus Corporation (CLRS), 24,25Class action litigation, fear, 46Clipper Fund, 23Closed-end fund arbitrage, 155,159capital gains, taxation, 160NAV, 160performance, quality, 160portfolio, illiquid/hard-tovalue securities, 160Closed-end funds, 155discount, narrowing, 160dividend, discount, 160investment reasons, 160Coca-Cola (KO), 49, 72, 183–185holdings, 3, 57–59, 189ROE, decrease, 58value play, 7water purchases, impact,58–59Commerce One Software,177–179Commoditiesinvestment, 12value investing, principles, 12Common stock, 130warrant kicker, inclusion, 131Companiescontrol, 38
growth, example, 175–176investment, 198market value, trading, 34negative growth/valuation,172R&D expenses, 16Concord EFS, First Datapurchase, 85Concorde, First Data purchaseattempt, 107–109Conrailsale, 104–105trading value, 105–107Consolidated-Tomoka LandCompany, 160Convertible arbitrage, 81Convertible debt, 131Convertible preferreds, 195Corruption, fear, 46Costco Wholesale (COST)Buffett approach, 59holdings, 59–60inventory turnover, 59Creative Computers, Ubid(interaction), 126–127Credit risk, 224Credit Suisse-First Boston(CSFB)Hedge Fund Index, 96hedge fund sub index, 96Tremont Hedge Fund Index,225–228Cuba, nuclear missiles(Kennedy’s announcement), 206–208Currencies, investment, 14Current holdings, 51DD. A. Sanborndiversification, impact, 37employment, 35–36Daily Journal, purchases, 164Dairy Queen, 1Dealsexpectation, 84failure, reason. See Arbitragemultiple bidders, 101opportunities, 101risk, 86selection, 87types, 85–94DeAngelis, Anthony, 43Death spiral convertibles, 132Debtabsence, 23commitments, 22–23covenants, 22–23load, 187offering, 130private offering, 132Debt to equity ratio, 22–23Demographics, monitoring, 15
243
IndexDempster Mill ManufacturingCompany, 37Dempster Mining, 9Buffett, purchase attempt, 4–5Depreciation, 47Disasters/recoveries, 204–215Disney, 72, 238core value play, 10Distressed debt, 6opportunities, 5Diversification, 17, 34. See alsoPortfolios; Riskimpact. See D. A. Sanbornneed, reduction, 35Diversified Retailing, 163Dividendsdiscount model, 42kicker, 139reduction, 36Document storage, importance,67Dodd, David, 15, 19philosophy. See Graham-Doddtext, 3Dot-com era, tradingopportunities/excesses,45, 162DoubleClick, 173–174Dover Corporationbook value, 53holdings, 51–53Dow Jones Industrial Average(DJIA), return, 236–237Dow Jones Railroad Index, 239Downside risk, 101Draper Fisher Jurvetson (VCfund), 164–165Drexel Burnham, 147, 166Due diligence, 64. See alsoBuffettrisk, 83DuPont shares, 122EEarnings, 3growth, 81predictability, 48stability, 23targets, 107yield, 198–200Earnings-to-price (E/P) ratio, 48Eifuku (hedge fund), 11, 124,126Energy companies, investments,232Englander, Izzy, 165Enron scandal/collapse, 46, 139,214Enterprise Fund, 162Equities, selloff, 143Equities, usage, 41Esperion Therapeutics, Pfizeracquisition, 106
Exchange traded funds (ETFs),86–87. See also IndexETFsExtreme advances/declines, 220FFaber, Marc, 239Federal Reserve (Fed) model,191, 198–202Fich, Eliezer, 96Financial risk, 126Financingcost, 44glitches, 87obtaining, 91First Aviation Services, Inc.(FAVS), 24, 28First Data Corporation (FDC)holdings, 60–61purchase. See Concord EFS;Concordesettlement. See U.S.Department of JusticeFirst Industrial Realty, 180–181,185Fisher, Philip, 15–16, 35, 149Fisher/Munger route, 149Fitch, 71Five Star Quality Care shares, 153Fixed asset base, 49Fixed-income arbitrage, 5, 12,81, 223strategy, risks, 224–225types, 224Fixed-income instrument, 39,223Flynn, Sean Masaki, 161Focused portfolio approach,16–17Foreign exchange risk, 224Frist, Tom, 66Front Line, 186Fund of Letters, shares(Buffett/Mungerpurchase), 162–164Fundamental risk, 126Future cash flows, predictability,47GGannett Co. Inc. (GCI)holdings, 62ownership, 62GAP Inc. (GPS)holdings, 63–64record revenues, 63ROE, 64Gasbarro, Dominic, 161Gates, Bill, 169charitable foundation, investments, 230diversification, 231personal money, 230
trading style, 229Gates Foundation, 230GE/Honeywell merger, antitrustprevention, 83Geico, 49, 64, 189–190, 195Buffett visit, 236investment, 189–190Gen Re Securities, 221General Baking Companybonds, 20General Dynamics, tender offer,93General Motors, 37, 122, 239Gilette Co., holdings, 57, 64, 185analysis, 133–134Buffett purchase, 3Gilette Co., value play, 7Glenayre (GEMS), 24, 31Global Crossing, 67Goizueta, Roberto, 57Goldman Sachs, 130Goodwill, amortization, 47Government spread trades,corporate spread trades(contrast), 224Graham, Benjamin, 15, 19, 81,121, 169net-net working capitalstrategy, 174–175rule, 21text, 3Graham-Doddadvocates, 16analysis. See Stocksinvestments, 149philosophy/principles, 19, 155plays, 189Graham-Newman, 122Grasso, Dick, 203Great Depression, 19–20Griffin, John, 234Gross National Product (GNP),gain, 197Gruss, Martin, 103Guerin, Rick, 163Guggenheim ExplorationCompany, relative valuearbitrage, 121Gutfreund, John, 135HHagstrom, Robert, 7, 17, 57, 62,134–135HCA Inc.accounting scandal, 66holdings, 64–66Heartland, 23Hedge funds, 100. See alsoCredit Suisse-FirstBostoneconomics, 7index, 100Hedging methods, 86
244
INDEX
High yield, 129Hostile takeover, 83, 85H&R Block (HRB)holdings, 56–57stock, changes, 57HRPT Properties Trust, personal holdings, 152–153Hunt Brothers, 10
Kilpatrick, Andy, 62Kohlberg Kravis Roberts & Co.(KKR), 38, 91–92,146–148deal, problems, 92involvement, 87–93, 159Kuwait, Iraq invasion (disaster),211–212
IIndex ETFs, 86–87Industry sectors, investments,231–232Informationarbitrage, 122gap, closing, 47Initial Public Offering (IPO),134, 160Inside information, 80Insider buying, 23Institutional ownership, 23Interest rate risk, 83, 224Internal Revenue Service (IRS),tax ruling, 94Internetadvantage, 10bubble, 45disadvantage, 9exploration, 138speculators, 45Investments, 42–43back door strategy, 140bargains, 20case studies, 62corollary, 42operation, 35portfolio, 37return, 41selection, 177–178styles, 11–14Investors, naïveté, 9IPP industry, 23Iran, hostage crisis (disaster),210–211Iraq War, aftermath, 34Iron Mountain Inc. (IRM)holding, 67–68shares purchase/sale, 67
LLarson, Michael, 232, 234Laser mortgage, personalholdings, 150–151Legal problems, 94Level Three Communications(LVLT)analysis, 137–139distressed debt, purchase, 139Lewis, Michael, 135Liberty Media, 101Life insurance policy, 221Life-settlement business,221–222Lipsey, Stan, 70Litigation risk, 46Living Benefits FinancialServices, 221London Stock Exchange, 82Long-short strategy, 103Long-Term Capital Management(LTCM), 12, 126, 223–225Royal Dutch Shell, interaction, 124–125Lowenstein, Roger, 135, 169lottery ticket, 136
JJDN Realty, personal holdings,151Jones, Paul Tudor, 52J.P. Morgan, 108–109trading, 110Junk bonds/securitiesanalysis, 143appeal, 145KKacperczyk, Marcin, 17Kennedy, John F. (assassination), 208–209
MMalekan, Omid, 204Malone, John, 101Managementenlightenment, 172fee, 6finding, 38impact. See Businessincentive. See Shareholdersrisk, 34strength, 15Management-led buyouts(MBOs), 22Manhattan Fund, 162MapQuest, 22, 35Marciukaityte, Dalia, 130Margin of safety. See SafetymarginMarket. See Mr. Marketbubble, 191calls, example, 193–202caps, 22, 23, 115fighting, 216price, 20pricing, 171–172returns. See Buffettrisk, 46
timing, 191valuation, 34Marketplace, volatility, 112–113McDonald’s, 238core value play, 10shares, reaction, 47McGraw-Hill, 70Mean reversion, 12, 216Merger arbitrage, 6, 11, 81, 103definition, 82–94funds, 87money, making (possibility),118–119opportunities, 5results, Buffett studies, 96,100success, 94–100uncorrelated opportunities, 86Merger risks, 83Mergers and acquisitions(M&A), 134MeVC shares, purchase, 164–165MGI Properties, personalholdings, 154Michaelis, George, 163Microsoft, 164investments, 230ROE, 184takeover. See VCNTMid-American Pipeline, 140Mikkelson, Wayne, 130Milken, Michael, 146–147, 166Millennium Capital, 165Mitchell, Mark, 94, 125–126Mockler, Colman, 133Moneyavailability, 9borrowing, 143movement, 42raising, 143return, 41tie-up, 87Moody’s Corporation (MCO)holdings, 70–71Morgan Stanley, 102, 130, 235MotherNature, 21Motley Fool, The, 167–170Mr. Market, 12, 34, 46M&T Bank Corporation(MTB)due diligence, 70holdings, 68–70stock investment, 70Munger, Charles, 38, 57, 64, 149,196Pabrai, relationship, 180Municial spread trades, treasuryspread trades (contrast),224Mutual funds, 100data, 17restriction, 114track records, 23
245
Index
NNASDAQ 100, 218National Furniture Mart, 1Nebraska Furniture Mart, 7, 9Negative enterprise value, 21Net Asset Value (NAV), 154,159. See also Closed-endfund arbitragediscount, 162funds, trading characteristics,162Net income per share, 47Net-net working capital stock,purchase, 176Netratings (NTRT), 24, 30New America Fund, level, 164New York Stock Exchange(NYSE), 82, 124, 188Nextel, Buff