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- [00:03]
Podcast Host
You're listening to A Book with Legs, a podcast presented by Smead Capital Management. At Smead Capital Management, we advise investors who fear stock market failure. You can learn more@smeadcap.com or by calling your financial advisor.
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Cole Smead
Welcome to A Book of the Legs podcast. I'm Cole Smead, CEO and Portfolio Manager here at Smead Capital Management. At our firm, we are readers and we believe in the power of books to help shape the informed investors. In this podcast we speak to great authors about their writings. The late, great Charlie Munger prescribed using multiple mental models and analysis. We analyze their work through the lens of business markets and people. Joining me to host this episode is our chairman and Chief Investment Officer, my dad, Bill Smead. Thanks for being here, dad.
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Bill Smead
Great to be here. Love this topic.
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Cole Smead
Yeah, we're going to have some fun. What was it like to meet the 25 year old Warren Buffett or the fairly wealthy 35 year old Berkshire Hathaway chairman? While we can't time travel, we can meet this investor through the work of our guest. Today, Brett Gardner is joining us to discuss his newly released book, Buffett's Early A New Investigation into the Decades When Warren Buffett Earned His Best returns. A little background on Brett. Brett is an investment analyst at Disareen Group and has worked at multiple investment firms in his career. He is a CFA charter holder and is a St. John's University Red Storm. More importantly, Brett bought his first stock at 16. So Brett, thanks for joining us today.
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Brett Gardner
Thanks for having me.
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Cole Smead
So to start out, I mean, this is great research. I love this. You know, if I was going to throw out a thing I've always had trouble trying to figure out is how many partnerships Buffett had. He like he had the MD Partnership and all the. You mentioned the Buffett Associates in your book. You know, so I love kind of going down the rabbit hole of investment structuring and some of that kind of stuff he got involved in. What inspired you to put all this out on paper and do all this research?
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Brett Gardner
About a decade ago I was rereading Snowball, which is Al Schroeder's biography. It's now my second favorite Buffett book. For the record, Schroeder would talk about these super cheap stocks that seems so obvious. The stock they're trading at 1 times earnings below net cash. And I was having difficulty finding the same security as myself.
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Cole Smead
Sure.
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Brett Gardner
And I kind of started going to the library and researching the companies that Buffett invested in, reading the old annual reports. And I started to realize that it was Much harder than I initially thought. And I think there's kind of this narrative out there that Buffett was kind of just like, sitting on his ass reading Moody's manuals and finding these insane bargains. And the more work I did, the more I realized that narrative was false. It kind of does kind of discredits the amount of work he did and tenacious research and creative ways he created, ways he created value for his partners. And then there were two companies in particular that I came across that made me actually want to write the book, which was Philadelphia and Reading, which is an anthracite coal company. It was Buffett's biggest personal position in 1954, and his mentor, Ben Graham, was on the board. In my opinion, Philadelphia and Reading was the early inspiration for Berkshire Hathaway itself.
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Cole Smead
Sure.
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Brett Gardner
And I don't think anybody quite connected the dots the way I think I did. And the second company was Walt Disney Productions, which Buffett has actually talked about multiple times. But there was this huge corporate governance risk associated with. With Disney that Buffett had to know about because it was on the front page of business periodicals at the time.
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Cole Smead
Sure.
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Brett Gardner
And had to get comfortable with in order to invest in the company. And so the story was so interesting that it made me want to actually write the book.
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Cole Smead
Yeah, I agree. And like we were talking about before, you know, there's some books that talk about obviously the Disney saga and everything that came through the history of Disney sources. How were you sourcing this? How much of it was, you know, stuff you could find directly, whether it be in Moody's or whether it be was any of this source through conversation with people you had around these businesses who obviously are still alive. You know, trying to understand kind of like the folklore of this versus the actual sourcing of some of this work.
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Brett Gardner
Sure. So the initial. The initial research was done at the New York Public Library. They had a lot of old annual reports on microcard and Microfiche.
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Cole Smead
Okay.
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Brett Gardner
And they also have this great database called Mergent Archives that has a lot of them on PDF, which made it easier to download and review later. Then the more I pushed, the more I realized there were kind of other documents out there. Some of this came about because I would start reading books on the industries and companies I covered, where I'd see in the footnotes. There would be certain bankruptcy documents or SEC filings that were referenced that would be useful in my research. And then I also came across theses papers, found that university libraries that I rather went and got myself or paid somebody to scan. I would say, the unfortunate fact is that a lot of these people who were big players when Buffett was investing in this period passed. So I didn't necessarily talk to that many people. I talked to more academics and people who might be familiar with the companies today who would point me in the direction of other documents. I also filed some Freedom of Information act requests to get some of the filings, but it was generally at the library and then at university libraries. That's how my documents.
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Bill Smead
Just on that point, you, in effect, did the kind of work that Buffett did when he was looking for these things in the first place. It's not like you sat down at the computer and asked Google to give you this information.
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Brett Gardner
So that's a very generous interpretation, I'd say. First, I did read the actual annual reports he read, and I read the Moody's manuals, which are very thick, because the New York Public Library had those as well. But Buffett also did a lot of scuttlebutt research where he would drive around Ohio finding people to speak with about the Greif Brothers Corporation.
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Cole Smead
And that was a Phil Fisher idea, right? Phil Fisher would use the scuttlebutt method, too.
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Brett Gardner
Yeah, completely. Buffett has actually given a lot of credit to Fisher, which I think is partially justified. But Buffett was doing this himself way before Fisher started writing. So Buffett kind of had this, like, instinct that he needed to go around and learn about these businesses himself rather than kind of just read documents, which is very much in contrast to Graham. I think Fisher's awesome, and his book is excellent, or his books are excellent. But I think Buffett was inspired to do this himself rather than finding in.
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Bill Smead
Fisher's book, you got to sit down with Charlie Munger. What was that like?
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Brett Gardner
So it was incredible. I was very lucky. I just want to be clear. Charlie met me as a favor rather than an interview. So there was no endorsement on my work or book or anything like that. But we talked about a couple of the investments that still a great favorite.
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Cole Smead
Who are you kidding?
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Brett Gardner
Oh, yeah. So I was in. So Peter Coffin invited me out to California and took me to Charlie's house to have lunch with him. And it was incredible. He was way funnier than I expected and also way nicer. He made me feel, like, very welcomed. I was a little nervous because you see him at the annual meetings, and he would say these short remarks, and he was very gracious, very nice, very funny. And, you know, I think you could tell I was nervous meeting him.
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Cole Smead
Sure.
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Brett Gardner
Because him and him and Buffett are like, the two heroes in my mind.
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Cole Smead
Yeah.
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Brett Gardner
And he put me at ease and told a lot of funny jokes and stories, and he also maintained an incredible memory. So I met him two months prior to his passing, and he remembered facts down to, like, the dollar.
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Cole Smead
That's awesome. Yeah, because Peter Kaufman obviously wrote Poor Charlie's Almanac.
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Brett Gardner
Yes.
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Cole Smead
Yeah, yeah.
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Bill Smead
Okay, so. So was Buffett's success foreknown?
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Brett Gardner
That's an interesting question.
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Cole Smead
Well, because we ask it. Because, like, in your book, I think you do a really good job of talking about, like, Buffett as he meets people. And there's, like, it. It wasn't like people walked through and said, oh, my gosh, the smartest guy in the world. We got to give all our money. Tim, that happened, like, in a snowball way. Right. It didn't happen overnight. It happened eventually. Is that fair?
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Brett Gardner
Yeah, 100%. I think that there. I mean, one of my favorite stories is in the Marshall Wells chapter where he meets Lewis Green, who was a friend of Ben Graham's. And Green was, like, super dismissive of him because he asked him why he bought Marshall Wells. And Buffett says, because Ben Graham bought it. And, you know, years later, when Buffett was trying to start his partnership, Green is at the Graham Newman's, the Graham Newman dissolution meeting, and criticizes Graham for not mentoring anybody. And he says, all they got is this Warren Buffett guy and who's going to ride with him? So Buffett was not necessarily an impressive figure at 2021 to everybody. He did get an A plus in Graham's class. He was writing profitable ideas up in various trade magazines. But it. It wasn't like he, like, came down from the heavens blessed with this bill to allocate capital.
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Cole Smead
Sure, yeah, yeah, yeah. Because I think people forget. I mean, to your point, I love that story when it's like, why is this kid here? He's, you know, he's not impressive to me. And it's like, we look now and you think, look, who are you? But at the time, again, it was, the future is not known.
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Bill Smead
Well, but the early partnerships, the way most of the books describe it.
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Cole Smead
Well, but that was before the partnerships.
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Bill Smead
Well, I understand, but early on, he'd go to these cocktail parties in Omaha, and he'd get, like, three or four doctors in a corner and just wanted to tell them all about all the cool things that he was seeing, and they could see the wisdom and passion for such a young man. And that's where the original capital came from, was through passion and through Well.
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Cole Smead
I mean, he wrote it as much in the trade trade articles that you mentioned. And that would be like someone out there posting on Seeking Alpha or something like that today. Right. Trying to find any visibility they could.
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Brett Gardner
Yeah, 100%. And I think that one of the things that Buffett did really well is he had friends and family vouch for him. So. So family members were some of his first investors. And then he also impressed enough people while he was at Graham Newman to get some recommendations. One of the stories I tweeted about the other day was this money manager, Arthur Weisenberger, who called Dr. Ed Davis up and was like, you need to invest with Buffett. And Ed Davis set motion the meeting with Charlie. Then once Buffett has initial capital, his returns told the story itself. But then he also used his network to attract more capital. Sandy Gottesman was in New York, Henry Brandt was in New York and talked up Buffett.
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Cole Smead
It doesn't hurt to be from the D.C. area as a kid with your father sitting in Congress.
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Brett Gardner
Right.
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Bill Smead
I mean, and his dad was a broker.
- [11:50]
Brett Gardner
Yes. So Buffett worked at his father's brokerage for a couple of years before Ben Graham hired him at Graham Newman. I go back and forth on how much that actually helped because Howard Buffett was actually not a universally beloved congressman.
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Cole Smead
Sure.
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Brett Gardner
He got voted out a couple terms. He was anti Roosevelt. So that may have actually hurt Buffett in a way.
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Cole Smead
I don't know why we by conversation for the day, we've also debated, if Buffett hadn't bought the Washington Post, would we know who Warren Buffett is? Because again, it's like Jeff Bezos owns the WaPo. His op ed this week was pretty dang interesting, you know, the last week. So another conversation. I want to pivot using Cleveland worsted mills. Again, I'm trying to think about, like, what do you learn as a young investor? This is a young investment for him. How can government spending affect the view of a business and use, you know, obviously the mills business as an example of that.
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Brett Gardner
Sure. So the, the government. So the government was buying a lot of worsted mills, which was jacking up the price of the product. And, you know, kind of gave these, these companies that were really not good businesses short term boost in profits and returns on invested capital, so made them look to be much better businesses than they were.
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Bill Smead
Sounds like now.
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Brett Gardner
Yeah, I think there definitely is an analogy to the COVID times where you had shortages leading to inflation and some companies get these fat margins that investors project out into the future, which doesn't really happen. Cleveland Worcester Mills is one example, Marshall Wells is another. Where during World War II and the Korean War, there were these shortages all over and basically you could just jack a price and earn these fat margins. And the thing that I actually found surprising was how quickly that went away. Like, I thought that maybe it would be like three or four years and usually like it was a year or two where returns, invested capital would just go back to normal.
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Cole Smead
Sure, that makes sense. You talk about the idea of a cigar butt, which is something that Buffett and Munger have talked about over the years, using worsted mills as a cigar butt example. Can you explain what is the definition of a cigar? But then also what kind of distributions was he getting off as an investor from this business that was ultimately liquidating?
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Brett Gardner
Sure. So the cigar book concept is that you're buying a mediocre business at a very cheap price where it has like one last puff where it's trading below asset value, the business is struggling, and eventually it's going to have a good year or a good quarter and stock will go up and you sell out. Now, with Cleveland Wilson Mills after World War II, they basically went on this plant modernization spending spree, so invested a ton of capex. Just as the industry was kind of like going back to normal and actually deteriorating because of foreign competition. Buffett bought it because it was trading at net current asset value and paying a fat dividend. Fortunately, what happened is the company cut its dividend. Buffett went to the annual meeting, it was all upset. I think he actually sold a loss. He lost money on it because of the dividend cut, whether the stock price declining. I think what's interesting with Cleveland Works and Mills is twofold. One is it was not a winner for Buffett or not a big winner for Buffett, but it was a big winner for shareholders who held on.
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Bill Smead
How did that get him involved in Berkshire Hathaway? How did Cleveland worsted Mills cause him to get involved in Berkshire Hathaway?
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Brett Gardner
I don't know. The lessons from Cleveland Worcester Mills were direct. But I think that what Buffett learned from something like that was the importance of controlling capital allocation. In the first half of the book, there are five case studies on companies, all of which were net nets, which meant that they were trading below net current asset value, which was a proxy for liquidation value. The first three in the book don't actually do that. Well, rather for Buffett or sometimes for investors as a whole, they didn't do terribly, but Buffett did compounded capital at 30% in his partnership years and had a one year pre partnership where he put up 144% year. I think Buffett saw these net nets not do well. One, because the businesses were not good, but two, because of capital allocation decisions. In the case of Cleveland Wilson Mills, management chose to cut the dividend and then management chose to liquidate. And liquidating was a smart move. It allowed shareholders to earn good return, get their money back. But I think Buffett was really pissed off about the dividend cut and he was probably emotional about it. And when he saw that happen, and in my view later on with Philadelphia and Reading, he saw the benefits of controlling capital allocation. Not just being an activist investor and pushing for things, but actually dictating corporate policy.
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Cole Smead
Now, did the chairman of Berkshire Hathaway, didn't he have involvement with, with worsted mills? And that didn't that kind of eventually connect him up at a later date to Berkshire?
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Brett Gardner
So it was actually Union Street Railway, the streetcar company where Seabury Stanton, who was Berkshire's president, was on the board. The reason why he was on the board is because Union Street Railways cars would drop textile workers off at the COVID street mill.
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Cole Smead
That's right, yeah.
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Bill Smead
Yeah. Let's move on to Philadelphia and Reading. The government didn't allow the railroad stone coal business. How's the government interest, Google interest in Google interest in Google today any different?
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Cole Smead
The idea was if you have the railroads controlling the coal, they control too much of the system. And it's like that was an idea in American society at one point and now we look and say, who cares? And the question is, is it really an interest even today? Maybe.
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Brett Gardner
Yeah, I think it's a good point. I mean, one of the things that I was struck at, which was not a focus on my book, was how often the government would intervene in these companies after the fact. Meaning, like by the time they intervened in the railroads, the anthracite railroads, the industry was already in decline. Like.
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Cole Smead
Yeah.
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Brett Gardner
And the time. And when they intervened in the movie studios in the late 40s, that industry was also in decline because it was about to decline because of tv. So government was always kind of like a day late in dollar short in my view. But I do think that they were generally more interventionalist. For example, with Philadelphia and Reading. Teddy Roosevelt intervened in the coal strike to try to get them back working. Sure. I think was the first time a president ever invited like labor and management together to get something done.
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Cole Smead
Hi, I'm Cole Smead, CEO and portfolio manager here at Smead Capital Management and.
- [19:25]
Host of this podcast.
- [19:27]
If you enjoy this podcast, I'd like to invite you to check out smeadcap.com at our firm. We are stock market investors. We advise investors who fear stock market failure with a discipline that has proven success over long periods of time. Learn more about our funds@smeadcap.com past performance is not indicative of future results. Investing involves risks, including loss of principal. Please refer to the prospectus for important information about the investment company, including objectives, risks, charges and expenses. Read and consider it carefully before investing. SMEAD funds distributed by UMB Distribution Services llc.
- [20:02]
Not affiliated so then obviously the railroad business, Philadelphia and Reading, they get involved in Union Underwear, which if I was correctly looking at this, they were the distributor of Fruit of the Loom. They didn't own the brand, but they distributed the brand. So can you kind of teach our listeners about that transaction that they did? Because again, you're back to capital allocation, as you're just mentioning just a second ago, for this low return business, they're actually getting into a higher return business, assumably. But then also you have a little story where Buffett laments over this bizarre debt structure that he wished was still around. Those were the good old days. Can you teach us about the bizarre debt structure that was involved too?
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Brett Gardner
Sure. Philadelphia writing was Warren Buffett's biggest position at the end of 1954. He had initially bought the stock a couple of years earlier, in 1954. He was working at Graham Newman and Graham was on the board and they were having conversations about taking control of the companies essentially. And Mickey Neumann, who was Ben Graham's partner son, kind of took control of the situation. He would eventually become president, but when they acquired Union Underwear, he was not the president. Sure. So Mickey Neumann had known Jack Goldfarb, who owns Union Underwear, for a few years. They had a couple conversations. Goldfarb was looking to sell his company for estate planning and he went to Wall street, tried to sell the company. He got some pushback, but he got some offers that were a few million dollars higher than what Philadelphia and Rennie would eventually pay. The reason for this was because he liked Mickey. You know, Buffett would obviously use that later on, using his likeability to find good deals. Now they paid about $15 million for union underwear and the company had some excess cash. So some of the cash in the bank accounts was actually used to fund the purchase.
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Cole Smead
So it was two and a half million dollars I think is what you said. Yep.
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Brett Gardner
And then they used non interest bearing debt to fund a majority of the rest of the purchase and the way this worked was interesting where it was equivalent to a cash flow sweep, except just on the income statement. Earnings above a certain amount would get swept to pay off the debt. And this de risk the situation, it was, you know, cheap company and you know, they bought it at a cheap price which they were able to obtain. The price one because of, because Vicky Newman was likable and persuaded Goldfarb to sell. But second, because they had this huge huge nol at the time, tax rates were about 50% and failover running wouldn't have to pay taxes on the earnings. So it made it that much cheaper for them. But the way they funded the transaction using this non interest bearing debt really made it a home run.
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Cole Smead
So at that time though, the tax rates in 1950, I was looking back at this earlier today, the tax rate on income of 40 to $44,000 was 51%. So I think another thing that didn't show up in your book, but I'd love to kind of hear your thoughts on, is, and we talk about this all the time, government is in the dividend business from a capital allocation perspective, right? They take a cut of our dividends, you know, almost roughly about a quarter of our dividends as US citizen. 30% if you're a non US on US income. Doesn't that weigh on the mind of someone like Buffett? Because I know we think a lot about capital allocation and how our taxes affect our marginal shift of capital. Is that fair?
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Brett Gardner
Yeah, 100%. I think Buffett has always been probably, maybe more tax sensitive than is commonly known. I mean the most example.
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Bill Smead
I'm glad somebody else notices that we were at a state thing or a talk about Rotary. Talk about a state, Texas by Bill Gates Sr. And he was using Warren Buffett as an example. And I got up and I said, Look, Mr. Gates, I have a lot of respect for Bill Gates. Dad, great guy, good man, good man. And I said, hey, wait a second. I said, Warren has got himself set up to virtually never pay any taxes on anything outside of corporate income tax. He doesn't pay a dividend in his stock. He never sells any stock. Only the operating businesses in Berkshire Hathaway pay taxes. That's it. That's the only way they touch him. He pays himself nothing. So don't use him as an example. He's a terrible example because the guy has basically grifted the United States government the whole time.
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Cole Smead
To your point, when you're collecting these partnership K1s pass through, you're still having to pay if you get the distribution. If it's a return of capital, great. You get no taxes on that because they're returning back principal. But anything over your basis is going to be considered ultimately a distribution. And thus you're going to get taxed on the gain or the income. And so you're going to have to deal with your tax bracket. So I was trying to actually take your book and say, okay, here's what Buffett made on the partnerships. But what did he make after taxes? What I was trying to calculate in the process.
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Bill Smead
Well, he paid himself in ownership of the partnership, correct?
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Cole Smead
Correct. But that would go in as a gain, assumably. But still you'd have to pay taxes on the gain when it was realized because of liquidation.
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Brett Gardner
Yeah, that's a good. That's a good point. I did look for this, but I couldn't find it as. Find as much information on it.
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Cole Smead
Sure.
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Brett Gardner
Because one of the things I was kind of curious about is that when he closed the partnership, how the taxes were treated when he distributed shares to partners, which would include himself. So when the partnership dissolved, he distributed Berkshire shares to his partners and himself. And I don't know the tax treatment on that when.
- [26:03]
Cole Smead
Real quick. So Mickey Neumann probably is slickest thing. And this is like a total financier move you talked about. They had their coal subsidiary. Okay. And so what they did is they booked intercompany debt. So that way when they took the capital out of the subsidiary, it would get booked as a return of capital in lieu of income passed up to the parent. Is that a fair way of assessing Mickey's unique tax trick? If you. If that's a good term to use.
- [26:29]
Brett Gardner
Yeah, 100%. I think that would. And let them pay almost $2 in dividends that year, tax free. And I tried to hunt down the actual law to make sure I understood it, but I couldn't really find it. But they talked about the annual reports or articles about it, so it's pretty clear it happened. I don't know if Mickey Neuman was the tax genius himself. There was somebody working with Mickey who. Who worked as a CPA for Graham Newman, who I suspect came up with the strategy. But it was brilliant.
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Bill Smead
20 bagged a $10 investment. Looking at that investment, was the capital allocation the primary determinant of the shareholder return?
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Brett Gardner
Yeah, 100%. I think it's really interesting. Where he bought initially, $17 went down to $9, which was roughly the net current asset value per share. He thought that there were some off balance sheet items. But the reason why with 20 bag was because of capital allocation. The coal business was an afterthought. What they did well was sell off the inventory, do some high finance tricks to. But it was generally the capital allocation that did it.
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Cole Smead
Sheltering income from the underwear business with Nols from the obviously bad old business, for lack of a better term.
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Bill Smead
Did Philadelphia and Reading end up being a picture of how Berkshire Hathaway was going to operate as a conglomerate?
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Brett Gardner
I 100% think that. To me, photography and Redding is Buffett's blueprint for Berkshire. Not only did he idolize Graham, he made his biggest position. He dipped back in the partnership in the 60s. He was friends with Mickey Newman and Ben Graham throughout his life. I think he took those lessons. And this is speculative, obviously, but I think when he's 24 years old and seeing this, he was like, I'm going to one day do this or something similar. He didn't know Berkshire was going to be the vehicle, but I think that was his blueprint.
- [28:46]
Bill Smead
When Cole came to start in this business, he spent a lot of time trying to find a small insurance company that we could buy so that he could do in this small insurance company. Some of the things that Buffett. I think Enum, by the way, to.
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Cole Smead
Buffett's point, there's a lot of bad people in the insurance business, just like there is in banking. That's why it stays so fashionable over time. Let's see. Can you talk about. So, you know, you mentioned the Buffett Associates partnership, which is one of the partnerships you talk about. He lays out. There's three type of investments that he had in that partnership. Can you teach our audience what the three types were?
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Brett Gardner
Sure. So there were workouts, controls and generals who would later break out the generals into two other categories. One was relatively, relatively undervalued, and one was on a private owner basis. So workouts were what are today known as special situations or arbitrage opportunities, liquidations, stuff like that. The amount he allocated to the workouts fluctuated on what was available in the market. Sometimes it was as low as 10 or 15%. Sometimes it was up to almost a third of the portfolio. I only wrote about one of them, British Columbia Power, but they were an important source for Buffett to generate income in down markets.
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Cole Smead
Sure.
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Brett Gardner
And then second category was controls, which were situations where he owned enough stock to dictate corporate policy. And there are a couple I don't write about, like San Moore, Mapp, Dempster Mills, and then Berkshire Hathaway would obviously be the obvious example. These Were, you know, like I said, his companies that he controlled, usually these were net nets that had excess cash or excess inventory that he took control of and did something with. In some cases, he took the securities or cash and sent them back to shareholders. Other times he would, like, invest within. Within. Within that company. And he made these controls frequently. Big swings. Sandborn maps was like 25, 35% of the portfolio. Dempster Mills was the same. And then the last group was Generals, which was basically just anything that was cheap. The Generals could become controls if they got cheap enough or Buffett could accumulate enough shares, but they were just generally cheap securities.
- [31:18]
Cole Smead
Gotcha.
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Brett Gardner
I think that from a portfolio management perspective, the controls and workouts were really important in driving returns because they were not entirely, but sort of market agnostic, where Workouts was always dependent on a corporate event, rather like the liquidation payment coming back from the company to help you realize returns. Or in a situational controls, he would mark them on his books at. At like, net current asset value or book value, not necessarily the market price. And also because there was, like, corporate action happening, it usually meant the stock was going up regardless of what was going on. Sure.
- [32:03]
Cole Smead
And this is back in the day when you just put it on your books whatever you wanted to, and the investors had to deal with it, too. So a little bit of different, you know, operating or regulatory environment. I think you got into a really interesting niche conversation that I don't think most people even pick up on. So I want to say I really appreciate. Why was Munger so open to talk about his investments and Buffett not? And I asked that question. Do you think this is why Berkshire talks less about what they do today? While obviously Charlie's not here, and obviously he was much older in the recent 10 years compared to the past. Because I think of, like, the. My. My favorite chance. Like, I'd rather not go to the Berkshire meeting. I'm going to listen to it, but I'd rather not go. I want to just listen to the Daily Journal meeting because it's like raw, uncut, uncensored. Charlie giving you his bare soul. And that's not what you get in the Berkshire meeting today.
- [32:57]
Brett Gardner
Yeah, I mean, I think it's a good point. I think that some of that's personality driven, where Munger is just blunt and to the point. I think it's just him. While Buffett. Buffett is a. I don't think Buffett ever really lies in public, but he says what he wants, meaning he'll tell you what he thinks, but he Won't give you the other side of the coin.
- [33:23]
Cole Smead
Yes. Sin of omission. He's not lying to you, but he's not telling you the full truth.
- [33:27]
Bill Smead
No. He doesn't want to die with a lot of enemies.
- [33:31]
Brett Gardner
Yeah. And I think that the Disney chapter is a great example of this, where he's talked about how great Walt is all the time, but then left out that Walt was sort of siphoning value from the company to himself. So I think, like, Buffett's like, a very literal speaker, and I think Munger's just built a little bit differently. And I also think the reason why Munger talked about a lot of investments in his early days was just trying to get to Curry Buffett's favor because he knew that Warren was, like, not a normal person. Sure.
- [34:02]
Cole Smead
He was wicked smart.
- [34:04]
Brett Gardner
Yeah, exactly.
- [34:07]
Bill Smead
Let's pivot to Amex, which is really fun. What was the original fraud that DeAngelis was pulling? And how did Amex get tangled up in it? At the beginning, sure.
- [34:21]
Brett Gardner
The Salad oil scandal was pretty complicated, but basically just boils down to the fact that D'Angelo was holding inventory that was supposed to be filled. He had these big tanks in New Jersey that supposed to be filled with oil, and they were filled with water instead. That was essentially it. And he had all these interesting ways of getting around, like the inspections where he would fill up part of the container where they would drop the measurement device in, and they see it's all. It's all oil when it was like, 98% water. And, you know, then he would, like, make it worse by gambling on futures in the market. And, you know, he would just, like, double down on his bet. And eventually the price went down. People discovered the inventory wasn't there. And the way that Amex got. Oh, sorry.
- [35:19]
Bill Smead
And Amex was warehousing. So that's how they were connected.
- [35:23]
Brett Gardner
Amex was warehousing and they were insuring the proceeds. So, like, Tino didn't really have. Tino had a very shady background before becoming an Amex client. And he needed somebody to kind of sign off on him and provide insurance and credit for the. For the banks that were lending against the inventories.
- [35:48]
Cole Smead
And you liken this to, like, an MBA style business where they're getting paid an insurance premium to insure these quote unquote assets.
- [35:57]
Brett Gardner
Right, exactly. They were just kind of clipping these coupons. In theory, it should be like an easy business with, like, no risk. And, you know, Amex had, like, good standing with the banks because they're selling Them the traveler's checks. And in theory it should just be like a coupon clipping business. That's not really how it turned out. They never actually really made any money in this.
- [36:18]
Cole Smead
Sure. And you talk about, you know, as Munger has talked about, incentives are just crazy. And so, you know, the incentives around the people with this business. I think you pointed out that as they're investigating this, they're finding out that people at Amex were co investing with DeAngelis in his business. So it's like they had a reason to hide the fraud. To a certain extent.
- [36:43]
Brett Gardner
Yeah. I mean, it was really insane in my view. It was like twofold. One, these people were invested. Two, if there was no field warehousing business, they would all be fired and had a job. So they were laser focused on protecting him. Also, Tino was like kind of a, kind of a likable guy. Like he was a little, you know, he was a con man, but he had like glyco.
- [37:05]
Cole Smead
Like a gladiator.
- [37:06]
Brett Gardner
Yeah, yeah. Like he knew how to. He was people pleaser. He was like the short fat guy who, you know, was charismatic. And so he had all these things working for him. And the Amex people, like, I mean, they were foolish, but to your point, the incentives were for them to be foolish.
- [37:29]
Bill Smead
So how important was the issue of trust to the Salad Oil scandal?
- [37:33]
Brett Gardner
It was critical because MX had at this point had spent over 100 years building its brand name in a way where they originally started with the express business, which was transporting cash and goods from one destination to another. Then they did the money order business and then the travelers checks. And traveler checks depended on the fact that Amex was there and they were going to cash the checks. And the travel checks were purchased at banks. The banks were critical for American Express's continued success. If there was any decline in trust, people would stop purchasing them, the banks would stop selling them.
- [38:22]
Bill Smead
Sure, we would get those before we take our family driving vacations. When I was a kid. Yeah, in the 60s.
- [38:29]
Cole Smead
So then, so then you kind of touched this. By the way, one of my favorite TV shows that I was really glad you mentioned in the book is like Mad Men. Such a great movie. I think when I think of Mad Men, I think of BUFFETT in the 60s, like, you know, ferreting out stocks in New York and that kind of stuff. So I appreciate that. But so obviously, you know, this idea of a dining card, a dining charge card takes off and so like the diner's card shows up. Amex looks and says like, oh, we should buy this. They're not successful, so they just go into the business directly. How did that business operate and how slow was that to kind of get off the ground? Because on one hand you have this traveler check business. It's like, you know, quote unquote, today we're like, oh, we have this large installed user base. But it wasn't that smooth, was it?
- [39:12]
Brett Gardner
No, it really wasn't because. Because people would purchase a travel checks and just kind of sit on them for sometimes months, sometimes years. Well, the charge card was a little bit different. So American Express didn't offer like what's conventionally known as a credit card until later on. So they had a charge card where people go to a restaurant, put down the card and American Express would pay the restaurant and they would true up with the customer. Initially it was like three months and then eventually one month. This wasn't really considered an extension of credit, even though it was. Sure, if that makes sense. Sure. And then Amex would like take a cut of the fee. The idea was that we take a cut of the fee of the restaurant bill, for example. And the idea was that this would lead to more transaction at the restaurants. And the restaurants were happy because cardholders were spending more money than the average person. And also Amex charged people for having the card. Now one of the things that made American Express entry into the business much easier than it would have been otherwise is the fact that he had this travel trucks business. So people knew the American Express brand name. This led American Express to charge more for the card from Consumers vs Diners Club. And then it also meant demand for the card was through the roof.
- [40:36]
Bill Smead
How did the holidays increase the moat of Amex?
- [40:39]
Cole Smead
I thought that was an interesting point that you brought up.
- [40:42]
Brett Gardner
Oh, you mean like how.
- [40:45]
Cole Smead
Well banks are not open on Sundays or Saturdays.
- [40:48]
Brett Gardner
Oh, right. So originally when it was a bank holiday in 30s, Amex remained open. And Amex was a source of cash for people when they literally couldn't get it from their bank. So that one, built trust and two, it was a way to be way for consumers to be a little bit more liquid than they would be would have been otherwise.
- [41:17]
Cole Smead
We hope you're enjoying the podcast. You know, we work hard putting together this show, but we work even harder for our investors at Smead Capital Management. At Smead, we believe in disciplined investing, which is why the Smead funds have a proven track record of long term outperformance. If you're an investor who fears stock market failure like I do and want to invest in Wonderful companies to build wealth. We invite you to visit smeadcap.com Past performance is not indicative of future results. Investing involves risks, including loss of principal. Please refer to the prospectus for important information about the investment company, including objectives, risks, charges and expenses. Read and consider it carefully before investing. SMEAD funds distributed by UMB Distribution Services llc.
- [42:00]
Not affiliated. You're now going to clean up the solid oil scandal. So here's Buffett analyzing the investment. Okay, obviously immediately you have this situation where, okay, trust could be questioned because they've been insuring something from a fraud. And at the same time, they can't just go out to the people that they've been insuring on and saying, listen, this is fraud. We're not going to pay these claims. Because ultimately those same parties were causing their major profit centers in the charge card. In the traveler's check business, is that the fair way to think about the idea of trust in their profitability?
- [42:36]
Brett Gardner
Yeah, 100%. The banks were liable for the missing oil, in theory, if Amex didn't step up, the banks looked to Amex to, to fill the hole and make them whole on this. But it wasn't really clear if they necessarily had to pay up. They in theory could have just put the bankruptcy, the subsidiary, the field warehousing subsidiary into bankruptcy and walked away. The issue was that the banks would be really pissed off, obviously, and it would ruin the tarnish the trust they had with the banks.
- [43:16]
Bill Smead
So Henry Brandt helped Buffett with what we call the scuttlebutt method. What did he do?
- [43:23]
Brett Gardner
So he went to some restaurants in New York just to make sure that the card was still being used, traveler's checks were being used, and he put together a research report on his findings. And Buffett himself did this work too. Buffett went to restaurants in Omaha, made sure that the card was still being used, that there was no disruption. And, you know, when Buffett started buying, and I think it's an important point that Buffett started buying five months after the salad oil scandal. He didn't buy immediately when the stock dropped. There was another Fortunes article that talked about how card usage was going up, travel check usage was going up, and consumers were really unfazed by it, which I don't think was probably that surprising because they probably didn't know as much warehousing scandal as the banks did who still had money on the line. And by April, it became very clear that Amex was going to do something for the banks. They were going to make them 100% whole, but they were Going to cover enough of the losses to keep them happy.
- [44:32]
Bill Smead
What was the lesson for getting into the field warehouse business and what did it have to do with the core business?
- [44:40]
Brett Gardner
It really had nothing to do with the core business. Amex made the false assumption that this is easy money to make, that they can just use their brand value from the banks to make some easy money. But there was a huge concentration of risk in the field of warehousing business, in contrast to the credit card business or the travel checks business, where you have a highly fragmented consumer base. So any one customer defrauding you is not that serious. I mean, the risk to Allied Crude, which was Tino's company, was massive. And the concentration of risk was a huge contrast to anything Amex did before or sans.
- [45:25]
Bill Smead
Yeah, we own a company called U Haul and what they did is they created a second business on the same property. They set up storage units. And of course the most likely person to need a storage unit is somebody that rents one of their vehicles.
- [45:39]
Cole Smead
Plays at your core. So it makes sense. Yeah, let's see. He obviously this is a massive position for him. He's talked a lot about over the years and you talk about this book, how concentrated he was in this business as he got deeper and deeper into it. This was big for his returns. Looking out, I want to say, what was it, five or six years in? Can you talk about the returns and then can you talk about why he didn't stay with it?
- [46:04]
Brett Gardner
Yeah. So he started buying the stock in April 1964, a few weeks after his father passed. And he didn't make it that big of a position initially, a couple million dollars. But he scaled the position up as the data started getting better. Meaning when he started buying in April 1964, the liabilities were ring fenced, meaning it was very clear what amount they were going to have to pay roughly. And that gave Buffett certainty that this was over. I could start buying. But he didn't really start scaling the position until he saw a couple of things. First is the trajectory the card business was on where they were just growing at double digit rates. A lot of us fall into the bottom line and the consumer adoption was rapid. They were increasing the price, they're increasing the take rate. There are all these levers they could pull on a charge card to create value. And travel checks. Business was continuing to be pretty good. This accounted for roughly a third of his returns over four years from 64 to 67. It might have been a little bit more than that. He eventually made it a 40% position.
- [47:34]
Bill Smead
In the partnership, it foreshadows. I came in the business in 1980 and Coca Cola was trading at 6 times earnings, paying a 5% dividend in 88,89. I think it had to do with the Berlin Wall falling made Pete Buffett a lot more comfortable with Coca Cola. But anyway, he bought at five times the price the stock was trading at in 1981 to buy into Coca Cola. And that's in effect what you're talking about.
- [48:05]
Cole Smead
Well, then they came back one year later and started buying after the returns had gone higher. And I think that's what you're laying out is the returns had actually gone way higher on Amex despite the solid oil scale.
- [48:13]
Bill Smead
And that's what I'm thinking about as you say that.
- [48:17]
Cole Smead
I think in that case it went from 25% returns on Coke to 50 plus percent return on equity. That's probably the same phenomena he was seeing in Amex.
- [48:26]
Bill Smead
He was originally a shareholder of Pepsi and was a Pepsi drinker originally. That might have had something to do with it also.
- [48:34]
Brett Gardner
That's totally correct. Once you start getting the data, the stock was not trading that expensive. It wasn't a single digit pe, but relative the market, it was at the same multiple or cheaper and growing a lot faster. And Buffett did all this work to figure out that it was just a much better business than the average American corporation at the time. But he really needed to see that data come in. There are two things that I think are important lessons. Here is one, Buffett didn't have this primal reaction to jump in when the stock was getting crushed during the Salad Oil scandal. He waited until the facts came in. I mean, stock got like wallops immediately after the Salad Oil scandal came out. JFK got assassinated a couple years, a couple days later, and Buffett didn't buy. Then he started working. And then once the liabilities were ring fenced, then he plunged in. And then he started scaling the position as the data came in on the quality of the business. Like he had this thesis that the business was really good. And it was. And in my view in particular, the charge card business was really good and could grow fast. And once the data started coming in, he's like, all right, I can scale this position up. And now I think that he sold for a couple of reasons. One, valuation started getting pretty hot in the late late 60s, so it's partially valuation driven. But second, competition started coming from the banks. The predecessor to Visa was just kind of really starting out. I think it was like 1966 when bank of America started being licensed to non bank of America banks and competitions was arriving.
- [50:19]
Cole Smead
Sure. Let's see. You talk about the retailer Hochschild Cohn & Company. Sandy Gottesman is really who brought him into that. Call it opportunity, if you want to call it that. What was, what was Sandy's relationship to the company? And then why did he call Buffett?
- [50:38]
Brett Gardner
Sure. So first I pronounced it exactly how you did, but I was corrected by a Baltimore author who kindly told me it is wholesale Cohn.
- [50:50]
Cole Smead
Well, that's like the Schuylkill in Philadelphia. If you haven't been there, you don't know.
- [50:55]
Brett Gardner
Right, Exactly. So I just had to point that out. So Godtesman's mother in law owned some preferred stock and the family was getting, the family was getting a little older. They didn't really have anybody who wanted to run the business, so they were looking to cash out. Is a story. You know, the thing that I point out is that Lily Cohn actually stayed around the company for a few years, but it seemed like they were wanting to cash out with some core family members getting older and maybe not being successive generations to run the business. So Sandy was familiar with the company because he helped them raise debt. He was running First Manhattan at the time and helped raise debentures. And once he found out they were going to sell and sell below tangible book, he called Buffett up and was like, you should take a look.
- [52:00]
Bill Smead
It's a CFA level one thing. But why would you pay attention to LIFO accounting in a retailer?
- [52:08]
Brett Gardner
Yeah. So the thinking was that there was a little bit of inventory cushion there because it's most likely that you were selling fifo, meaning first in, first out. You got the goods, you sold them. But in LIFO accounting you were selling the last and first out. In theory, there was a little bit of excess inventory value that was not appropriately captured on your books.
- [52:36]
Cole Smead
In other words, also you're giving yourself the cost advantage, the smaller margin on cost if cost went higher. But the reality is you're actually selling product that you built originally or made originally. Is that fair?
- [52:47]
Bill Smead
I hadn't thought of this before, but the terrible experience that he had in retailing, considering how much Charlie Munger thought and loved Costco, maybe that's why Buffett never bought Costco.
- [52:59]
Cole Smead
Oh yeah. But Charlie took risk on Alibaba, which he said was nothing more than an Internet retailer. I think Charlie throwing the craps dice a little more than Buffett at times. That's why he used more leverage. Do you want to go to the Next one.
- [53:11]
Bill Smead
Sure. What wasn't the real issue with the retailer? The sustainability of returns on capital through the cycle. It was a tiptoe business, as he and Munger said.
- [53:22]
Brett Gardner
Yeah, that's exactly right. I think that there was just the fact that you go down to the store at Howard and Lexington in downtown Baltimore and you turn 360 and you see four exact stores that are the same thing. They sell basically the same stuff.
- [53:42]
Cole Smead
Sure.
- [53:43]
Brett Gardner
And there was no competitive advantage. And there was a time when they can survive because people would take the streetcars out of the city and shop at their favorite store and maybe even hit up the second or third one. But the inner city of Baltimore's population became stagnant and started declining around this period because the population was moving to the suburbs. There were branch stores that were opening up. Hostile comb did a little bit of it, but its competitors did it better. And you know, once people stopped going to the city, they stopped shopping at the stores. And this led to returns deteriorating. And I mean, it was never like it was not that good of a business when Buffett bought it anyway, but it was just going to get worse. And I actually asked Munger question on this because he disagrees with my conclusion. But after Martin Luther King Jr. Was assassinated, there were riots across the country and that accelerated some of the population dispersion to the suburbs.
- [54:47]
Cole Smead
They call that white flight during the 60s.
- [54:50]
Brett Gardner
Yeah. And I think that had a bigger impact than people think. It's hard to quantify these types of things. But the city of Baltimore's population declining pretty rapidly or more rapidly after that. I think that played a role in the investment being a loser. Munger says it was going away anyway, and he's probably right. But I think that they could have earned a few more bucks off of it if that didn't happen.
- [55:15]
Cole Smead
Sure. I'm going to show up a slide. I love this because it showed the complicated matters of things of Disney. As Buffett's analyzing the business. Can you explain, like the relationship of Walt to the Disney company and what was his effectively his management company of Disney Wed. Sure.
- [55:36]
Brett Gardner
So Walt was not the CEO or president. He was on the board of directors and his title was executive producer in charge of all productions. But he ran the company. There's no if, ands or buts. Yeah, no if fans or bots. He ran the company. His brother Roy was the president and would become CEO after his passing. He was the first one to take the title. But Walt ran the company. He ran the show. Roy to me is a very underrated figure in Disney's history. There's a great book by Bob Thomas on him. And he did a lot to help finance Walt Expeditions. But Walt control the show. He was the creative force behind the company, and what he said eventually got done. Now, Walt had an interesting history where he created this figure called Oswald the Rabbit in the 1920s. And he essentially had it stolen from him, from his distributor, because Disney was a producer and. And distributors sold his content to movie theaters. And I think this made Walt very skeptical and cynical about corporations and even his own. So in the early 50s, he made an outside company called WD Enterprises, which is his initials, Walter Elias Disney. And he used this to essentially generate income outside of Walt Disney Productions, which was. And Walt Disney Productions was the company that Buffett invested in. So WED licensed his name to the. To. To Walt Disney Productions. It would eventually own the monorail. And Walt, through this company, also had the right to invest in someone Disney Productions movies, including Mary Poppins, which he made a million dollars off of. Now, the first reason he started the company was because he wanted to generate income outside of Walt Disney production. But he eventually used it to build Bill Disney the theme park in California because Roy kind of pushed back on him. He didn't really want to do it. He thought it was a stupid move. So Walt started working on this in WD Enterprises, and he hired folks, including folks from the Disney Company at WED and really started building the park there. But what I emphasize is, even though Walt was a good guy, having WED was sort of unacceptable. Like corporate governance.
- [58:24]
Cole Smead
It's not the kind of thing that Buffett would typically want to get involved in. But also, if you recognize the genius of Walt Disney, you could kind of understand, as I tell people, problems like that create discounts if they can go away over time. You paid nothing for the discount.
- [58:38]
Brett Gardner
Yeah, I completely agree. I think one of the reasons why Buffett kind of limited his position size. Like he made an 8 1/2% position, which is a big position, but not compared to what he was doing at the time. This was. This was like right when, like when American Express was like 40% of his portfolio. Yeah. And he would frequently take 25, 35% swing. It was a big bet, but wasn't his biggest, in my view. He probably limited it partially because of concerns about Walt Disney himself and also because of the industry generally. But Warren was certainly aware of his corporate governance risk because he was on the front page of Fortunes. As he was buying the stock he went out and met. Walt seemed to like him. And I think he also realized what a genius he was. Yeah, which I don't think. I don't think using an investment analyst lens is applied to Walt Disney would make that an obvious conclusion.
- [59:29]
Cole Smead
Hey, I want to give a big shout out to everyone who's been working so hard on the show. You know, we recently hit the top 10 investing podcasts on Apple Podcasts and even number one in the business category in several countries. As you may know, this show is brought to you by Smead Capital Management. Smead Capital Management understands how frustrating and illogical the stock market can be. If you are searching for funds with a proven track record, give the Smead funds a look. Or better yet, reach out@smeadcap.com and don't forget to mention that you're a fan of the podcast. Past performance is not indicative of future results. Investing involves risks, including loss of principal. Please refer to the prospectus for important information about the investment company including including objectives, risks, charges and expenses. Read and consider it carefully before investing Smead Funds Distributed by UMB Distribution Services llc.
- [60:20]
Bill Smead
Not affiliated When I think about Mary Poppins, Buffett bought in the year after Mary Poppins 66 was the blockbuster. And just for our audience, it's hard to wrap your mind around how huge Mary Poppins was. I mean I saw that movie in an old style Orpheum Theater in downtown Portland and I would say think of the most popular Disney movies the last 10 to 20 years.
- [60:52]
Cole Smead
Or like the Barbie movie but way more powerful.
- [60:55]
Bill Smead
I mean literally if you were a 5 to 12 year old kid, you saw that. Okay, so therefore thinking about we're not growth stock people, but for growth stock people, you know, to go from there, that sugar high of that blockbuster movie and its impact on earnings meant that I was shocked when I read your book that the earnings actually grew. Talk about what the trends were in box office sales at the time.
- [61:25]
Brett Gardner
Sure, the movie industry was really declining at the time. Pretty much everyone other than Disney and United Artists was struggling mightily because of the rise of TV competition and movie industry operated a little bit differently than it does today, where a lot of movies now are kind of like released everywhere at the same time, while back then it would kind of be rolled out everywhere. So Mary Poppins was debuted the year prior to Buffett buying the stock, but it was being rolled out across the globe, which is why earnings ended up going up. But the movie industry was not a very good one then. There were seven majors. Disney was not considered a major because it only released a handful of films Each year compared to 20 or 30 for the bigger companies. But Disney had more home runs. And at the time, Mary Poppins was like the fourth highest grossing film of all time. It was just like an incredible success. And, you know, Buffett actually went to the theater a few blocks from where I am today to watch the movie himself. I also watched the movie and I liked it way more than I expected.
- [62:46]
Cole Smead
I think he said, like he went by himself. He felt like he should have rented a kid.
- [62:50]
Brett Gardner
Exactly.
- [62:51]
Bill Smead
Yeah, exactly. So Blazing Saddles was an incredibly good movie. And the silent movie he made incredible fun of the conglomerate Gulf and Western, which he called Engulf and Devour. Right. And them buying Paramount and then later, now we have the. The Godfather show that has also dug into that. Teach our audience who the other studios were and what kind of valuation he got from their open market prices.
- [63:29]
Brett Gardner
Sure. So they were actually very similar companies to the ones operating today. There was mgm, United Artists. I know I'm forgetting a few of the other ones off the top of my head. Columbia, there was another one that was another big one. I'm not remembering right now, but seven companies were. Are still operating today.
- [63:52]
Cole Smead
I was say Fox.
- [63:53]
Brett Gardner
Yeah, Fox was another one. Got that one. And, you know, they have been. They've been around for, I think, almost. I think every single one has been around for over a century at this point. So there were of the companies that we know today, and stocks were not doing well because the earnings were poor at that point in time. But there were sort of to be a little bit of M and A that was juicing the valuations a little bit like Gulf and Western. The conglomerate you were just mentioning was purchasing paramount for like 15 times EBIT, which is a pretty expensive valuation. The theory being that they had this excess land because the studio and also because earnings were temporarily depressed in their view. I did the research to figure out whether that actually became true or not. My guess is not because box office was continuing to decline. Decline?
- [64:47]
Cole Smead
Yeah. In 100 to 1 in the stock market. I'm sure you've probably read that book by chance. They. There's a quote from the book, you know, talking about these incredible compounders. It's the vision to see them, courage to buy them, and the patience to hold them. The patience is obviously the toughest. What kind of patience did Buffett exhibit on Disney?
- [65:09]
Brett Gardner
He held it for a year. He didn't. He bought in 1966. Walt actually passed away in December, unfortunately. And the stock rose off that. Roy, his brother, said that he thinks the stock rose because movie studios stocks as a whole were cheap. But there was also rumors of takeover. Walt and his wife owned about 40% of the company. The theory was the company was now in play with his passing and Warren sold out a 55% gain.
- [65:47]
Bill Smead
Our first exposure to this whole subject was Keenan Flagler Business School, the University of North Carolina business school. Students and, and Buffett always says, everybody always asks me what my poorest investment was. In other words, the worst investment I ever did. And he says, my sins of omission versus commission. I never lost more than 2% in a single thing. But he said in, I think it was 96 that he sold at a 50% gain. He, he bought up 5% of the company for $4 million. He sold a 50% gain a year later and it was a 250 bagger by 1996. So just think about if he'd have sold it well in 2021, what that number would have been.
- [66:38]
Cole Smead
When we were talking about before Brett, tracking it after is something we kind of played around with because we're trying to sit down and say, okay, here's the greatest investor of all time. He makes mistakes, just like we make mistakes. And did he make more than one mistake? Right. Because, you know, there's opportunity costs and everything. And like we were talking about before this thing went off like a rocket. I mean, when it went up in 67, it went up for seven, probably six years. Right after the 66, you know, disappointment of no Mary Poppins. So you know it. So it made a ton of money. But on the flip side, it was part of the Nifty 52.
- [67:16]
Brett Gardner
Yeah, I think that's a great point. So I talk about this a little bit in the book where from when he sold to when he eventually got Disney stock again to the Cap Cities merger in the 90s, Buffett actually did better within Berkshire than Disney did. Meaning, like his decision to sell was not as terrible as Buffett makes it at the seam.
- [67:38]
Cole Smead
Sure.
- [67:40]
Brett Gardner
In theory you could have just made that one decision on and held, maybe sacrificed a couple of points and just relaxed. But, you know, his IRR was better within Berkshire. However, I think that your talk, your point about him not buying back in the 70s is really interesting. And because by the, by the 70s you had two theme parks up and running, generating profit.
- [68:00]
Cole Smead
Yeah. The Florida and the California.
- [68:02]
Brett Gardner
Yeah. So in theory it should have been a safer business. And because the other thing I would defend the sale on is, you know, reading the 66 and 67 annual reports, I think that Just how profitable the theme parks were going to be was not obvious. I think that, you know, you could think about how profitable they could be, but you cannot handicap it. Well, yeah, sure.
- [68:26]
Cole Smead
So let me, let me, let me add one more thing because Buffett, here's again thinking about, you know, the partnerships, obviously they ended in 69. Right? Buffett underperformed 70 to 74. He actually lost to the S and P during that five year stretch. Okay. And so it's like, I mean I think a lot about what if he had held Disney over that five year stretch relative to what he was doing with capital? Because his five best relative years I think ever was 75 to 79.
- [68:57]
Bill Smead
Well, and near, near the, at least.
- [69:00]
Cole Smead
At least in the Berkshire case.
- [69:01]
Bill Smead
Yeah, near the bottom. In nineteen nineteen seventy four, he was interviewed in Forbes magazine because he had warned people about how overvalued the market was in 72.
- [69:14]
Cole Smead
He called it charlatans. There's a lot of charlatans.
- [69:17]
Bill Smead
And so they asked him what he thought about it and he said, well, I feel like an over sex man in a harem at the bottom in 74. So if you're feeling like an over sex man in a harem and you're buying bargains, which he was buying bargains, I think Cole's point is very valid. Why didn't he come back? So that's a total pit of despair market. But then Again, on the 911 attacks, the stock got torpedoes because the sky was you couldn't fly for 18 days. So every travel oriented business went in the tank. And so that's 2001. So he passed quite a few times on it.
- [69:54]
Brett Gardner
I think it's a great point. I haven't studied that as much as you guys have. Maybe the next book.
- [70:01]
Bill Smead
There you go.
- [70:02]
Brett Gardner
I would defend the sale on it.
- [70:03]
Bill Smead
Moody's Manual akin to Value Line for a baby boomer or a Bloomberg for a millennial.
- [70:10]
Brett Gardner
I would say it's similar to a value line. I think the value line is probably more robust on a company by company basis.
- [70:16]
Bill Smead
Amen. Amen.
- [70:18]
Brett Gardner
Value line has. I have a big stack on one of my bookshelves of small cap Value line. They gave you a nice full pager with more information than Moody's did. Moody's was like, I mean the pages were pretty big, maybe like I want to say a foot wide, foot tall. I'm probably even like being a little shortchanging them. But there might be like three or four companies per page. So there wasn't that much information. And then there are Actually a couple Moody's manuals, and some of them did have more robust data, but most of them, especially the ones Buffett was buying, like Union Street Railway, Marshall Wells, Cleveland Mills, would only have, like. Only take up like a third of.
- [71:01]
Bill Smead
The page in Forbes. Yeah. So you point out a couple takeaways, and Cole really likes to think about this. Explain Buffett's soft power he exerted as an owner over his investment career compared to his most activist earlier days.
- [71:19]
Brett Gardner
Sure. So I use the label hard power to characterize the period when he was taking control of companies by buying significant or majority stakes and dictating corporate policy. So he would. He does Dempster Mills, Sandboard Mapp, Berkshire Hathaway, obviously. And in these cases, like, you know, might is right. You win because you have the most shares and there's no persuasion necessary. Now, in the 60s and 70s, he started inching towards the soft power, using his social skills to build relationships with the people. I think the first example of this that I know of is in 1964 when he writes to Howard Clark, the president of American Express, kind of like dismissing the Salad Oil scandal, like, just being, like, move past it. It's no big deal. Even though it was a lot of money for shareholders. And then I think the more prominent example is what he did with Washington Post with K. Graham. So K. Graham controlled the company, had a dual class stock structure, could have sold Warren just. Just go away. But Warren was nice, wrote these letters. They vacationed together. Warren introduced K. To Charlie, and they became friends. I don't view this as a cynical, manipulative thing by Buffett at all.
- [72:55]
Cole Smead
Sure.
- [72:56]
Brett Gardner
But it did allow him to help teach K. About capital allocation in business. He would apparently go to Washington with these stacks of annual reports for her to read, and he would walk her through how to think about these things. He got on the board, and he helped persuade the board to make the right decisions.
- [73:15]
Bill Smead
I want to give Cole a little credit on something here for us as a company. Our Salad oil scandal was American Express divorcing the branded credit card at Costco, the stock went from 98 down to 55. And that was our entry point, was that particular thing back in 16. And Cole had pointed out that two insurance companies, Safeco, which we worked in Seattle for 40 years, we were very familiar with Safeco and then Progressive. They got to a point in the late 1990s where they had a choice. They either had to pull back from underwriting, because underwriting was. They were underwriting at a loss, not underwriting at a profit or they had to continue underwriting and expect to make it up on investment results. Safeco chose that to bet that they could beat with investment results. And of course, Progressive 10 begged and Safeco got crippled when everybody knows who Flow is now as part of Limu Emu, the most annoying advertisements in the history of mankind.
- [74:22]
Cole Smead
The point being that Amex produced good enough returns on its own. It didn't need to lose money with the Costco customers, which were a low margin loss leader in many cases.
- [74:31]
Bill Smead
In comparison, we looked at the demographics and said, millennials like to travel.
- [74:37]
Cole Smead
We're very happy Amex customers. As we fully disclose, we own a position in the company. We think it's a wonderful business and we think the future is always getting brighter. I was going to ask you. I found your book via X. You post a lot online, which I really appreciate, because it's like, if you hadn't posted some of this stuff, I would have never been like, who's this guy with this book? And he's just got great data and where the. Thank God for Elon Musk and X and all that kind of stuff. So is there anything you've been posting lately that you found terribly interesting that didn't end up in this either? Because the editor or Time or whatever that was?
- [75:13]
Brett Gardner
Yeah. So there are a couple things. One thing that I posted might have been a few months ago is there was this letter from Buffett to Merchants National Properties, which is still a publicly traded company today, and Buffett owned the stock in book 5657. And he wrote a fairly abrasive letter to the board of directors, basically accusing them of some weird insider dealings. And I haven't actually posted the entire story yet. But what's kind of interesting is it seems that they actually became. He became friends with the CEO in subsequent years. Like, I don't see all the interactions, but Buffett started off very aggressive. I don't say it was like quite like a Dan Loeb letter, but it was, it was not polite. And, you know, Buffett was able to turn that into like a fairly friendly relationship with the President. Sure, it's pretty interesting. And then a couple of the other stuff is some letters from Buffett to other people, sometimes to Graham that I came across. And it's kind of funny. So after Buffett graduated from Columbia, he would write to Graham all the time, pitching stocks and just trying to get in front of him all the time. And Graham would be sort of dismissive. It's hard to entirely trust your judgment on what you're reading from a document 70 years ago. But sure, Graham, like, almost didn't seem to be bothered. Like, he'd write, like, he wouldn't say, like Dear Warren. It would say Buffett sometimes with the T, the second T missing, for example, stuff like that was just like, kind of funny and also like a little bit sad in a way, because it was clear how desperate Warren was. Like reading these letters. It's just clear how much. How hungry was and desperate he was for his idol's perfection when he lost, he lost his.
- [77:08]
Cole Smead
I mean, at one point in his life, you know, like, when they're getting together, his dad's dead. I remember there was a get together in 69 in La Jolla, if I remember correctly, and Schloss and a bunch of the guys got together. And to your point, I mean, he's fatherless at this point in his life. And so that, by the way, and the weird part is if you think of like, you come back to like the human part of Buffett, you're we're talking about Ben Graham, who ended up going out to have an affair with his son's girlfriend. I mean, this is like, it's not Epstein ish completely, but it's getting closer and closer by the day of kind of weird sexual perversion. So again, to your point, like, he thought he was a monster of a thinker with Graham, but he was no perfect person and obviously had his own faults.
- [77:47]
Bill Smead
And another one I'd like to add to that was we were dumbfounded during the whole Covid thing. People were absolutely mortified. And, and Buffett did his remote annual meeting without Charlie.
- [78:05]
Cole Smead
Without Charlie, one of the saddest meetings ever.
- [78:07]
Bill Smead
And he talked about, one of the things he talked about for an optimism thing was the way that Ben Graham and the Economist, the other guy, brought in front of congressional testimony to talk about how, oh, we'll survive this terrible thing. And Buffett should have been saying, you know, if Ben was alive right now, he'd be happy as a clam at high tide. Because in 2020, in the spring of 2020, you could buy anything you wanted, anything you wanted at a total fire sale.
- [78:44]
Cole Smead
It was all the lower than $10 billion market cap stuff that he's been complaining about for years.
- [78:48]
Bill Smead
There had to be more net, net oriented things available at that point in time that there's been in the last, other than 08, which he did do a pretty good job on. Right. So I'm still scratching my head at that here. He's got his two underlings that he can allocate capital to and say, hey, go buy some bargains. This is crazy, but it doesn't really fit with what I do.
- [79:13]
Brett Gardner
Yeah, I think it's kind of funny. Buffett has always had such tremendous respect for Graham, and the Graham net nets, at least in the United States, have declined over the past decades. But War has always gone out of his way to constantly compliment Ben Graham. I think with that, as value investors, we all owe a great debt of gratitude to him, obviously. Analysis, intelligent investor. And I think Charlie Munger has, you know, did a great job of pushing people to. To evolve where, you know, Graham was like, very not interested in the quality of businesses, not interested in meeting management. And Buffett and Munger, you know, blaze their own path.
- [80:06]
Cole Smead
Yeah, Brett, where. Where can our listeners and our audience follow you going forward? Like, for example, what's your handle on X?
- [80:14]
Brett Gardner
So my handle on X is Brett Gardner. B R E T T G A R D N E R underscore 10 just 10 can also reach me out on LinkedIn as well. And, you know, I'd love to hear from people. I think one of the really fun parts of writing this book is getting outreach from people who are interested in the same stuff you are. And I think that I kind of love learning from everybody else as well.
- [80:41]
Cole Smead
By the way, your volume two would be taking. Damn right. The Story of Charlie Munger and, you know, taking. Going deeper into the. What was it? The. The Munger Guerin Partnerships or Munger Wheeler. I can't remember which one it was, but I'd love to. I would.
- [80:56]
Bill Smead
That would be great.
- [80:57]
Cole Smead
By the way, he. Charlie was my saint. Like, that's like my patron saint. And so to your point, I just feel blessed to be around you for the fact you got to visit with him and chat.
- [81:08]
Brett Gardner
Yeah. So when I initially started writing, I kind of wanted to do a Munger book. Munger investing book, I think. Damn right. And Portray's Almanac are fantastic books, but more in like, the first 20 years of Munger's career as well. The issue I had is that his partnership letters aren't really available. I did do some research on Munger obviously, as well, during this period. And the one thing I point out is he was also way more activist than people knew.
- [81:40]
Cole Smead
Yeah. In that book, they talk about the fund of letters, which was a close end fund that he bought. It was actually a venture capital fund. So I told him, by the way, Munger used leverage. So the bottom in 74 took prisoners. I mean, no one got out alive and Charlie was at the bottom of that bear market, levered, you know, to the hilt. So, Brett, we really appreciate your time. I just wanted to open up to Bill, just to ask, like, any kind of parting thoughts or. I mean, it's just so much fun.
- [82:10]
Bill Smead
No, this is just. I only knew about your book a week ago and I thought, oh, my gosh, this is gonna. I read the book. I enjoyed it thoroughly. I recommend everyone go out and get it, and it's just. It's a feast. It's literally a feast.
- [82:27]
Cole Smead
Brett, your book makes me think about, you know, elements of Buffett that people don't talk about. Like, I think we run into a lot of people say, well, here's the sector or industry I'm going to specialize in, or I only like asset light businesses. But that's not how Buffett learned. He learned by taking shots, taking risks, the flexibility, the ability to learn, and the adaptation that he used over his career from the things he did learn. We talk a lot about being lifelong learners as investors. Buffett's early investment. Your book highlights superbly this for our audience. If you enjoyed this podcast, go to Apple, Spotify, YouTube, or wherever you listen to A Book with Legs, give us a review. Tell others about this book and the great authors like Brett Gardner that we have the opportunity to understand and study the world with and through for our tribe. If you have a great book that you'd like to recommend, email podcastmeadcap.com that's podcastmeadcap.com. you can also send your suggestions to us on X. Our handle is Meadcap. Thank you for joining us for A Book with Legs podcast. We look forward to the next episode.
- [83:29]
Podcast Host
Thank you for listening to A Book with Legs, a podcast brought to you by Smead Capital Management. The material provided in this podcast is for informational use only and should not be construed as investment advice. You can learn more about Smead Capital Management and its products@smeadcap.com or by calling your financial advisor.