Warren had applied to Columbia too late to get into a university dorm, so he found the cheapest lodgings available: joining the YMCA for a dime a day and paying a dollar a day for a room at the Y’s Sloane House on West 34th Street, down near Penn Station.1 He was far from broke, enriched by $500 from the Miller scholarship and $2,000 from Howard, a graduation gift and part of a deal not to start smoking.2 He also had $9,803.70 saved, some of it placed in stocks.3 His net worth included $44 in cash, his half interest in the car, and $334 invested in his Half-Witek golf ball business. But since Warren looked at every dollar as ten dollars someday, he wasn’t going to hand over a dollar more than he needed to spend. Every penny was another snowflake for his snowball.
On his first day in David Dodd’s class, “Finance 111–112: Investment management and security analysis,” he recalls that Dodd broke his customary reserve and greeted him personally and warmly. Warren had already more or less memorized the course textbook, Security Analysis, Graham and Dodd’s seminal book on investing.4 As the principal drafter and organizer of Security Analysis, Dodd was of course intimately familiar with its contents. Yet when it came to the text itself, Buffett says, “The truth was that I knew the book even better than Dodd. I could quote from any part of it. At that time, literally, almost in those whole seven or eight hundred pages, I knew every example. I had just sopped it up. And you can imagine the effect that would have on the guy, that somebody was that keen on his book.”
Published in 1934, Security Analysis was a mammoth textbook for serious students of the market, laying out in much more detail the innovative concepts that were later summarized for a popular audience in The Intelligent Investor. Dodd had taken meticulous notes at Ben Graham’s lectures and seminars for four years, organizing them and enriching the examples with his own knowledge of corporate finance and accounting.5
Dodd’s class focused on valuing defaulted railroad bonds. Since childhood, Warren had been slightly obsessed with trains, and thanks to the checkered history of the Union Pacific, Omaha was practically the center of the universe when it came to bankrupt railroads.6 Warren had read his favorite book on bonds, Townsend’s Bond Salesmanship, for the first time at the age of seven after making a special plea to Santa Claus for this tome.7 Now he took to the subject of bankrupt railroad bonds like a duck to the warm spring rain. Dodd showed an unusual interest in him, introducing him to his family and taking him to dinner. Warren soaked up the fatherly attention and also felt sympathy for Dodd, who cared for his mentally ill wife.
In class, Dodd would ask a question and Warren’s arm would shoot into the air before anyone else’s, waving for attention. He knew the answer every time, wanted to give it, was not afraid of attention, and did not mind looking silly. Nor did he seem to be showing off, as a classmate recalled; he was simply young, eager, and immature.8
Unlike Warren, most of his Columbia classmates had little interest in stocks and bonds and were probably bored by this mandatory class. They were a remarkably homogenous group of men,9 mostly headed to General Motors, IBM, or U.S. Steel after they got their degrees.
One of them, Bob Dunn, was on his way to becoming the academic star of the class of 1951. Warren admired his presence and intelligence and often went over to the dorm to visit him. One afternoon, in the other room of Dunn’s two-room suite, Fred Stanback found himself wakened from a nap by a loud voice. Half asleep, he began to realize that the voice was saying such interesting things that he didn’t want to doze off again. Rising from his bunk, he wandered into the next room. There he found a crew-cut, badly dressed kid, rattling a mile a minute, who leaned forward in his seat as if a starting gun were poised behind his head. Stanback plopped down in a chair and began to listen to Warren, who was declaiming with great authority about some undervalued stocks he’d found.
Warren talked about a clutch of tiny companies, including Tyer Rubber Company, Sargent & Co., and a somewhat larger business, hardware wholesaler Marshall-Wells.10 Listening, Stanback became an instant disciple. He went out straightaway and bought stocks for the first time in his life.
Stanback grew up, analytical and reserved, on Confederate Avenue in the tiny hamlet of Salisbury, North Carolina. He was a born audience for Warren. The two started spending time together—a fast-talking, scrawny-looking kid and a sandy-blond handsome young man with a molasses voice. One day Warren had an idea. He asked Professor Dodd’s permission to cut class to attend the annual meeting of Marshall-Wells. A few months before starting at Columbia, he and Howard had jointly bought twenty-five shares of this stock.
“That was the first annual meeting I ever attended. They held their meeting in Jersey City, New Jersey, probably so fewer shareholders would attend.”
Warren’s vision of shareholder meetings rose from his conception of the nature of a business. He had recently sold his tenant farm, doubling his money over five years. During the time he had owned it, he and his tenant farmer had shared the profits on the crop. But his tenant didn’t share the profits from selling the land. As the capitalist, Warren put up the money and took the risk, and then he got the gain, if there was any.
Warren thought of all businesses this way. The employees who managed the business shared in the earnings that their labors produced. But they were accountable to their owners, and it was the owners who got the gains as the value of the business increased. Of course, if the employees bought stock themselves, they became owners, too, and partners with the other capitalists. But no matter how much stock they owned, as employees their job required them to report to the owners on how well they had done. Thus, Warren saw a shareholder meeting as a time of accounting for the stewardship of the managers.
This vision was rarely shared by company managements, however.
Warren and his new friend Stanback took the train to Jersey City. Arriving in a drab meeting room, they found half a dozen people awaiting a session in which the company planned to shuffle through an agenda of legal obligations in a perfunctory fashion.
One of those present was Walter Schloss, a thirty-four-year-old man who was working for the pittance of fifty dollars a week as one of four employees of Ben Graham’s company, the Graham-Newman Corporation.11 As the meeting began, Schloss starting asking pointed questions of management. He was a bantamweight, mild-mannered, dark-haired man from a family of New York Jewish immigrants, but he probably struck the Marshall-Wells crowd as abrupt by the standards of Duluth. “They were a little upset,” says Stanback, “that these outsiders were barging in on their meeting. They’d never had anybody come to their meeting before, and they didn’t like that.”12
Warren was immediately taken with Schloss’s approach, and when Schloss identified himself as working for Graham-Newman, he reacted as though at a family reunion. As soon as the meeting ended, Warren approached Schloss and they began to talk. He found him a man after his own heart, a believer that wealth is hard to accumulate and easy to lose. Along with other financial setbacks, when Walter was thirteen, his mother had lost her inheritance in the crash of 1929.
The Schloss family got by through perspiration and determination. Fresh out of high school in 1934, Walter worked as a Wall Street runner—a member of the Pony Express of the brokerage firms—carrying messages up and down the street. Next, working in the company’s “cage” handling securities, he had asked his boss if he could analyze stocks. The answer was no—but he was told, “There’s a fellow named Ben Graham who’s just written a book called Security Analysis. Read that book and you won’t need anything else.”13
Schloss read Graham’s book cover to cover and wanted more. Two nights a week from five to seven, he started going to the New York Institute of Finance, where Graham taught investing. Graham had begun these seminars in 1927 as trial runs for a college course he was thinking of teaching at Columbia. At the time, the public couldn’t get enough of stocks, and the class was packed.
Graham mentioned names of stocks he was currently buying as teaching examples. People like Gustave Levy, the head trader at Goldman Sachs, scurried back to act on these ideas and make their firms and themselves rich. Schloss was so captivated that he wound up as one of a couple of employees working for his idol, Ben Graham, and his partner, Jerry Newman. Warren found himself instinctively drawn to Walter, not just for his enviable job but also because of the story of his gritty, disadvantaged background. At the Marshall-Wells meeting, Warren also recognized another shareholder by his barrel-shouldered, cigar-smoking profile. This was Louis Green, a well-known investor who was a partner in a small but respected securities firm, Stryker & Brown, and an ally of Ben Graham’s.14
Warren was mightily impressed by Lou Green and wanted to make a good impression, so he struck up a conversation with him, and he and Stanback and Green rode back together on the train from New Jersey. Green offered to take the two young men to lunch.
That was like hitting the jackpot. Warren discovered Green was tightfisted, a man after his own heart. “This guy was enormously wealthy, and we went to some cafeteria or something like that.”
At lunch Green began explaining what it was like to be pursued by women who were after his money. As he was somewhat past middle age, his technique for dealing with this was to confront the woman’s motives directly: “You like these false teeth? How about my bald head? Or the potbelly?” Warren was enjoying the conversation, until Green suddenly changed the subject and put him on the spot.
“He said to me, ‘Why did you buy Marshall-Wells?’
“And I said, ‘Because Ben Graham bought it.’ ”
True, Graham was already his hero, even though the two had never met. And since the inspiration for buying Marshall-Wells had indeed come from Security Analysis, Warren may have felt he had to be scrupulous about how he had learned of it.15 But, in fact, he had good reason to own Marshall-Wells beyond its mention in Security Analysis.
Reputedly the largest hardware wholesaler in North America, Marshall-Wells was earning so much money that if it had paid out those earnings to shareholders as a dividend, they would have gotten $62 a share. The stock traded at around $200 a share. Owning a Marshall-Wells share was something like owning a bond, one that paid thirty-one percent interest (the $62 earnings on a $200 share). At that rate, in three years, Warren would have nearly two dollars of value for every dollar he had invested in Marshall-Wells. Even if the company didn’t pay the money out, the stock would have to rise eventually.
But Warren did not explain any of this to Lou Green. Instead, he said, “ ‘Because Ben Graham bought it.’
“Lou looked at me and said, ‘Strike one!’
“I’ll never forget the way he looked at me when he said it.”
It dawned on him: “Warren, think for yourself.” He felt foolish.
“We’re sitting in this little cafeteria, I’m with this impressive character, and all of a sudden I’m striking out.”
He did not want to make any more mistakes like this, and he did want to find more stocks like Marshall-Wells, so as Graham’s seminar approached, Warren started memorizing everything he could find out about Ben Graham’s method, his books, his specific investments, and Graham himself. He had learned that Graham was chairman of the board of a company called Government Employees Insurance Company, or GEICO.16 This stock was not mentioned in Security Analysis. When he looked in the Moody’s Manual, he found that the Graham-Newman Corporation had owned fifty-five percent of it but had recently given out the stock to its shareholders.17
What was this GEICO? Warren was curious. So on a cold, wintry Saturday morning a few weeks later, he jumped on the earliest train to Washington, D.C., and showed up at GEICO’s door. No one was about, but a guard answered his knock. As he recalls, Warren asked in his humblest manner whether anyone was there who might explain GEICO’s business to him. He made sure to mention that he was a student of Ben Graham’s.
The guard trotted upstairs to the office where GEICO’s financial vice president, Lorimer Davidson, sat working. Faced with this request, Davidson thought to himself that “being a pupil of Ben’s, I would give him five minutes and thank him, find a polite way of sending him on his way.”18 He told the guard to show Warren in.
Warren introduced himself to Davidson with precise but flattering sincerity: “ ‘My name is Warren Buffett. I’m a student at Columbia. Ben Graham is going to be, probably, my professor. I read his book, and I think he’s wonderful. And I noticed that he’s the chairman of Government Employees Insurance. I don’t know anything about it, but I wanted to come here and learn.’ ”
Davidson started talking to Warren about the arcane business of auto insurance, thinking that out of kindness to a pupil of Graham’s, he would waste a few minutes of his valuable time. But, he said, “After about ten to twelve minutes of his questions, I realized that I was talking to a highly unusual young man. The questions he was asking me were the questions that would have been asked by an experienced insurance-stock analyst. His follow-up questions were professional. He was young, and he looked young. He described himself as a student, but he was talking like a man who had been around a long time, and he knew a great deal. When my opinion of Warren changed, I began asking him questions. And I found out that he had been a successful businessman at age sixteen. That he had filed his own income tax at age fourteen and every year since then. That he had had a number of small businesses.”
Lorimer Davidson had accomplished so much himself that he was hard to impress. “Davy,” as he was universally known, had been pocketing an incredible $100,000 a year in commissions before the 1929 crash.19 Afterward, he found a job making about $100 a week selling bonds.
One day, Davy happened to call on the Government Employees Insurance Company. When he found out how GEICO worked, he was instantly captivated.
GEICO sought to make auto insurance cheaper by marketing through the mail without an agent.20 That was a revolutionary concept at the time. Borrowing an idea from a company called USAA that sold only to military officers, GEICO’s founders, Leo Goodwin and Cleves Rhea, had decided to sell its insurance only to government employees because they were responsible individuals who were accustomed to following the law. Thus, the Government Employees Insurance Company was born.
Later, the founding Rhea family had hired Davidson to sell their stock. While putting together a syndicate of buyers, he approached Graham-Newman Corporation in New York. Ben Graham was interested but deferred to his gruff partner, Jerry Newman. “Jerry thought that to buy something at the offering price was illegal. He said, ‘I never bought anything at the offering price before; I’m not going to start now,’ ” Davidson said.
They dickered. Davidson brought Jerry Newman around to investing $1 million for fifty-five percent of the company, with some modest concessions. Ben Graham became chairman of GEICO, and Newman joined its board. Six or seven months later, Lorimer Davidson told GEICO’s CEO Leo Goodwin that he would take a pay cut to work for GEICO, managing its investments. Goodwin consulted with Ben Graham, who agreed.
Hearing this story from Davidson, Warren was fascinated. “I just kept asking questions about insurance and GEICO. He didn’t go to lunch that day—he just sat there and talked to me for four hours like I was the most important person in the world. When he opened that door to me, he opened the door to the insurance world.”
Warren had studied insurance at Penn, and there was an aspect of it a little like gambling that intrigued the oddsmaker in him. He had become interested in an insurance scheme called a tontine, in which people pool their money and the last survivor gets the whole pot. But tontines were now illegal.21
Warren had even considered actuarial science—the mathematics of insurance—as a career. He could have spent decades toiling over tables of mortality statistics, handicapping people’s life expectancies. Besides the obvious ways this suited his personality—which tended toward specialization; relished memorizing, collecting, and manipulating numbers; and preferred solitude—working as a life actuary would have let him spend his time pondering one of his two favorite preoccupations: life expectancy.
However, his other favorite, collecting money, had won out.
Warren was starting to grapple with the fundamental concept of business: How do companies make money? A company was much like a person. It had to go out and find a way to keep a roof over its employees’ and shareholders’ heads.
He grasped that because GEICO sold insurance at the cheapest price, the only way it could make money would be to have the lowest possible costs. He also learned that insurance companies take their customers’ premiums and invest them long before the claims are paid. That sounded to him like getting to use somebody else’s money for free, just the kind of idea that appealed to him.
GEICO seemed to Warren a no-lose proposition.
That Monday, less than forty-eight hours after he arrived back in New York, Warren dumped stocks worth three-quarters of his growing portfolio and used the cash to buy 350 shares of GEICO. It was an extraordinary move for the normally cautious young man.
That was especially true because, at its current price, GEICO was an investment that Ben Graham would not have approved of, even though Graham-Newman had only recently become its largest shareholder. Graham’s idea was to buy stocks trading for less than the value of their assets, and he did not believe in concentrating in just a few stocks. But GEICO was growing so fast that Warren felt confident of being able to predict what it would be worth in a few years. On that basis, it was cheap. He wrote a report about it for his father’s stockbrokerage firm, saying that GEICO was trading at $42 per share, a multiple of about eight times its recent earnings per share. Other insurance companies, he noted, were selling at much higher multiples of their earnings. Yet GEICO was a small company in a large field, whereas its competitors were companies “whose growth possibilities have largely been exhausted.” Warren then made a conservative projection of the company’s value in five years. He thought the stock would be worth between $80 and $90 per share.22
In April, he wrote to Geyer & Co. and Blythe and Company, the most prominent brokerage firms specializing in insurance stocks, asking for their research. Next he visited these experts to talk to them about GEICO. After he heard their views, he explained his own theory.
They told Warren he was nuts.
GEICO, they said, could not succeed over the larger, more established companies that used agents. It was a tiny company, with a market share of less than one percent. Huge insurance companies with thousands of agents dominated the industry, and so it would ever be. Yet here was GEICO, growing like a dandelion in June and printing money like the U.S. Mint.
Warren didn’t understand why they couldn’t see what was right before their eyes.