By the time he dined with Katharine Graham in 1973, Buffett was no longer just an investor who was buying newspaper stocks. He was becoming a business mogul on a small scale. Berkshire Hathaway and Diversified were his bailiwick. Charlie Munger was the czar of Blue Chip Stamps.
The interlocking ownership of these three companies had tightened the business relationship between Buffett and Munger, and resembled the embryo of an empire built by an investor whom Buffett admired, Gurdon W. Wattles.1 His company was like a Russian doll; open it and inside find another company, and another, and another. Wattles controlled them, although he did not own one hundred percent of any of them. From early in his career, Buffett admired the Wattles model. He talked about Wattles all the time to his friends. “The only way to go is coattail-riding,” he would say.2
“Wattles had this little closed-end investment company called Century Investors. He did this chain thing where he would be buying stock in a company at a discount, which would be buying stock in another company at a discount.… The big company at the end of the thing was Mergenthaler Linotype, which was two-thirds owned by American Manufacturing. In those days, you didn’t have to file with the SEC to publicly reveal that you were buying, so nobody knew and he just would keep buying until he got control. He bought control of Electric Auto-Lite, partly through Mergenthaler, and he was doing the same thing with Crane Co. Somewhere in the chain was Webster Tobacco.… Everything sold at a discount, and you could just keep buying all of them and make more money every time you made a purchase.… I owned Mergenthaler, I owned Electric Auto-Lite, I owned American Manufacturing.3 What would cause the value to come out, that was always the question. But you just had a feeling you were with a smart guy and eventually it would.
“For ten or fifteen years I followed him. He was very Graham-like. Nobody paid any attention to him except me. He was sort of my model as to what I hoped to do for a while. It was so understandable and so obvious and such a sure way of making money. Although it didn’t make you huge money necessarily, you knew you were going to make money.”4 What interested Warren about the Wattles model: the way one company could legitimately buy cheap stock in another.
Eventually Wattles had merged his empire into one company, Eltra Corporation. This stock was now a favorite of Bill Ruane’s, because the company’s earnings were compounding at fifteen percent a year.5
The Buffett-Munger companies were beginning to look a little like Eltra before its combination: Berkshire was Diversified’s largest shareholder and also owned Blue Chip stock. Each of them also owned businesses that were not traded publicly. See’s Candies was so profitable that it more than offset the losses from Blue Chip’s trading-stamp business. Munger now took the step of buying twenty percent of a near-defunct investment firm, Source Capital, for Blue Chip. “We bought it at a discount from its asset value,” says Munger. “And there were two assholes who were the sellers. We had a no-asshole rule very early. Our basic rule has always been that we won’t deal with assholes. And so Warren, when he heard about Source Capital, said, ‘Now I understand the two-asshole exception to the no-asshole rule.’ ”6
Source Capital was small change. Buffett and Munger were always on the lookout for anything new they could acquire, especially something bigger that would give Blue Chip the kind of boost that See’s Candies had. They had found a sleepy West Coast savings-and-loan company, Wesco Financial. They bought some cheap Wesco shares for Blue Chip Stamps.7 Then Wesco announced that it was going to merge with Financial Corporation of Santa Barbara, a hot stock, with an aggressive approach that Wall Street liked. Analysts thought Santa Barbara was paying too much for Wesco.8 Yet Buffett and Munger saw the opposite: They thought Wesco was handing over its stock too cheap.9
Founded by the Casper family, Wesco owned Mutual Savings, a savings and loan that had prospered when the GIs came home during the post-WWII building boom. Even so, Wesco had never exploited its opportunities for growth. But it was extremely profitable because it kept its costs so low.10
Betty Casper Peters, the only member of the founding family both interested and able to serve on the board, felt that Wesco’s managers condescended to her, dismissed her suggestions that they should grow the company, and used her family’s legacy only as a ticket to ride at the head of the Rose Bowl parade.11 Peters, an elegantly dressed, high-cheekboned former art history student, had school-age kids, no business background, and spent much of her time tending the family vineyard in Napa. Now she drove back and forth to Pasadena on Wednesdays to attend board meetings. Running a savings and loan, she found, was hardly a black art. She subscribed to everything relevant she could get her hands on and sat down and read and figured it out.
As Peters’s frustration grew, she pushed for a merger. She knew the Santa Barbara offer wasn’t great. But although the company’s executives hung around the country club too much for her taste, they were aggressive, acquiring branches and doing things that she thought should be done.
Munger thought that he and Buffett should keep buying Wesco stock. If Blue Chip kept adding to the eight percent of Wesco it already owned, it could accumulate enough stock to defeat the Santa Barbara deal. But then he discovered that it would take fifty percent of the stock, a much higher obstacle. Munger had a greater incentive than Buffett to keep going, since Blue Chip was his partnership’s most important investment. He urged going ahead; Buffett thought the threshold too high and held back.12
Soon thereafter, Munger went to see Wesco’s CEO, Louis Vincenti, and tried to persuade him to abandon the Santa Barbara deal.13 And Vincenti brushed Munger off like a flake of dandruff—not an easy thing to do.
After being rebuffed, Munger and Buffett had no intention of launching a competing hostile bid. Further, Munger could not imagine that such a thing might be necessary. He wrote Vincenti, appealing to his higher values.14 It was wrong that Wesco should sell itself too cheap; Vincenti should simply see that. Munger told Vincenti that he was Buffett and Munger’s sort of fellow. He told Vincenti something like, “You’re engaged to this other girl, so we can’t talk to you, but if you were free, you’re the kind of man we would like.”15
Munger’s old-fashioned, Ben Franklinesque sense of ethics and his noblesse oblige notion that gentlemen should agree upon the right conduct among themselves must have sounded like Sanskrit to Vincenti. But at least Vincenti did let slip that Betty Peters was the shareholder pushing for the merger.
Munger sent Don Koeppel, CEO of Blue Chip, to see Peters. She dismissed him as a minion.16 So it was time for the big gun. Within ten minutes of Koeppel’s departure, Buffett called her. Peters had just finished reading the chapter on him in Jerry Goodman’s Supermoney, which her husband had given her for Christmas. “Are you the same Warren Buffett that’s in Supermoney?” she asked. Buffett admitted that he was the man who, according to Jerry Goodman, represented the triumph of straight thinking and high standards over flapdoodle, folly, and flimflam. They agreed to meet twenty-four hours later.
At the TWA Ambassador Lounge at the San Francisco airport, Buffett, with Pepsi in hand, underplayed his talent and record while asking questions in a warm, unthreatening manner. They talked for three hours, mostly about Omaha, where Peters’s mother had grown up. They talked about politics. Peters, a lifelong Democrat, was pleased by Buffett’s views. Finally he said, with considerable understatement, “Betty, I think I can do better with Wesco than this merger. Inasmuch as you’re giving up the company, why don’t we give it a try?”
Peters was taken with Buffett. In fact, her concern now became that something might happen to him if she swung her vote to him. He told her he had a partner, someone who would be in charge of Berkshire and the Buffett family’s stockholdings if the proverbial truck mowed him down.
On her next trip to Pasadena, Peters sat down to breakfast with Buffett and Munger at the grand old Huntington Hotel so that she could get to know this mysterious partner. They asked her for a meeting with the Wesco board. Peters then did something brave, allowing herself to look capricious in front of the board rather than let the company make a serious mistake. At the next board meeting she asked the board to reverse course and meet with Buffett and Munger. The board waved her off and voted at a special meeting to “use every effort to complete the merger with Financial Corporation of Santa Barbara.”17
Forgetting who actually owned the company was their mistake. Peters brought her whole family around to voting against the Santa Barbara deal.
“And then my task,” says Peters, “was to go back into that little hermetically sealed Pasadena boardroom and tell all these buttoned-down gentlemen, including the management, that we’re not going forward with the Santa Barbara savings deal.” When she returned to the Spanish-style building, she was thinking about the plaza outside the boardroom windows, with its tile-lined fountain. “If the windows had been open,” she says, “they would have thrown me out of them. I knew that what was going on in everyone’s mind was ‘My God, is this what happens when you let a hormonal woman on the board?’ ”18
Wall Street thought so; it sent Wesco stock nosediving from a high of above $18 to $11 on the news. An analyst claimed Santa Barbara was paying too much for Wesco, a “sleeping company for years, with old management.” Another referred to it as “garbage.”19
For her courage, Buffett and Munger now felt indebted to Peters.20 They had also decided they wanted to own Wesco themselves and felt it would be possible to win Vincenti’s cooperation. But, by then it must have been apparent that Lou Vincenti would not gambol along behind them like a lamb after its mother. Accordingly, they loosened the purse strings and told their brokers, for once, to bid liberally on the stock. Blue Chip paid $17 for Wesco shares—the price at which it had traded before the deal fell through.
“I will admit we were eccentric,” says Munger. “We deliberately paid more than we had to, but we felt we’d scuttled the damn merger and we didn’t like taking advantage of it by buying at the market price. We thought it was kind of the right thing to do. Well, nobody could understand that. They thought something must have been dishonorable about doing that. We really thought we’d make a better impression on Louie Vincenti.… [W]e wanted Louie to be our partner for the long term. We were trying to behave well.”21
By March 1973, Blue Chip owned a quarter of the Wesco stock. And Buffett, who had never stopped buying Blue Chip, continued his drive to get hold of more. Including the thirteen percent of Blue Chip he owned outright as well as his share of the stock owned by Berkshire and Diversified, Buffett was now effectively the largest Blue Chip shareholder. Blue Chip began to formally tender for Wesco’s shares, this time paying $15 a share in cash, until it owned more than half.22 Within weeks, Munger outlined for Lou Vincenti a vision for the company23 that, not surprisingly, resembled the way Buffett thought about Berkshire Hathaway and Diversified. Wesco, residing inside Blue Chip and with Munger as chairman, would be another new doll among the rest.24
Then, no sooner had Blue Chip bought the majority of Wesco than the whole stock market fell apart.25 Buffett’s stake in the Washington Post lost a quarter of its value.26 Ordinarily he would have bought more, but he had promised Graham that he wouldn’t. Instead, he recommended it to his friends, and looked for new opportunities.27 He bought National Presto, maker of pressure cookers and popcorn poppers,28 and Vornado Realty Trust, which put him on its board.29
Buffett had a set of legacy shareholders at Berkshire Hathaway who understood his investing approach and would never question his judgment. Thus he had earned the luxury of ignoring Mr. Market, which had marked down the value of his portfolio to a fire-sale price. Others were not so lucky. Bill Ruane’s Sequoia Fund was headed for a terrible year, and Ruane’s main financial backer and friend, Bob Malott, was unhappy and sold on Buffett’s approach and track record instead. He asked for Buffett’s help with the pension fund of FMC Corporation, the company he now headed. So Buffett went to San Diego and spent several days interviewing investment managers and explaining his thinking to FMC’s investment people. At first he said no to the request of managing the portfolio himself—then eventually agreed to manage a portion.30 Along with his acceptance, he gave a warning: FMC would come last among his priorities, after Berkshire and Diversified, and Warren and Susie Buffett. The canny Malott jumped at the opportunity anyway, not mistaking the larger point: That Buffett was willing to do it at all meant that he would do it well.31
Between his duties at FMC, Vornado, Blue Chip, and Wesco, and regular trips to New York, Buffett was now traveling much of the time. He was also busy courting Katharine Graham and had made such a good impression on her that she began to call him for advice. Susie made the rounds of Omaha, busy with the board of the Urban League, still giving out her scholarships and taking on other crusades.
As 1973 progressed, even Hamilton the dog must have noticed the silence and emptiness descending on the Buffetts’ crazy, noisy home.32 Howie was two hundred and seventy-five miles away from Omaha at Augustana College. Susie Jr., unhappy with Lincoln, had transferred to the University of California, Irvine, where she was majoring in criminal justice.33 Susie had taken her confidante, Peter, a high school sophomore, to look at schools in Orange County. Instead of moving, they stayed in Omaha. Susie had gotten Peter interested in photography, and now he spent much of his time in the basement, where his mother had built him a darkroom.34
Often now Susie stayed up late at night alone, listening to music that transported her to some different place.35 She loved the jazz guitar of Wes Montgomery and great soul music, like the Temptations, who sang of a world in which it was men who felt all the longing.36 She read books like I Know Why the Caged Bird Sings, Maya Angelou’s autobiographical account of overcoming the forces of racism, sexual abuse, and repression that made her early years a prison. “The idea of being confined in a place not of your choosing ran deep for her,” Peter says—not surprising after her childhood shut away in a sickroom, and growing up with a sister who was disciplined by being locked in a closet. Susie longed for romance, but now understood that she and Milt were never going to get married. Nevertheless, she could not bring herself to give up her relationship with him.
She was also spending more time with her tennis crowd of younger people at Dewey Park. One, John McCabe, a coach with a subdued personality, a sadness somewhat like her own, and a certain fragility, resembled most of her other lonelyhearts, but she seemed particularly drawn to him.37 Susie now had reasons to be away from the house most of the time. The rhythm of the house slowed from its all-day carnival atmosphere. Peter, never much attuned to his parents’ lives, noticed only the growing silence, not its cause. When he got home from school, he petted Hamilton, made something for himself for dinner, and headed downstairs to the darkroom.38
Warren’s conception of his marriage had never changed, even though the marriage itself was changing inexorably. When he was home, Susie still seemed just as devoted to him as ever. He saw how active and busy she was and wanted her to be fulfilled, as long as she continued to take care of him—which he assumed was fulfilling to her. As far as he knew, the balancing act that had always worked for them still did.
The “retired” Warren was investing at full throttle ahead in late 1973, in the midst of a market swoon. Between Cap Cities and the Washington Post and his growing friendship with Kay Graham, his interest in media over the past few years had permutated into a deep understanding of the subject at all levels. One night at dinner in Laguna Beach, he and Carol Loomis started strafing Buffett’s friend Dick Holland, who worked in advertising, with questions about the advertising business. “Whenever he did that,” Holland recalls, “I always knew something was cooking.” Sure enough, as a secondary way to play media, Buffett plunked down a huge amount—almost $3 million—for the stocks of advertising agencies Interpublic, J. Walter Thompson, and Ogilvy & Mather, stocks so distressed he paid less than three times their earnings.
As 1974 began, stocks for which he had recently paid $50 million lost a quarter of their value. Berkshire, too, slid down to $64 per share. Some of the former partners began to fear it had been a mistake to keep the stock.
Buffett saw it just the opposite way. He wanted to buy more Berkshire and Blue Chip. But “I’d run out of gas. I had used all the $16 million of cash I got out of the partnership to buy stock in Berkshire and Blue Chip. So all of a sudden I woke up one day and had no money at all. I was getting $50,000 a year salary from Berkshire Hathaway and some fees from FMC.39 But I had to start my personal net worth over again from zero.”
He was very, very rich but cash-poor. Yet the companies he controlled, especially Berkshire Hathaway, had cash to buy stocks. To move some of Berkshire’s money to Diversified, Buffett sent a pipeline into Berkshire. He set up a reinsurance company—a company that insures other insurers40—in Diversified. This company, Reinsurance Corp. of Nebraska, agreed to take part of National Indemnity’s business, receiving premiums and covering losses. Because National Indemnity was so profitable and generated so much “float”—premiums paid ahead of claims, i.e., cash—as time passed, the pipeline would give Diversified millions more dollars to invest.41
With this money, Buffett began to buy stocks for Diversified. Principally he bought stock in Blue Chip and Berkshire Hathaway. Soon, Diversified owned ten percent of Berkshire. It was almost as though Berkshire was buying back its own stock—but not quite. Diversified’s owners and Berkshire’s weren’t the same. Buffett still forbade his friends to buy Berkshire—whereas he, Munger, and Gottesman were partners in Diversified.42
At the time, even though the three did one another business favors and swapped stock ideas on occasion, their interests didn’t necessarily align. Asked later under oath if he was Buffett’s “alter ego,” Munger said no. He acknowledged similar mannerisms and ways of speech. But “I’ve never chosen a role of being a junior partner,” he said. “I like the idea of having a sphere of activity” of my own.43 On one occasion, Munger said, he had found a block of Blue Chip stock that he and Gottesman wanted to buy for Diversified. Buffett wanted to take the block away from them and buy it for Berkshire Hathaway. After “a discussion”—clearly about who needed it more—the combined strength of Munger and Gottesman had somehow overpowered Buffett, and Diversified got the stock.44 At least that way they kept a little share.
Still, Buffett did own forty-three percent of Diversified, so its purchases of Berkshire had added almost five percent to his personal ownership. Buying through Diversified was particularly attractive in that it tended not to ratchet up Berkshire’s stock price. Hardly anybody was paying attention.45
But why did he want it at all?
“Berkshire was not worth more than forty bucks as a business. You couldn’t have sold the textile mills and insurance business for more. And half the money was in a lousy business, I mean a really lousy business: twenty bucks a share of the forty bucks. And I didn’t know what I was going to do, I literally didn’t. I mean, I was rich enough already. But in effect, I was betting that I could do something. I was betting on myself.”
He didn’t know what he was going to do, except invest. Verne McKenzie, who had returned from New Bedford to become Berkshire’s controller, thought that to Buffett, it simply “looked like an interesting game. All he was doing was solidifying his control.” That he was, and doing so in the manner in which he always approached investing—as a collector, one who bought in secrecy to avoid tipping off other bargain hunters. But as the chairman of Berkshire Hathaway and Diversified, he was once again mostly buying from sellers who had been his former partners. Although perfectly legal, it was not exactly sporting conduct. But their willingness to sell, in his mind, ended his special obligation to them.
Buffett had also been buying Blue Chip Stamps all along, though so far, Blue Chip had remained primarily Munger’s province. It owned the best of the businesses, however, namely See’s. Now Buffett began to pursue Blue Chip stock like a great white shark after a well-fed seal. Buffett’s ownership of Blue Chip quickly surpassed the combined interest of his partners in that stock, Munger and Rick Guerin—Munger’s associate from the Pacific Coast Stock Exchange, who now ran an investment partnership of his own.
Buffett’s accumulation of all these stocks, however, differed from his buying in the era of cheap cigar butts. Two large question marks hung over Blue Chip, Diversified, and Berkshire. All that money pouring in to both Berkshire and Diversified from the insurance business would have to be put to good use. And the bet on Blue Chip’s legal problems would have to work out.
By year-end 1973, Blue Chip had settled eleven lawsuits.46 All that remained was the Justice Department’s ruling that it divest one-third of its business to cure its monopoly. That would not be easy because inflation had run rampant, President Nixon had frozen prices on commodities to try to halt it, and commerce had entered a new era of trying to match rising costs to frozen consumer prices.
The stamp business was dead, but Buffett, the implacable acquirer, had his stock. After this series of trading gyrations, Blue Chip had Wattled its way into the set of Russian dolls. “It was the same principle,” Buffett says. Including all the pockets in which he had bought shares indirectly, he owned more than forty percent of Berkshire and more than twenty-five percent of Blue Chip Stamps. Even though these stocks traded at depressed prices, he could fund more deals and buy more stocks because all of the dolls had their own self-charging batteries, “float,” cash that could be invested in advance of paying claims. This innovation dramatically improved the deal.
The businesses themselves had also improved since the dismal days of windmills and fire maps. Berkshire owned not only the whopping float-generator National Indemnity but also a clutch of little insurance companies that Buffett hoped would eventually turn into small powerhouses, even though he was struggling to whip them into shape. Meanwhile, the deadweight of Hochschild-Kohn had disappeared and Buffett kept shrinking the textile mills.
But in the bigger picture, what Berkshire, Diversified, and Blue Chip really possessed were two things. The first was the homeostatic business model—the idea of grafting float onto a holding company so that it could respond internally to the changing environment. The second was the power of compounding, as float and investments doubled and redoubled over time.
The novelty and strength of Buffett’s model cannot be overstated. Nothing else like it existed, or would for years to come. “That was the golden period of textbook capital allocation,” he says.
The timing was stupendous. Capital from the insurance companies was pouring into Berkshire and DRC at the same time that the market was collapsing, the environment that Buffett liked best. While he had not yet decided exactly what to do with the collective enterprise he had built by the end of 1974, of two things he was certain. One was the business model’s power, and the other his skill in using it. Above all, he had confidence in himself.
“Always,” he says. “Always.”