At one point the world’s wealthiest, billionaire Warren Buffett is still one of the richest today with an estimated net worth over $73 billion dollars. That’s a lot of money!
While best known today as the CEO and investment manager at the conglomerate Berkshire Hathaway (BRK-A), the legendary investor’s real secret to getting rich comes from early career after a brief stint on Wall Street.
Of course, he wasn’t born destitute. He grew up in Omaha, Nebraska, where he learned about stocks from his stockbroker father, and bought his first shares of stock at age 12. Later, his father Howard would be elected to Congress, and Buffett spent his teenage years in Washington D.C.
Besides his interest in stocks, young Buffett had a number of businesses, from renting out a car to placing and fixing pinball machines in barber shops and other locales, besides first working in the family grocery store, learning the principles of accounting and money.
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After earning a master’s degree in economics at Columbia University in 1951, Buffett spent a few years on Wall Street working under Benjamin Graham. Graham, known for creating the science of value investing, was an early influencer on Buffett, and even taught him while at Columbia. Graham’s book The Intelligent Investor, was the first authoritative tome on the concept of investing with an eye towards value, and is still published and read today.
Buffett spent just a few years on Wall Street working under Graham, before heading back to his hometown of Omaha, making his first real estate purchase with the home he still lives in today. This is where the story of Buffett’s wealth gets interesting.
Big Things From Small Beginnings
Seeking out friends and family, Buffett started an investment partnership in 1956. Much like an early hedge fund, Buffett would take a percentage of any profits he made above a set amount. Unlike today’s modern hedge funds, he didn’t charge large up-front fees.
The first partnership started with $105,000. Buffett contributed a mere $100 of his own money. By the time Buffett dissolved his partnerships at the end of the 1960’s, he would be a multi-millionaire and well on his way to billionaire status.
But that $100 of money was more than enough to get started. In the 1950’s, before the internet, research into a company’s financials proved much more difficult and time-consuming. The benefit from that extra work was the reward. This was still an era where an investor could find what Ben Graham termed “net-nets,” or companies that had assets on hand such as cash or land that as at least equal to the value of what shares were trading for. Today, this concept survives as book value.
Buffett’s focus as a deep value investor allowed him to profit from these opportunities throughout the 1950’s and 1960’s. He also bucked the trend of diversification, often putting as much as 30 percent or more of the fund into a single name. This allowed him to acquire board seats, and get management at companies to sell of lagging divisions, declare large dividends to return cash to shareholders, and other measures that would allow Buffett to profit.
The First Brush With Blue Chip Trades
It was also during the investment partnership era that Buffett started to rethink value in terms of financial statements and numbers and into thinking about a business as a whole. His real opportunity came in 1960, when American Express shares took a dive. The company had a warehouse subsidiary that had guaranteed the soybean oil inventory of the Allied Crude Vegetable Oil Refining Corporation.
There was just one problem: The tanks were filled with saltwater. American Express shares tumbled on the news. Buffett started buying. He knew that the company’s core business of traveler’s checks was a solid one, and wouldn’t be hurt by the scandal. Rather than try to milk out as much money as possible, Buffett used his position as a shareholder to encourage the company to try and work out an amicable solution.
While the stock market chipped off over $125 million in the company’s market cap—a sizeable percentage in those days, AmEx was eventually able to reach an agreement that only cost the company $32 million. Shares rebounded quickly and Buffett was able to add to his fortune, having learned that buying great companies during moments of fear, uncertainty, and doubt, were the way to go.
By owning companies like American Express, which Buffett has dubbed “compounding machines,” an investor can get a great return, increase their holding period, and indefinitely hold off income taxes from selling the shares. Avoiding taxes from a long holding period have since become a hallmark of Buffett’s investment style.
The Buffett Partnership Returns
This two-fold focus on deep value companies based on financial metrics and buying beaten-down blue chips led to great returns. Between 1957 and 1965, Buffett’s partnerships were able to earn a return of 29.8 percent annually, more than twice the 11.4 percent return of the Dow Jones Industrial Average during the same time.
The success of the partnership led to additional investors over the years under a limited partnership agreement. It performed nearly as well as the regular partnership.
By the 1960’s, Buffett was pursuing all attractive opportunities, and thought he found one in a textile company, Berkshire-Hathaway. He had started buying shares in 1962 at $7.50, thinking the company was worth far more.
While the textile business was rapidly receding in New England for lower wages in the South or overseas, the company had a large cash position and had a number of other assets that made it look attractive relative to its liquidation value.
When the company closed some of its textile plants in 1964 and made a tender offer for shares, Buffett came to an agreement to sell his shares for $11.50, a 50 percent gain on the price he had paid in 1962.
However, the tender letter came in at $11.375 per share. Buffett, slighted by the management’s attempt to buy him out an eighth-of-a-dollar short, decided to buy more shares with his money instead. By 1965, Buffett would control over 38 percent of shares, which had since risen to $14.86. The CEO was let go, and Warren Buffett appointed himself Berkshire Hathaway CEO.
Buffett has since said this was the worst investment he ever made, as the textile operations continued to lose business and were eventually shut down in the 1980’s. Had he instead bought an insurance company outright instead of using Berkshire as a vehicle to buy insurance (and later other) companies, Buffett believes the total difference in value would be about $200 billion greater.
Shifting From Partner to CEO
As the largest shareholder, Buffett made himself CEO, and Warren Buffett’s Berkshire Hathaway started on the path to the giant conglomerate it is today.
Buffett dissolved his partnerships in the late 1960’s, citing the fact that a rising market and their own market-beating returns were unlikely to occur in the future. That’s in stark contrast to most funds, which tend to operate perpetually or until a large market drawdown forces their closure.
Using Berkshire’s cash hoard and cash flow from its diminishing textile operations, Buffett started using Berkshire as a vehicle to acquire entire companies. His first focus was on the insurance business. As Buffett has often noted, the insurance business is heavily regulated yet profitable. And policyholders have to pay money in before they get out. On some policies, like auto insurance, they may never have a claim.
All the money held by an insurance company that doesn’t have to be paid out right away is known as “float.” It’s a powerful and inexpensive form of other people’s money, and Buffett has used that float to buy more companies, which in turn has led to more cash flow, which in turn leads to more money being available to buy more companies.
This is the process of compound interest, and by finding a source of funds that cost nothing most years, Buffett was able to increase his wealth at a rapid rate, much faster than buying dividend-paying stocks or real estate would have provided.
During the 1970’s, the stock market performed poorly, following the bull market run of the 1960’s. Valuations dropped as inflation raged. But most companies were able to pass inflation costs onto consumers in the form of higher prices. That was part of the reason behind Buffett’s decision to buy See’s Candies in 1972. The west-coast chocolatier has been able to raise prices without losing business every year since.
A steep bear market in 1973 allowed Buffett to start buying the Washington Post Company, parent company of The Washington Post now owned by Amazon. Pre-internet Buffett was a huge buyer of newspapers in whole or in part, as a newspaper often provided a local monopoly on advertising. Limited competitors are a key criterion that Buffett looks for when making an investment. While anyone can start a newspaper, by the 1970’s most markets had few if any competitors, save for national papers such as the Wall Street Journal or U.S.A. Today.
The Berkshire Phenomenon
It was in the 1970’s that Buffett, quietly operating far from Wall Street, started to get on Wall Street’s radar. By then, the multi-millionaire was making his own moves and cutting deals to acquire entire companies. Traders in-the-know started quietly buying Berkshire shares, which have never split, and have provided an excellent return, even as they’ve never paid a dividend.
Buffett continued buying in the 1970’s, focusing on the values that were emerging as the stock market sold off. He continued adding to insurance operations, including the initial stake in Geico Insurance, which today is wholly owned by Berkshire. With many investors exhausted by the poor performance of the 1970’s, Buffett ended the decade worth over $140 million. Most of that wealth came from growing the value of Berkshire, where, as CEO, Buffett was only taking home $50,000.
In 1982, at the start of a new bull market, another phenomenon happened as well. That was when America hit a new era focused on wealth creation. Forbes magazine listed Buffett in its first list of the Forbes 400, outlining the 400 wealthiest people in America. At the time, Buffett’s net worth was listed at $250 million. Today, to make the list, one needs to be a billionaire.
Most of the top performers on the Forbes 400 have made their money from either starting a business or real estate. Buffett still remains at the top for those who have created their wealth strictly through investment acumen.
Warren Buffett’s net worth didn’t top one billion dollars until 1982, when he was in his 50’s.
Many have tried to take the mantle of “greatest investor” from Buffett. But his reputation and track record of using deep, intrinsic value and owning great companies for the long haul, combined with folksy investment advice, have proven the test of time.
There are dozens of books doing a deep dive on how Buffett values companies, to the investing history of Buffett, to books that just collect Warren Buffett quotes. Warren Buffett’s portfolio is widely followed by investors who seek to follow Buffett into the next top-performing stock.
While best known today for his value approach in large-cap stocks, young Buffett was able to amass the beginnings of his first billion by running an investment partnership much like a hedge fund, almost entirely with borrowed money to start. And Buffett has long invested in ways that provide him with more capital to invest, whether from the capital provided by partners or from the “float” of insurance companies. These are skills that any investor can use to build their own wealth.
And, of course, investors can buy Buffett’s investment prowess themselves by becoming Berkshire Hathaway shareholders. While Berkshire stock famously pays no dividend yield, the combination of owned subsidiaries and a trackable stock portfolio make for an inexpensive alternative to buying a mutual fund.