Buffett exemplifies the eight traits we gleaned from the research about female versus male investors exceptionally well, and he certainly is a shining example of market-beating performance. But we can’t sum him up that easily. We’ve got to add three additional principles to fully understand what makes Buffett Buffett, what makes him tick, what makes him special, and what makes him the master investor he is. After all, if we are to become better investors ourselves, and that’s certainly the goal here, we need to know everything we can about what makes Buffett do the things he does and act the way he acts.
Our first Buffett-centric principle, then, is to value and cultivate your relationships with people. This is something Buffett considers vital to good business. Building lasting relationships with the people you are working with, or investing your money with, or going into business with, is important for long-term success. Buffett places a premium on people, even sometimes putting them ahead of the potential for more profit, and he speaks proudly of this fact.
In a letter to his partners way back in 1968, Buffett said, “When I am dealing with people I like in businesses I find stimulating (what business isn’t?), and achieving worthwhile overall returns on capital employed (say, ten to twelve percent), it seems foolish to rush from situation to situation to earn a few more percentage points. It also does not seem sensible to me to trade known pleasant personal relationships with high-grade people, at a decent rate of return, for possible irritation, aggravation, or worse at potentially higher returns.”1
And in his 1989 Berkshire letter to shareholders, Buffett echoed this thought, saying, “We have found splendid business relationships to be so rare and so enjoyable that we want to retain all we develop. This decision is particularly easy for us because we feel that these relationships will produce good—though perhaps not optimal—financial results. Considering that, we think it makes little sense for us to give up time with people we know to be interesting and admirable for time with others we do not know and who are likely to have human qualities far closer to average.”2
Given that we know Buffett is concerned with allocating his capital the most efficient way he can, the fact that he places a high enough value on his relationships to forgo the potential for higher-profit endeavors in favor of continuing to work with people he knows, likes, and trusts shows us how meaningful this is to him. Now, granted, he undoubtedly hopes and wishes that this trade-off won’t be necessary, and he’ll ideally find situations where he’s both making as much money as he possibly can and likes the folks he’s doing it with. And in fact, Buffett’s been adept at finding this mix over his long career.
Speaking of Buffett’s focus on the “people” side of investing, Nell Minow, editor and cofounder of The Corporate Library, an organization that focuses on corporate governance, said, “I think one of the most impressive things about him is not the way he looks at stocks, although gosh knows he is very good at math, but the way he looks at people. He has been an excellent judge of people all the way along.”3
Look at someone like Rose Blumkin, whom we talked about earlier. She was as dedicated to running Nebraska Furniture Mart as Buffett is to investing. He admired her and counted her among the greatest business minds he’d ever known. He knew he didn’t need to help Mrs. B run her store; she knew quite well what to do. In turn, she kept working hard for him, growing her business as if she’d never sold it in the first place. And that’s exactly as Buffett wants it.
When Buffett buys a company for Berkshire, unlike many other acquirers, he doesn’t run right in and start implementing new rules, changing management, and generally stirring up trouble. He buys a company when he believes in the existing management and with the current way a company’s being run—otherwise, he’d look elsewhere for opportunities. Buffett does as little as possible to upset the status quo, leaving the management team alone to keep doing what they’re doing. He provides guidance and support as needed, but he mostly just stays out of the way.
He feels comfortable operating this way because of the value he places on working with good, smart, motivated people. It makes it easier to sleep at night when you trust the people you’re in business with, whether that means buying an entire company outright, or investing in shares of one. For Buffett, quite simply, people matter.
Writing in the Berkshire “Owner’s Manual,” Buffett says of the managers of Berkshire’s subsidiary businesses, “Most of our managers are independently wealthy, and it’s therefore up to us to create a climate that encourages them to choose working with Berkshire over golfing or fishing. This leaves us needing to treat them fairly and in the manner that we would wish to be treated if our positions were reversed.”4
For us, we may not be thinking about buying whole businesses outright (yet), but the people factor still is important. Knowing who’s in charge of a company you’re thinking about buying shares of is every bit as crucial as it is when Buffett gets to know the people running a business he wants to own.
Now, obviously, it’s a little bit easier for Buffett to get face time with those people than it would be for us to, say, call a meeting with the folks in charge of Coca-Cola. But you can still do research and learn as much as you can about just who it is you’re entrusting with your money. And that is the best way to think about it. It helps keep the importance of having solid, trustworthy management front and center.
KEYS TO ASSESSING MANAGEMENT
“Evaluating company management or a CEO is not easy because different individual qualities can engender success in different circumstances. But I can certainly tell you two fundamental questions to ask. First, are the management team and the current CEO competent? Second, are management incentives properly aligned with shareholder interests?
“To answer the first question, I review the company’s performance over several years. For example, when I evaluated Johnson & Johnson and its management, I examined the company’s earnings, the return on equity, and the allocation of cash flows for more than 25 years. I prefer evaluating a company’s performance over a long period to discover whether management teams can deliver positive results under different CEOs. While it is important to evaluate several metrics, a carefully computed return on equity ratio is probably the most important metric for determining management competence. I found consistently good performance over the entire period, and I did not spot any incongruent acquisitions, large equity issuances, or egregious ethical violations. To me, the results reflected disciplined management. I also read all of the CEO William Weldon’s letters to shareholders since he was appointed in 2002.
“To answer the second question, I check the number of shares held by the CEO and other top managers in the company. I am suspicious of CEOs who are awarded a large number of stock options but hold only a small number of shares. In addition, I prefer CEOs who have been with the company for a long time and are promoted from within. They should at the very least have experience in the same industry. Finally, I try to learn about their lifestyle. A CEO with an extravagant lifestyle is less likely to be prudent with shareholders’ money than a CEO who lives more modestly.
It’s easy to find out the names of the top executives at a company you’re considering investing in. From there, be like Buffett and read all you can about them. If the company has a website, check it out to see if there are bios available for the top brass. Google the names to see what you can come up with. Read interviews with them if you can find any, or articles written about them or the company. Fool.com is a good place to start. You’re looking to find out how long they’ve been with the company, what their history there is, how much stock of the company they’re running they own, and just generally whether you can get a feel for what type of person’s in charge.
The desired qualities in management are the same ones we see personified in Buffett—honesty, humility, a passion for business, loyalty, a sense of fairness, an ownership-minded outlook, and even a sense of humor, if you can get it. Someone like Jim Sinegal (whom Prem Jain also singled out; see the sidebar), Costco’s cofounder and chief executive officer, is a perfect example. Buffett’s owned shares of warehouse retailer Costco for Berkshire, and it’s easy to see why. Not only is the business strong, but it’s smartly run by a guy who’s cut from the same mold that Buffett is.
Sinegal has no pretense about him. He speaks clearly about his business to shareholders and the media alike. He’s humble and even answers his own phone—this at a company with a market cap north of $25 billion. (Yes, he really does answer it! But leave the man alone. He’s got a business to run, for Pete’s sake.) He’s passionate about Costco and its employees, too, meaning that people also matter to him as they do to Buffett. He’s committed to treating his employees better than average, providing them health insurance, and paying them above-market wages. He believes that all the involved constituencies in a business—shareholders, employees, and customers alike—can win.
You wouldn’t even have to know that Berkshire owned shares of Costco to figure any of this out. Just reading interviews with Sinegal and learning about the man himself would show you that he’s someone you can believe in and trust with your money. He’s never cagey, and Costco doesn’t play any accounting shenanigans. Every single tube in that hundred-pack of Aquafresh is accounted for and noted. It’s a straightforward company run by a similarly straightforward guy.
HOW THE PROS JUDGE MANAGEMENT
Rapuano says, “I’ve found that just because somebody’s a really smart guy or girl, that doesn’t mean they’re a great manager of a company. So what I’m assessing on that side is almost always just whether they are very good at capital allocation. That’s not just whether or not you buy back stock or what kind of debt you use. That’s also what R&D you fund, how you choose to grow, do you understand earning excess returns in your business, and do you understand when it’s appropriate not to invest. So I judge the quality of management almost exclusively on whether they get that capital allocation piece of the pie.
“For an average investor, they can do the mathematical thing that I do, which is look at their history of capital allocation. That’s something that anyone can do, because you just need the 10-Ks to do that. But the objective judgment of a management team is much tougher. You can’t really tell from seeing a guy on CNBC if you can trust him or not.
“You can learn a lot from the conference calls, though. You can learn a lot from how they answer the questions, whether they answer them straightforwardly and how they frame their answers, whether they’re aggressive or conciliatory. But you are a little bit out of luck, as an individual, not having access necessarily to them. And frankly, even as a small firm, I don’t always have access to CEOs and CFOs. I usually have to win my way into their hearts by proving that I’ve done all the work, and that often takes a long period of time. Eventually I get in. Sometimes it takes a lot of phone calls, though, asking questions that the IR [investor relations] person can’t answer, to demonstrate my interest and my integrity and the work that we’ve done before finally getting the CEO or the CFO to pay attention.”6
In addition to placing importance on the people he does business with, whether he’s buying their company or investing in it, Buffett has also maintained close relationships with certain people for years. He is steadfastly loyal to those close to him. Charlie Munger, who serves as Berkshire’s vice chairman and Buffett’s right-hand man, is the first and primary person who comes to mind. He is as close to Buffett as anyone has likely ever been and is likely ever to get.
Buffett and Munger (who, as it happens, was also raised in Omaha and even worked in Buffett’s grandfather’s grocery store as a teenager) met in 1959, and from the beginning, this was a friendship destined to endure.8 A pair of brainy bookworms, they were both interested in investing and quickly fell into talking for hours on the phone (Munger was living in California, while Buffett was, of course, in Nebraska) and seeing each other in person when they could.9
Before long, Buffett and Munger were investing together, doing deals in concert, starting with the aforementioned Hochschild-Kohn investment in 1966. From there they (thankfully) moved on to other, more successful ventures, until they finally combined forces officially. In 1982 Munger became vice chairman of Berkshire Hathaway.10 Trying to imagine Buffett without Munger is like trying to imagine any famous duo throughout time without both partners. It’s Lewis without Clark. Captain without Tennille. Hansel without Gretel. Chocolate without peanut butter.
In other words, Buffett with no Munger would mean a very different future and scenario for both men today. It isn’t only that they’re pals, either. Munger has had a tremendous influence on Buffett, helping the way he thinks about investing evolve beyond the strict Grahamian cigar butt school of thought. We’ll get further into Munger’s influence on Buffett in our next chapter.
Another person whom Buffett counts as a close friend might surprise you, given Buffett’s public aversion to technology—that’s Bill Gates, cofounder of computer software giant Microsoft. The two, who have since volleyed back and forth in rankings on the Forbes list of richest people in the world, met in 1991. They formed a quick friendship, built on mutual respect and appreciation for one another. Buffett got Gates to take up his favorite pastime, bridge, and even helped out when Gates was asking for his wife’s hand in marriage. (Buffett and Gates tricked Melinda, his betrothed, into coming to Omaha and then opened up Borsheim’s, a local jewelry store Berkshire Hathaway owns, for her to choose her engagement ring.)11
Though it began as a friendship, it has grown into a business relationship, with Buffett asking Gates to serve on the board of directors of Berkshire in 2004. In June 2006 Buffett announced that he would be donating 85 percent of his Berkshire Hathaway stock over time to charitable organizations, with the bulk of that going to the Bill & Melinda Gates Foundation.12 More recently, Buffett and Gates have started a campaign together to encourage other billionaires to donate half their money to charity.13
Buffett is loyal to his inner circle of friends, choosing to work with and interact with the same core group for years. In addition to Munger and Gates, he’s tight with Tom Murphy, who was in charge of Capital Cities, the company that eventually bought the television network ABC, and then would sell to Disney. Berkshire owned shares of ABC at the time it was sold, and Buffett actually counts not investing in an earlier TV deal that Murphy was selling him on as one of his biggest mistakes of omission.
Through the years he was also close friends with the late Bill Ruane, a talented fund manager Buffett met at Columbia. It was actually Ruane’s newly formed Sequoia fund that Buffett suggested his partners invest in when he shut down his partnership in 1969.14 Buffett met Walter Schloss, another giant of the value investing world, at the first annual meeting he ever attended, while he was at Columbia.15 Buffett featured both Ruane and Schloss, along with Munger, in his “Graham and Doddsville” speech at Columbia as examples of investors like himself whose long track records of success at picking stocks made the efficient market theory look like hogwash.
Buffett realizes that the people you choose to do business with and associate with can have a huge effect on your outcome. He also knows that good businesses do better with good people in charge, people you can trust to behave ethically and honestly. The most perfect business in the world, with a large, well-protected moat, ample cash flows, and a fat margin of safety won’t compel him to invest unless the people portion of the equation is just as strong. And once he’s committed to a business with management he likes, he is loyal and sticks by them.
Writing in his 1986 letter to shareholders, Buffett said, “We intend to continue our practice of working only with people whom we like and admire. This policy not only maximized our chances for good results, it also ensures us an extraordinarily good time. On the other hand, working with people who cause your stomach to churn seems much like marrying for money—probably a bad idea under any circumstances, but absolute madness if you are already rich.”16
For us, this is something we can also put into play in our investing lives, and we should. Keep the following in mind:
• A business is only as strong as the people running it.
• Read up on the management of companies you are considering investing in. Look for smart, open, loyal, fair executives you can admire.
• Don’t be afraid to put people before profit; Buffett isn’t.