Part 5: SimoleonSense Interviews Warren Buffett's Biographer, Alice Schroeder.
Copyright 2010 Alice Schroeder & Miguel Barbosa
Please do not repost without asking for permission.
Miguel: How is Warren different than other value investors?
Alice: He's more interested in money, for one thing (laughs).
In terms of how that affects his investing behavior, number one, in his classic investments he expends a lot of energy checking out details and ferreting out nuggets of information, way beyond the balance sheet. He would go back and look at the company's history in depth for decades. He used to pay people to attend shareholder meetings and ask questions for him. He checked out the personal lives of people who ran companies he invested in. He wanted to know about their financial status, their personal habits, what motivated them. He behaves like an investigative journalist. All this stuff about flipping through Moody's Manual's picking stocks … it was a screen for him, but he didn't stop there.
Number two, his knowledge of business history, politics, and macroeconomics is both encyclopedic and detailed, which informs everything he does. If candy sales are up in a particular zip code in California, he knows what it means because he knows the demographics of that zip code and what's going on in the California economy. When cotton prices fluctuate, he knows how that affects all sorts of businesses. And so on.
The third aspect is the way he looks at business models. The best way I can describe this is that it's as if you and I see an animal, and he sees its DNA. He isn't interested in whether the animal is furry; all he sees is whether it can run and how well it will reproduce, which are the two key elements that determine whether its species will thrive.
I remember when his daughter opened her knitting shop. Many parents would say, I'm so proud of Susie, she's so creative, this is something of her own, maybe she can make a living at it. Warren's version is, I'm so proud of Susie, I think a knitting shop can produce half a million a year in sales, they're paying whatever a square foot for the storefront, and labor is cheap in Omaha. It was similar when Peter was producing his multimedia show, The Seventh Fire. Many parents would say, wow, my son has pulled off a critically acclaimed show. Warren obviously thought that, but what he articulated was, they're charging $40 a ticket, I think the Omaha market is too small for that price point, whereas in St. Louis they may cover the overhead, and I think he paid too much for the tent because the audience doesn't really care what kind of tent it's sitting in and it hurts margins, etc. etc.
Miguel: Speaking of tents. I have never been to the BRK shareholder meeting. Has it become cult-like at this point?
Alice: I started going in the late 90's. I envy people who were going earlier. But I've been going long enough to see how it has grown over the years and turned into more of a circus. Warren has got a huge streak of P.T. Barnum in him and likes to put on a show that every year, tops itself. He encourages the cult. It's like the nerdy kid whose lunch money was stolen grew up, and now even the popular kids treat him like a god. Put yourself in his shoes and you'll get a sense of it.
From the perspective of the shareholders, I think there used to be more serious investing content. Warren uses set pieces to describe certain ideas that he repeats tirelessly. This is efficient; he'll never be caught out for being inconsistent; it drills home his points through repetition. It's also simply the way his mind works. He thinks of a story to explain a concept (See's Candies = moat) and when the subject comes up, he turns on the mental tape recorder and it plays. Repetition doesn't bore him the way it bores other people.
At the shareholder meeting, I do think the repetition stokes the cult because it discourages people who used to come for the unfolding, unique quality of the dialogue from attending.
Miguel: Okay, so back to Warren tell us about his ruthless side?
Alice: Sure…sure… How he bought National Indemnity; how he bought stock back from his partners; how he bought and got his price for Nebraska Furniture Mart; how he has dealt with labor unions. Salomon is another instance, and probably the best publicly-known example.
To use a nonpublic example, I've seen him "encourage" people to do what he wants by subtly raising the possibility of what he might leave them in his will. But without promising anything. This is torture for some people; they are always working for a commitment that never comes.
Another aspect to it is the degree to which other people are the bad cop when it's necessary to be ruthless. I once commented to him on the way he uses other people as surrogates to protect himself from being the bad guy, and his response was, "Prepare to be enlisted," not really jokingly. Now that I think of it, in a sense, I did get enlisted.
Giving the managers sole responsibility for everything that happens at their businesses is always described as a unique and friendly aspect of Berkshire. While that is true on one level, it is also a way of protecting Warren. Warren takes being risk-averse to a level that is barely comprehensible. He has boundaries made of steel. If he can't control something completely he doesn't want to control it at all. It's how he behaved with the partnership, and he's extended this to Berkshire Hathaway.
Therefore, this way of delegating "to the point of abdication" (in his words) is actually filed with the SEC; the 10-K for Berkshire Hathaway emphasizes that it is unusually decentralized and that Warren delegates to an extreme degree. I've seen Warren claim that he cannot overrule a decision of Debbie Bosanek: not that he is delegating to her, but that he actually isn't empowered to overrule her.
If there were ever a serious shareholder class action lawsuit, the lawyers would pull out the 10-K and claim that Warren should not be deposed because he is not really responsible for what happens at Berkshire. There's an absurdity to it, because the CEO of a company is responsible for the actions of his direct reports whether he wants to be or not. Their title is manager, not CEO.
Lastly, Warren can sometimes have a hard time seeing the human side of things. So for example, when his sister was close to filing for bankruptcy after the crash of 1987, he rationalized not helping her on the grounds that if he helped her, he was helping her creditors, who were market speculators. His kids have been on the receiving end of similar episodes, large and small, for years. But I'd rather not tell other peoples' stories and expose them to the potential consequences.
Miguel: I see what you're saying. I remember a story regarding his children (or friends of his children) and him saying "If I do it for you, I have to do it for everyone."
Alice: That's a favorite phrase of his. It's actually a great concept. He's wise to be wary of setting precedents. You have to think through the whole chain of consequences before you agree to what might seem like a small favor. That's especially true of someone in his position.
Still, it can become a catch-all excuse. It's not true that if he gave money to one friend's charity, he would have to give to everybody's. You can make distinctions between your kids based on their individual needs. He's capable of making choices.
Miguel: What you are saying about setting precedents? It reminds me of Cialdini's tactics of persuasion and especially reciprocation and foot in the door technique.
Alice: Yes…When I read Cialdini I thought, "Gosh. It's as if Warren wrote this book based on his experience."
Miguel: He understands the psychology of people.
Alice: Reciprocity and Social Proof. Those are his top two techniques.
I think it was also Cialdini who mentioned that if people do you a favor they like you more. Warren has an ability to get people to invest psychologically in him.
One reason he prefers people visit him in Omaha is that somebody spending the time and money to make that journey is going to leave persuaded. They aren't going to go away thinking they wasted their money. Because the way you resolve cognitive dissonance is in whatever way makes you feel most comfortable.
Now obviously it's not a waste to go see Buffett speak. What I'm saying is that this kind of structural persuasion and elicited psychological investment tilts the odds in his favor.
Miguel: So it's almost like an emotional sunk cost. You don't think of it as a sunk cost so you keep reinvesting emotional resources to sustain a view or experience.
Alice: Yes.
Miguel: What else can you tell me about his ruthlessness? It's interesting that he can be so strong willed and yet has that characteristic where he is very cautious and doesn't want to be disliked. Where does this strength come from? From my interpretation of your book, it seems to stem from a young age. That is to say he has a backbone when it comes to business and money even from an early age.
Alice: No one can ever know for certain but I believe it was innate in him. He told me a story about when he was 6 years old, and a customer wanted him to break a pack of Gum that the was selling into individual pieces.
His reaction was, "I've got my principles," and he refused to do it. I don't think anyone taught him that. I think he was born with that.
Miguel: Tell me about his memory. I ask about this because psychological research has uncovered a capacity for forming false memories and yet Warren Buffett seems to retain massive amounts of information (with minimal distortions). In your opinion, how does Buffett's memory work?
Alice: Well I wrote about the bathtub memory in the book. If something is unpleasant, it goes down the drain. He also retains a sort of DVD of events in his head.
If there is new information the old version gets overwritten. It's gone. He remembers stories and certain facts, and the rest is discarded as if for efficiency or comfort.
So let's say he is at a party. There will be 2 things he remembers. He will remember that Carol Loomis wore a yellow dress and that somebody else told him a certain joke. That is all he will remember. It's as if the rest disappears. Sometimes he'll remember more if prompted, but there's not much fuzziness. Either he remembers something or he doesn't.
Then, if it turns out the joke was a different one than he thought, it's as if he never heard of the first joke.
That is not to say he believes his own memory is infallible. He's keenly aware of how stories are transmuted through the telling. He was very clear (and upfront) with me about this in the beginning. One reason he said, "Use the less flattering version," is that he thought other people might remember things better than him.
Miguel: What about his memory in terms of investments?
Alice: Oh that's freaky. You're sitting there talking about something like "Isn't it amazing that after Jack Welch left GE, the company started having all these problems because of buried accounting issues?" and he will say, "Yes, that's like …" and pull a company from 30 years prior and start spouting numbers. Then he will pick another more recent company, and another.
He has accumulated a filing cabinet of knowledge about companies, and it's very big. Part of his teaching style is to have certain examples at the ready.
Miguel: How has he developed this mental database ?
Alice: Well I think there are things you can do to improve recall. But there is something to be said about being born with a prodigious memory. It seems to me that there are 3 qualities of great investors that are rarely discussed:
- They have a strong memory;
- They are extremely numerate;
- They have what Warren calls a "money mind," an instinctive commercial sense.
Warren is all of these.
By numeracy I mean an excellent recall for numbers, fast mental arithmetic skills, and preferably, an intuitive grasp of the time value of money, intuitive enough that you don't necessarily need a calculator to do basic calculations.
The money mind is far more important than the others.
Miguel: Tell me a little more about this.
Alice: Warren's skills as an investor have often been compared with a musician, and I think that's exactly right. The "money mind" is an instinct, almost a sixth sense, of sniffing where there is an opportunity to make money and knowing how to exploit it. Somebody who is starting businesses when they are six years old is different than the average kid. When you apply focus (which he often talks about) to those three qualities then your skills as an investor are turbo-charged.
Miguel: How can we develop more of a money mind? Is this the part that is more innate or is it more a consequence of him being an entrepreneur at a young age?
Alice: I have had many conversations with him about this. He thinks it's innate. There are people who just naturally gravitate towards activities that make money. That's not a value judgment. Something else might be more socially useful. However, I also believe the average person can be trained to become much more "money aware." You can train yourself to do an amazing amount … to go from being average to becoming good. But you will have to work at it in a way that someone like Warren will not.
Miguel: You say it's important to be numerate. Is this what attracted you to accounting?
Alice: No. Personally I have a lopsided skill set when it comes to mathematics. Patterns of numbers are not like musical bars to me. I was decent at geometry, higher math but had to work at them. Where I excelled was statistics. I did extremely well at statistics. It's interesting but Charlie Munger says that's the course that isn't mandatory but should be.
Insurance is a business of statistics and probability. I have wondered whether the mathematics of statistics uses a different part of your brain than discrete math.
Miguel: Are there any other traits that act as a magnifying glass for Warren Buffett? Comment on how his traits help him see the world in a different way?
Alice: Yes. There is temperament. His emotional oscilloscope moves in quite a narrow range. That's useful when you're playing against with Mr. Market. He's stressed it as an essential quality.
I also believe his understanding of human nature is immensely valuable. He is superb at figuring out what the great businesses are, but great people must run them. And he has been successful at seeking out really terrific management. He has made a few whopper mistakes, but they are definitely outliers in the trend of being great at picking top people.
Miguel: What are Warren's weaknesses as an investor?
Alice: It's as if large amounts of money paired with limited risk can overwhelm his peripheral vision. So if there's is a disproportionate opportunity to make money in what is a superficially a protected way such as through a preferred stock where your downside is limited, he doesn't blink at things that would normally give him pause.
He did this with US Air and Salomon Brothers. You could also argue Goldman Sachs convertible preferred and USG were hardly typical investments.
Second, sometimes he will decide on some theory upon which he wants to invest in something even if it's not an obvious barn burner in terms of financial aspects.
BNSF is an example. You have people championing this for all sorts of reasons, but certainly it did not meet his normal investing metrics. That doesn't mean it was a mistake, but it may be a good investment for different reasons than people think.
Sometimes he falls in love with people and invests accordingly or, worse, falls in love with people because they've sold him their companies. He fell in love with John Gutfreund at Salomon, and with Ron Ferguson at General Re. Among others.
Lastly, he clearly has a blind spot when it comes to anything that flies and has wings.
Miguel: Meaning?
Alice: Meaning he has invested 3 times in aviation: Pacific SW Airways, USAir, and NetJets. These have ranged from near-misses to disasters. He hasn't had good luck with aviation. He's called himself an Air-a-Holic. It's a weird little quirk to see this in somebody that you think of as super-rational.
Miguel: What other blind spots does he have that we can learn from?
Alice: I'm sure I could think of other things, but it would be disproportionate to spend more time focusing on blind spots. His accomplishments outweigh his blind spots by so much.
Miguel: Sure.
Miguel: Do you think there is particular reason for his focus on consumer and financial companies?
Alice: Yes. With financial companies you have leverage that can be controlled, "regulatory oligopoly," and trust. Insurance float is only one example of leverage. The spread on "float" in banking can be controlled too, if you lend intelligently. Banking is a nice little business for the few who are willing to do it in a vanilla manner. "Regulatory oligopoly" is the entrenched competitive position that's, in effect, provided by your regulator and its rules. It can give you quite a few, or few hundred, extra basis points of return.
I think Buffett's consumer plays have been overrated as a theme. He likes good companies with enduring business models. Many happen to have been consumer companies. He got intrigued by the idea that a brand could be a very enduring asset. Then he was surprised at how quickly the value of brands eroded in the 1990's. Brands with true "moats" are exceedingly rare. Of course he wants one when he can get it, but these companies usually also are expensive.
Miguel: Maybe I can ask you a tangential question. Many value investors follow this lead of avoiding all macroeconomics, whether it's risk, etc. Tell us about the way he looks at the economy as a whole? How does he factor that into his database and decisions?
Alice: Buffett is keenly aware of the economic cycle and relevant data. He uses economic data to put context around what is happening in specific businesses. Meaning that it lets him visualize macro-risks at the company-specific level. Second, macro data signals to Buffett where Mr. Market is going awry, for example, what parts of the stock market might be fertile digging grounds.
For example, he knew to some degree that we were in a bubble in the past few years (leading up to 2008) because you could do some statistics that would show corporate profits being at unsustainable levels and housing growth exceeding demographics to a ridiculous degree. He didn't get into the mortgage business, although you'd better believe, people were showing up on his doorstep urging him to do it with all sorts of apparently lucrative deals. The economy is context.
Miguel: How else does he process macroeconomic information? How does this relate to his fascination with history?
Alice: History was one of Warren's best subjects even when he was very young (in school). He has a liking for it. But at the same time pattern recognition is one of his primary skills and perhaps his greatest skill. So in terms of data points, unlike many people who learn by seeking information on an as-needed basis, Warren is always looking for fuel for pattern recognition before he needs it.
He's always looking for context. Having an interest in a broad sweep of history provides vast context for making many decisions because it enables analogies. And that I think has been very helpful for him in avoiding fallacies such as "This time it's different."
It allows him to make analogies between industries, for example between the internet/dotcom stocks and early auto stocks, as in the speech he gave at Sun Valley that is described in The Snowball.
Miguel: Tell me more about his pattern recognition skills? How is this one of his greatest skills?
Alice: Take this example. If you look at the dotcom stocks, the meta-message of that era was world-changing innovation. He went back and looked for more patterns of history when there was a similar meta-message, great bursts of technological innovation in canals, airplanes, steamboats, automobiles, television, and radio. Then he looked for sub-patterns and asked what the outcome was in terms of financial results.
With the dotcoms, people were looking to see what was different and unique about them. Warren is always thinking what's the same between this specific situation and every other situation.
That is the nature of pattern recognition, asking "What can I infer about this situation based on similarities to what I already know and trust that I understand?" There is less emphasis on trying to reason out things on the basis that they are special because they are unique, which in a financial context is perhaps the definition of a speculation. (Warren is not averse to speculation, by the way, as long as it's what he calls "intelligent speculation," meaning he's got long odds in his favor.) But pattern recognition is his default way of thinking. It creates an impulse always to connect new knowledge to old and to primarily be interested in new knowledge that genuinely builds on the old.
Miguel: Comment on Warren Buffett's emotions. I'm particularly interested in his ability to be so rational and unemotional.
Alice: This is a great segue. Pattern recognition skills are worthless if you invent patterns that aren't there. My one really difficult experience as an analyst was at PaineWebber during the dotcom bubble. It was like bullishness was a drug poured into the NYC water supply. Everyone believed. The idea that investment banking pressure was solely responsible for the Internet bubble has been overplayed. We were a wirehouse, and we drank the Kool-Aid just like everybody else.
People think Wall Street was cynical; there was less cynicism than history has recorded. Largely, the predictions about the Internet's transformative power were true. There just wasn't a lot of money in it for investors. Which is another favorite theme of Warren's. The futility of standing on tiptoe at the parade.
I recommended insurance stocks when they looked moderately priced, and then followed them all the way down to dirt cheap. Nobody wanted to buy anything real. My stock calls were mostly awful, and they would have been awful no matter what I picked unless I had said to sell the whole group. It's that difference between stock-picking and investing.
Somehow, Warren was able to ignore the whole thing. People sometimes speculate that he is emotionless, and I'm frequently asked if he is autistic. He's certainly not emotionless, but his emotional pendulum swings in a very narrow arc except on those rare occasions when something personal has deeply upset him. While he does use rules to make decisions, it's key that he's detached and not temperamentally excitable to begin with.
On business matters, his steady pulse is helped by his exceptional skill at reading other people's emotions. He reads people in a conscious manner that could be the result of self-training to recognize "emotional tells"; even so, he's remarkably fluent at it. If this skill could be bottled he could sell it for an awful lot of money.
Temperament is innate, but I would argue that anyone can focus on modulating their temperament within whatever band they have to work with. Anyone can work at being better at reading other people's emotions.
Tune-in Tomorrow for Part 6: Curve Ball – Surprising Facts About Warren Buffett
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