The naïve figure who utters profound truths appears to hold a perennial and universal appeal. The naïf who succeeds and mysteriously makes sense of an entirely alien environment is the subject of movie after movie — from the character Peter Sellers played in Being There to Tom Hanks' character in Big.
Also part of this phenomenon is Warren E. Buffet, the sage of Omaha who has been enormously successful in a field where competition is ruthless. In 1964, the per-share book value of Mr. Buffet's company, Berkshire Hathaway Inc., was $19.46; by 1997, it was $25,488. Mr. Buffet's success has been examined from every angle as he turned his company from a shirt manufacturer to a holding company that writes property and casualty insurance through the GEICO Corporation and reinsurance through the General Re Corporation; publishes a newspaper, encyclopedias and instructional material; makes confectionery products, home-cleaning systems and footwear; operates a retail home-furnishings center, and provides training to aircraft pilots. Yet, if emulation is a measure of understanding, it appears little understood.
Above the maelstrom of analysts, commentators and private investors stands Mr. Buffet, a man of resolutely simple tastes, who oozes old-fashioned decency from every pore. As he has become more famous and Berkshire Hathaway ever more successful, Mr. Buffet's public utterances and writings have become more playful. "As happens in Wall Street all too often, what the wise do in the beginning, fools do in the end," he wrote in 1989. This was followed in 1990 by: "Lethargy bordering on sloth remains the cornerstone of our investment style."
He has cornered many a market, but the one in homespun wisdom may be his surprising legacy.
The Essays of Warren Buffet brings together a selection of Mr. Buffet's letters as chairman and chief executive officer to his shareholders. They are organized thematically rather than chronologically under the headings of corporate governance; corporate finance and investing; common stock; mergers and acquisitions, and accounting and taxation.
Lawrence A. Cunningham, a professor at the Benjamin N. Cardozo School of Law at Yeshiva University in New York City and a director of the Samuel and Ronnie Heyman Center on Corporate Governance, expertly weaves Mr. Buffet's enigmatic epistles together and provides an extremely useful introductory overview of the world according to Mr. Buffet.
When gauging the wisdom of an investment, Mr. Buffet advises investors to look at five features: "The certainty with which the long-term economic characteristics of the business can be evaluated; the certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash fiows; the certainty with which management can be counted on to channel the reward from the business to the shareholders rather than to itself; the purchase price of the business; the levels of taxation and infiation that will be experienced and that will determine the degree by which an investor's purchasing-power return is reduced from his gross return."
Mr. Buffet admits that many will find such criteria "unbearably fuzzy." This is only partly the case. Analysis can lead to conclusions about the long-term economic prospects of a business. Analysis can also establish what is a reasonable purchase price and help predict future macro-economic conditions likely to have an impact on the investment. Where analysis falls down and things begin to become fuzzy is in assessing the incumbent management.
Time and time again, Mr. Buffet returns to the issue of sound management. He lauds some of his own managers: "They love their businesses, they think like owners and they exude integrity and ability." This is the quintessence of Mr. Buffet's philosophy. Given the right conditions, good managers produce good companies. Never invest in badly managed companies. Charles T. Munger, Berkshire Hathaway's vice chairman, and I "really have only two jobs," says Mr. Buffet. "One is to attract and keep outstanding managers to run our various operations." The other is capital allocation.
The trouble is that there are a great many poor managers. "The supreme irony of business management is that it is far easier for an inadequate chief executive officer to keep his job than it is for an inadequate subordinate," lamented Mr. Buffet in 1988, before going on to criticize the comfortable conspiracies of too many boardrooms. "At board meetings, criticism of the chief executive officer's performance is often viewed as the social equivalent of belching."
Mr. Buffet believes that executives should think and behave as owners of their businesses. He is critical, therefore, of the "indiscriminate use" of stock options for senior executives. "Managers actually apply a double standard to options," Mr. Buffet writes. "Nowhere in the business world are 10-year, fixed-price options on all or a portion of a business granted to outsiders. Ten months, in fact, would be regarded as extreme." Such long-term options, argues Mr. Buffet, "ignore the fact that retained earnings automatically build value and, second, ignore the carrying cost of capital."
Mr. Buffet's own management style is characteristically down to earth. "Charlie and I are the managing partners of Berkshire," he explained in 1996. "But we subcontract all of the heavy lifting in this business to the managers of our subsidiaries. In fact, we delegate almost to the point of abdication: Though Berkshire has about 33,000 employees, only 12 of these are at headquarters." In fashionable books this would be called empowerment; to Mr. Buffet it is brazen common sense.
Mr. Buffet is a ponderous minimalist in an age of hyperactive behemoths. "Charlie and I decided long ago that in an investment's lifetime it's too hard to make hundreds of smart decisions.... Indeed, we'll now settle for one good idea a year. (Charlie says it's my turn.)," he wrote in 1993. Mr. Buffet is humorously embarrassed by the purchase of a corporate jet: "It will not be long before Berkshire's entire net worth is consumed by its jet," he writes. (Perhaps, though, the purchase sparked the idea to buy Executive Jet, the world's leading provider of fractional ownership programs for general aviation aircraft, in July.)
In the Berkshire Hathaway boardroom, belches are welcomed. Mr. Buffet admits to mistakes and errors of judgment. After a long struggle, Berkshire was eventually forced to close down its original textile company. "I should be faulted for not quitting sooner," Mr. Buffet told shareholders, going out of his way to praise the efforts of the management — "every bit the equal of managers at our more profitable businesses." (Even good managers cannot save what has become a bad business.)
Perhaps the single most important aspect of Mr. Buffet's management style is that 99 percent of his and his wife's net worth is in the company's shares. "We want to make money only when our partners do and in exactly the same proportion," he explains to shareholders. "Moreover, when I do something dumb, I want you to be able to derive some solace from the fact that my financial suffering is proportional to yours." The secret of Warren Buffet is revealed: Put all your eggs in one basket.
Stuart Crainer ([email protected]) is a U.K.-based business journalist and a contributing editor to strategy+business. Mr. Crainer is author and editor of numerous management books, including the Financial Times Handbook of Management (Financial Times Prentice Hall, 2001) and The Management Century: A Critical Review of 20th Century Thought and Practice (Jossey-Bass, 2000).