Becoming Berkshire:1967 - Buffett & Clyde
Issue 10 | 1967 Part 1 - This issue sets the stage for the winding up of the partnership and transformation of Berkshire Hathway into the conglomerate you see today.
In 1967, the Green Bay Packers beat the Kansas City Chiefs in Super Bowl 1. The Dow Jones Industrial Average (DJI) opened at 786 and closed at 905, up 15% for the year. The five largest companies by market capitalization were IBM, AT&T, General Motors, Exxon (Standard oil of New Jersey), and General Electric. And movies like Cool Hand Luke, Bonnie and Clyde, In the Heat of the Night and The Graduate ushered in the rise of a new Hollywood.
The 1960s introduced a new generation of money managers, far removed from the likes of Graham’s generation, who managed capital with memoirs of the depression.
There is a Missing Generation on Wall Street because nobody went there from 1929 to 1947. To the older generation, the Depression of the thirties was a profound, traumatic experience. Stocks crashed in 1929, but that was not the worst. They rallied in 1930 and then started a steady erosion that scarred anyone who experienced it for life. United States Steel, which sold at $262 on September 3, 1929, drifted down to $22. General Motors slipped to $8 from $73. Montgomery Ward went from $138 to $4. 1
Wall Street had reawakened to a younger breed, many of whom had not been alive in 1929 and were bored with their elder’s endless recitations. For them, speculation bore no curse; the bull market of the sixties was as free as first love. Even the stocks that they traded were new electronic issues, big conglomerates, and small growth stocks. Investments in mutual funds went from $1.3 billion in 1946 to $35 billion in 1967, and pension funds increased in size to $150 billion. Performance fund managers sold companies like Alcoa, Union Carbide, Telephone, and Texaco and purchased growth stocks like IBM, Polaroid, and Xerox. 2
Gerald Tsai Jr. was a central figure in this limelight, and he first made his name in the early ’60s as a portfolio manager at Fidelity. Known for momentum investing and rapid portfolio turnover, Tsai started his own firm in 1965, and his Manhattan Fund brought in a huge amount of investor money. Stocks often moved based on what Tsai was buying or was thought to be buying, and pros and amateurs alike emulated his in-and-out trading style.3
Another gunslinger was Fred Carr, a money manager who lived a lavish lifestyle in Beverly Hills. His fund returned 116% in 1967, and he predicted he would do 200% in 1968; he was the epitome of the new performance manager. His saying was, “We fall in love with nothing. Every morning, everything is for sale, every stock in the portfolio, my suit, and my tie.”
Buffett Limited Partnership
Buffett was having less fun than Gerry Tsai or Fred Carr and was finding it increasingly more challenging to put capital to work.
In the 1967 Partnership letter, Buffett started by listing a few reasons why beating the Dow by 10 points in 1967 may be difficult.
1. The market environment has changed progressively over the past decade, resulting in a sharp diminution in the number of obvious quantitatively based investment bargains available;
2. Mushrooming interest in investment performance (which has its ironical aspects since I was among a lonely few preaching the importance of this some years ago) has created a hyper-reactive pattern of market behavior against which my analytical techniques have limited value;
3. The enlargement of our capital base to about $65 million when applied against a diminishing trickle of good investment ideas has continued to present the problems mentioned in the January 1967 letter; and
4. My own personal interests dictate a less compulsive approach to superior investment results than when I was younger and leaner.4
Changing Market Environment
The bull market of the 1960s had brought an influx of young analysts and aspiring money managers to Wall Street.
Such statistical bargains have tended to disappear over the years. This may be due to the constant combing and recombing of investments that has occurred during the past twenty years, without an economic convulsion such as that of the ‘30s to create a negative bias toward equities and spawn hundreds of new bargain securities. It may be due to the exploding ranks of security analysts bringing forth an intensified scrutiny of issues far beyond what existed some years ago.5
Investment Performance
As performance mutual funds exploded, so did compensation on Wall Street and the scrutiny of performance.
Investment performance by large aggregates of money is being measured yearly, quarterly, monthly, and perhaps sometimes even more frequently (leading to what is known as "instant research"). In my opinion what is resulting is speculation on an increasing scale. This is hardly a new phenomenon; however, a dimension has been added by the growing ranks of professional (in many cases formerly quite docile) investors who feel they must “get aboard”.6
Buffett was becoming increasingly skeptical of valuations.
"Furthermore, we will not follow the frequently prevalent approach of investing in securities where an attempt to anticipate market action overrides business valuations. Such so-called 'fashion' investing has frequently produced very substantial and quick profits in recent years (and currently as I write this in January). It represents an investment technique whose soundness I can neither affirm nor deny. It does not completely satisfy my intellect (or perhaps my prejudices), and most definitely does not fit my temperament. I will not invest my own money based upon such an approach – hence, I will most certainly not do so with your money.”
Any form of hyper-activity with large amounts of money in securities markets can create problems for all participants. I make no attempt to guess the action of the stock market and haven't the foggiest notion as to whether the Dow will be at 600, 900 or 1200 a year from now. Even if there are serious consequences resulting from present and future speculative activity, experience suggests estimates of timing are meaningless. However, I do believe certain conditions that now exist are likely to make activity in markets more difficult for us for the intermediate future. I have also seen the penalties incurred by those who evaluate conditions as they were - not as they are. Essentially, I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing large and apparently easy, profits to embrace an approach which I don’t fully understand, have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital.7
Capital Base
It is funny that Buffett acknowledged the difficulties of running a $65 million fund compared to having close to $200 billion in the War Chest at present time.
The third point of difficulty involves our much greater base of capital. For years my investment ideas were anywhere from 110% to 1000% of our capital. It was difficult for me to conceive that a different condition could ever exist.8
Personal Motivation
Buffett admits that he was younger, poorer, and probably more competitive when he started the Partnership. He also mentions that he may be more interested in investments that may not promise the greatest economic reward, e.g., Berkshire Hathway.
An example of the latter might be the continued investment in a satisfactory (but far from spectacular) controlled business where I liked the people and the nature of the business even though alternative investments offered an expectable higher rate of return. More money would be made buying businesses at attractive prices, then reselling them. However, it may be more enjoyable (particularly when the personal value of incremental capital is less) to continue to own them and hopefully improve their performance, usually in a minor way, through some decisions involving financial strategy.9
All in all, you get a sense that Buffett is flirting with the idea of terminating the partnership, especially as more of his time is occupied with Berkshire Hathaway.
Berkshire Hathway 1967 Annual Report
By 1967, it was clear to Buffett that Berkshire Hathway could not be transformed into a consistently profitable enterprise. Buffett instructed Ken Chace that all capital investments in textiles had to be approved by him, and money was to be released from inventory and receivables as much as possible while allowing the mills to stay open. Buffett was hesitant to close the mills so long as the managers and workers were willing to try and produce profits.10
Berkshire, which previously reported on a fiscal year ending September 30, adopted a Calander year for accounting purposes.
Sales dropped from $49.4 million in fiscal 1966 to $39 million in fiscal 1967, which lead to a production cut of 15% in an attempt to avoid building inventories and the termination of skilled labor.
The portion of our business which proved unsatisfactory was the cotton lawn business. It was decided to close the King Philip D Divisions in Rhode Island where the goods were manufactured.11
1967 marks the year that Berkshire transformed from a textile company to the fortress we see today. Adam Mead, in his magnificent book, The Complete Financial History of Berkshire Hathway, lays out the importance of this year.
Buffett started allocating capital outside of the textile business - and in doing so, changed the face of Berkshire forever. The seminal event in 1967 was the acquisition of National Indemnity Company. The purchase of National Indemnity was perhaps the most important event in Berkshire’s history, as it would provide a strong platform for future growth. More immediately, it provided an outlet for the cash freed up by shirking Berkshire’s textile operation. 12
The next issue, Part 2 1967, will deliver an analysis of the acquisition and the history behind National Indemnity.
Check Out the previous Becoming Berkshire issues:
Issue 9| 1966 Part 2 - Warren Buffett & The House of Mouse
Issue 8| 1966-Hochschild, Kohn & Co.
Issue 7| 1965 - Hostile Takeover
Issue 6| 1964 - Buffett's Folly
Issue 5| 1963/64 - The American Express Salad Oil Swindle
Issue 4| 1963 - I Want to Hold Your Hand
Issue 1| 1930-1949 - An Oracle is Born
Smith, Adam. The Money Game, 1968.
Lowenstein, Roger. Buffett. the Making of an American Capitalist, 1995.
Brooks, John. Go-Go Years: The Drama and Crashing Finale of Wall Street’s Bullish 60’s, 1973.
Buffett Partnership, LTD. Shareholder Letter 1967.
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Arnold, Glen. The Deals of Warren Buffett Vol1: The First $100m, 2017.
1967 Berkshire Hathaway letter to shareholders.
Adam J. Mean. The Complete Financial History of Berkshire Hathway: A Chronological Analysis of Warren Buffett & Charlie Munger’s Conglomerate Masterpiece, 2021.