Last week I wrote about the 1957 Buffett Partnership Letter. It didn’t strike me then that Buffett was all of 27 years old. When I think of him, I think of an old man guzzling cherry Coke. But back in 1957, Warren Buffett wasn’t old and there was no cherry Coke to drink. By the way, I cheated and read ahead several letters. It’s incredible how sensible, mature, and fair-minded he seems to be even at that age. But I’m getting ahead of myself.
1958 was a year of great returns for the Dow, which Buffett suggests was because of speculators who were there for as long they think profits can be made quickly and effortlessly. He says that a widespread public belief in the inevitability of profits from investment in stocks will lead to eventual trouble. I suppose you could say that for any asset class. But he holds no illusions about his own investments. He says, prices, but not intrinsic values in my opinion, of even undervalued securities can be expected to be substanially affected. Beware that just because you have bought what you think is an undervalued security, there is no guarantee that its price will not decline even further, especially in a bear market.
The most meaty part of the letter is where he explains the special situation that he had mentioned in the previous letter. The situation involved a company called the Commonwealth Trust Co. He started buying the company when its intrinsic value was $125. But it traded at $50. The company also earned $10 per share but gave out no dividends. A bigger bank held a 25+% stake in the company and had wanted to merge. But the merger was being prevented for personal reasons. The Buffett Partnerships managed to acquire 12% of the company for about $51 per share but then ran into competition. The price got bid up to $65 and he stopped buying! He still thought the intrinsic value was $125 but he stopped buying at $65. Talk about margin of safety. In any case, later in the year he found another special situation where the risk/reward was better. So he sold the block in Commonwealth for $80 a share – a 20% premium to the then prevailing price.
At least two things stood out for me here. The first is the margin of safety he had in his buying. He stopped buying at $65 when he thought it was worth $125. It was a special situation after all, and could have taken a long time to work out. Second, when he found a better opportunity for his money, he did not stay married to the idea. He did not stay to get the entire $125. Instead, he booked profits at a good price and switched horses.
He would give up this policy of switching bets in later years. But that was only when the amounts he managed got far too large for that kind of agility. This is an often forgotten fact when young investors start following the Warren Buffett way. He did not have the same constraints early on, which he had later. And so his style was different as well. We’re allowed to do the same!
Read the original here.