Investment Theory #13: Buffett’s 1968 Letter

In 1956, Warren Buffett concluded his work for Benjamin Graham and returned to Omaha, where he started an investment partnership. This partnership was formed with seven limited partners, made up of family and friends, contributing $105,000, and Warren Buffet contributing $100. It grew over time.

This post continues my series about that partnership. The goal is to gain some insight into one of the most successful investment vehicles in modern history.

Links to past years can be found here: 1957, 1958, 1959, 1960, 1961, 1962, 1963, 1964, 1965, 1966, 1967

Historical Context

In 1968, the DJIA returned 7.7%.

In January, the Viet Cong launched the Tet Offensive; a series of surprise attacks across South Vietnam. In March, the United States Congress repealed the requirement for a gold reserve to back U.S. currency. In April, Martin Luther King Jr. was shot dead at the Lorraine Motel in Memphis; riots erupted in the aftermath. In May, both sides of the Vietnam War agreed to peace talks in Paris. In July, Saddam Hussein became Vice Chairman of the Revolutionary Council in Iraq after a coup d’etat. In September, Boeing unveiled its new 747 model aircraft. In November, Richard Nixon defeated Hubert Humphrey in the presidential election. In December, the crew of Apollo 8 became the first humans to see the far side of the Moon.

Performance in 1968

This is the last annual letter with a performance update. A few months later, Buffett will announce his “retirement”. Naturally, Buffett turns in the best performance in the partnership’s history:

We established a new mark at plus 58.8% versus an overall plus 7.7 % for the Dow, including dividends which would have been received through ownership of the Average throughout the year. This result should be treated as a freak like picking up thirteen spades in a bridge game. You bid the slam, make it look modest, pocket the money and then get back to work on the part scores. We will also have our share of hands when we go set.

Blue Chip Stamps Case Study

Blue Chip Stamp’s business model was simple – they would sell stamps to retailers that could be given out to customers. If Customers collected enough stamps, they could trade them in for prizes. The stamps became a currency of their own, and Blue Chip built a monopoly around them.

In 1963, this market power caught the eye of the Department of Justice who filed suit. The stock slumped. In 1968, the lawsuits began to be settled and Buffett began building a sizable position. What attracted him was the float that Blue Chip produced. They received cash up front for their stamps, but didn’t have to return prizes until later – sometimes years later. The cash could be invested in the mean time and produce a sizable return.

Later, as the business model began to die out, that float would be used to purchase all of See’s Candy.

National Indemnity Case Study

National Indemnity was an insurance company based in Omaha, and founded in 1940 by Jack Ringwalt. In the beginning, National Indemnity wrote liability insurance on taxis which were considered too risky for other companies. Ringwalt believed that there was a proper rate at which any insurance policy could be written given an understanding of the risk involved. As they grew, they expanded into writing other insurance policies.

In 1967, Ringwalt was looking to sell and called up Buffett, a long-time friend. Buffett could have bought the company for the partnership, but instead had Berkshire pay $8.6 million for it. National Indemnity would form the base for everything that Buffett built after the Partnership was retired. Like Blue Chip Stamps, National Indemnity had a large float – they would receive premiums on policies upfront and wouldn’t have to pay them out until years later.

Conclusion

With National Indemnity and its sizable float, Buffett had found a permanent capital base that he could make levered investments with. More importantly, he no longer needed capital from emotional partners who would subject him to short-term performance critiques. It’s not surprising that shortly after he would announce the closing of the partnership.

References:
https://en.wikipedia.org/wiki/1968
https://www.amazon.com/gp/product/0553384619/

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Author: David Shahrestani

"I have the strength of a bear, that has the strength of TWO bears."

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