How Warren Buffett Built His Empire – Forbes 1990 – Part One: Changing strategy

July 31, 2015

20

By Rupert Hargreaves. Originally published at ValueWalk.

Warren Buffett’s investment strategy has changed dramatically over the years. Indeed, his strategy has gone through several changes, all of which have been inspired by different market environments.

For example, when Warren Buffett started out, running the Buffett partnerships, he was a deep-value investor. As he learned the deep value discipline under the Godfather of value investing, Benjamin Graham, he was rather good at it.

But by the mid-60s, the market was changing, and Buffett was struggling to find opportunities that met his deep value criteria. Here the first change of strategy took place.

Warren Buffett: Berkshire Hathaway

Buffett closed his partnerships and started running Berkshire Hathaway, seeking out other businesses with a high return on equity but low capital spending requirement to add to his empire.

Additionally, in the 1970s Buffett saw that many companies, especially big-city news-papers, were cheap relative to the earning power of their franchises–as well as to potential cost savings from technological innovations about to be introduced. He made substantial investments in the Buffalo News, the Washington Post Co., and Affiliated Publication’s. People who didn’t see what he saw gladly sold him shares at prices that now look ridiculously cheap.

This didn’t last long, and the market soon caught up, leaving Buffett no choice but to change his strategy once again.

Warren Buffett: Merger arbitrage

During the takeover mania of the 1980s, Buffett bought shares at every-day market prices. Buffet bought General Foods, Beatrice, and RJR Nabisco. On General Foods alone, he more than doubled his money when he sold in 1985. Then he waited for somebody else to do a takeover. Also, during the early 80’s Buffett became one of the first investors to begin to appreciate the value of consumer brand names. General Foods and Capital Cities are two examples.

By the mid-80s, Buffett was making healthy returns from merger arbitrage. Stakes risked were small, but returns were nothing short of impressive.

Warren Buffett

From Forbes Magazine 1990:

“In 1987 he bet relatively small amounts. A $2.7 million investment in Southland on Oct. 10 turned into $3.3 million just ten days later–on an annualized basis, that’s a 740% re-turn. What fun.

There were, of course, plenty of Losers and break-evens in that crash year. Still, overall in 1987 Buffet’s arbitrage activities earned a 90% return, versus the S&P’s 5%.

Emboldened, Buffett increased the arbitrage stakes. In 1988 he bet on almost 20 different deals, putting in as much as $120 million. Net net, Buffett’s trades’ equally weighted average annual return would have been 35%, compared with the 17.07% gain.”

“What deals did Buffett play? Some picks came as no surprise: Philip Morris International Inc. (NYSE:PM), RJR Nabisco and Kraft Foods Group Inc (NASDAQ:KRFT). Other names were more surprising: Interco, Federated, Southland and Marine Midland.”