Book Review: Warren Buffett and His Investing Ground Rules

A book by a J.P. Morgan Asset Management analyst delves into the investor’s letters from his early years running his first partnership.

Warren Buffett’s stock-picking wizardry has spawned its own literary genre. The number of books on the Oracle of Omaha rivals those about some U.S. presidents.

The latest entry to this library, Warren Buffett’s Ground Rules: Words of Wisdom from the Partnership Letters of the World’s Greatest Investor, covers new territory by going back to Buffett’s first partnership letters, written a half-century ago. Author Jeremy Miller, a research analyst at J.P. Morgan Asset Management, delves into Buffett’s correspondence from the 1950s and 1960s and finds that Buffett hasn’t budged from his underlying principles of value-driven, commonsense investing.

The letters “provide timeless principles of conservatism and discipline that have been the cornerstone of Buffett’s success,” Miller explains. They also illuminate a significant development in Buffett’s investment approach, as he moved from his so-called cigar butt strategy to one concentrating on high-quality companies.

In 1956, at age 25, Buffett launched an investment fund with $105,000 he had raised from family and friends. In his early days as a money manager, Buffett was the most value-oriented of value investors. He might have been born after the Crash of 1929, but memories of the Great Depression loomed large for him.

Seeking to avoid risk, the eager young stock picker scoured the markets for bargains he referred to as “soggy cigar butts.” These seemingly undesirable companies had been cast aside; their sullied financial statements drove most investors away. Buffett saw a “free puff” he could wring out of them, extracting some profits with almost no chance of a loss. A mapmaker and a farm equipment manufacturer were among the unloved stocks he bought during this period.

He proved a shrewd judge of companies, and in just a few years the assets in Buffett Associates rocketed from $105,000 to more than $7 million. The soggy cigar butt strategy, alas, proved a victim of its own success. As Buffett’s portfolio ballooned, tiny companies no longer produced the returns he needed.

In the 1960s, Buffett’s focus shifted from cheap stocks with unsightly business models to quality brands facing temporary troubles, Miller recounts. Buffett began to load up on blue-chip stocks such as American Express Co. in New York and Burbank, California–based Walt Disney Co.

Still, Buffett stayed true to his roots as a commonsense investor — one who would raise an eyebrow at the excesses of Wall Street. Just as he would sit out the late 1990s dot-com boom, Buffett cast a skeptical eye at the frothy markets of the 1960s. In his early letters he took the opportunity to needle prominent growth investors such as Gerald Tsai, who played an integral role in building Fidelity Investments’ first growth fund, the Fidelity Capital Fund.

Foreshadowing his famous annual letter to shareholders of Berkshire Hathaway, Buffett’s correspondence with his early partners was folksy and insightful.

He often touched on the miracle of compound interest. In one vintage missive, Buffett mused that the Mona Lisa, which in 1540 fetched $20,000, might have been worth more than $1 quadrillion by the 1960s.

In another piece of pithy analysis, Buffett warned his partners against persuading themselves that they knew how to time the market. After stocks swooned in 1966, Buffett noted that several investors had called him with forecasts of further declines.

“This always raises two questions in my mind,” Buffett wrote. “One, if they knew in February that the Dow was going to 865 in May, why didn’t they let me in on it then; and, two, if they didn’t know what was going to happen during the ensuing three months back in February, how do they know in May?”

Buffett also railed against the temptation to trade too much, arguing that most investors would benefit from a policy of making only ten buys during their lifetime. As the 1960s drew to a close, he wound down his partnerships after a fruitful run. In 1969, Miller points out, Buffett was worth $26 million. His remarkable returns continued, of course: As of mid-September 2016, Buffett’s 308,261 Class-A shares of Berkshire Hathaway were worth some $67 billion.

Miller makes the case that there’s nothing flashy or especially complicated about Buffett’s investing strategy. His real genius has been his ability to make sound decisions with great consistency. “It’s an attitude-over-IQ approach,” Miller concludes. “Staying true to one’s process without getting drawn in by the trends is one of the hardest things for even the most seasoned investors.”