Warren Buffett's revenge

A timely new book about the Sage of Omaha's management practices shows how, after Enron and the dot-com bubble, the multibillionaire was right about everything.

Andrew Leonard
January 25, 2003 2:46AM (UTC)

Trust, fairness, reciprocity -- these are the secrets to Warren Buffett's success, writes author James O'Loughlin, in "The Real Warren Buffett: Managing Capital, Leading People." Buffett runs his astoundingly successful company, Berkshire-Hathaway -- a conglomerate that owns more than 40 companies, employs nearly 150,000 people, and has averaged a phenomenal 25 percent return on investment over the last three decades, turning Buffett into the second-richest man in the United States -- with a staff of barely more than a dozen. And he pulls off this magic trick without a strategic plan, without any "synergy" between his disparate holdings, without micromanaging or any of what O'Loughlin calls the "normal tools of management."

Instead, as he likes to say, he buys companies that are run by the right people and then he gets the hell out of their way. "Paradoxically," writes O'Loughlin, "this creates loyalty among his managers and obedience to his wishes manifesting themselves in an overwhelming eagerness to please ... This should not be surprising. Trust, fairness, and reciprocity form the basis of the same social glue that has carried successful human organizations all the way from the savannah plains of Africa, where it evolved as the first-best solution to cooperation, exchange, and progress."


So why aren't there more business leaders like Buffett? Enough skeptical journalists have devoted their attention to Buffett (most notably, Roger Lowenstein, author of the splendid "Buffett: The Making of an American Capitalist") that it is reasonable to believe that this guy is exactly what he seems: a plain-speaking, teetotaling man of uncrackable integrity who works really, really hard and sticks to his investing and management principles through boom and bust. Which makes him, in the circles of corporate America as we have come to know it over the past few years, a freak of nature. Like a comet streaking through the heavens every 75 years or so, Buffett isn't exactly a guy that you can emulate, or model yourself on. You can only watch in amazement, shaking your head, before returning to the real world, where people are conniving and corrupt.

Buffett is usually analyzed in terms of his unparalleled success as a stock picker. O'Loughlin, drawing primarily from Buffett's own published writings -- in particular, his annual letter to investors in Berkshire-Hathaway -- bucks that trend by focusing on the man as a leader and "allocator of capital." It's an interesting and worthwhile approach. As a leader, Buffett offers an instructive contrast to the blustery, take-no-prisoners approach of executives like G.E.'s infamous Jack Welch. And as an allocator of capital, Buffett is brilliant: He's not concerned with growth for the sake of growth, he's concerned with maximizing return on capital. That is his primary strategy, and it guides all his investment and management decisions. Whatever light O'Loughlin sheds on Buffett's radical rejection of the philosophy that growth is, by definition, good, is worth one's attention.

Unfortunately, "The Real Warren Buffett" could have benefited from a good bit more reported detail about the companies that Buffett owns and a good deal less bland repetition of the same maxims over and over again. O'Loughlin has a tendency to distill Buffett's plainspokenness and transform it into pseudo-business-school jargon that distracts more than it illuminates. For example, O'Loughlin plucks a perfectly normal phrase that Buffett likes to use to describe the areas he feels comfortable working in, his "circle of competence," and, waving a magic capitalizing wand over it, turns it into "The Circle of Competence." Suddenly, a straightforward statement that means "I'll buy a company if I understand the market it operates in" turns into a bogus nostrum, suitable for embroidering, framing and hanging up on a wall in a therapist's office.

A more interesting approach would have been to spend more time delving into how much Buffett's management style and investment strategy differed from the schools of thought that flourished during the new-economy heyday, and how sharply they clashed with the values represented by such popular (at the time) icons of capitalism as Enron. O'Loughlin makes some glancing references to this theme, and they pique reader interest. In some ways, the dot-com bubble was Buffett's toughest test -- the market value of Berkshire-Hathaway dropped by half during the bubble, all the way back to 1985 levels, and Buffett came under severe criticism for failing to embrace technology stocks, or otherwise kowtowing to new-economy management paradigms (such as compensation via stock options or, again, the belief that growth was the most important measure of a company).

Buffett was a lone voice in the wilderness during the bubble, but his strategy has been vindicated by the rebound of Berkshire-Hathaway while the rest of the stock market continues to flounder. Now, more than ever, it's time to listen to Buffett.

But there's a problem. The implicit assumption in "The Real Warren Buffett" is that CEOs should take notes and run their businesses accordingly. But what if Buffett's isn't a duplicable model? What does that mean for average investors and, more important, market regulators? It's unlikely that we can, as individuals, become mini-Warren Buffetts -- I, for one, have no desire to spend every waking hour poring over financial reports, with only the odd sip of Cherry Coke to comfort me. But what about the opposite -- can we stop people from being anti-Buffetts?


One theme running through "The Real Warren Buffett" is that it is more instructive to look at Buffett as a leader than as a stock picker, because, in this modern age, it simply isn't possible to beat the market as Buffett has done so successfully over his life. In other words, there's nothing to learn from Buffett as super-investor, but there are nuggets of useful wisdom to glean from how he runs his businesses and manages the cohort of CEOs who report to him -- even though the vast majority of us are unlikely to find ourselves overseeing an empire of insurance, furniture and gas pipeline companies.

Though not the primary focus of the book, this thesis dovetails with a sub-theme that pops up from time to time: how the stock market has matured over the course of Buffett's life. Once upon a time, goes the theory, great bargains were easy to come by. If you burrowed into the quarterly reports, and Moody's analyses, and asked a lot of questions (and, it is clear, no one has ever been or is likely to ever be better than Buffett at this kind of work), then you could identify a company whose stock price was below what it should be. Then, you buy and hold. This is "value" investing. Think of it as the antithesis to day-trading, which is all about betting on which direction a stock will go in the next day, or hour, or minute, and buying and selling accordingly.

But great bargains aren't so easy to find anymore, says O'Loughlin, and his view is buttressed by the supremacy of the so-called efficient market theory. Efficient market theory holds that a company's stock price, at any given time, represents the market's fair appraisal of all the publicly known knowledge about a given company. You can't beat the million eyeballs of the market, goes the theory, so don't even try.

Efficient market theory is a mainstay in academia and accepted wisdom on Wall Street, O'Loughlin tells us (as Lowenstein does in his own biography, which is as much a history of investing in the latter half of the 20th century as it is a penetrating look at Buffett). The increasing difficulty in beating the market, O'Loughlin explains, is one reason that Buffett eventually focused on buying whole companies rather than simply trying to outperform the Dow every year by picking and choosing stocks. (It should be noted, however, that Buffett is still a major speculator, of sorts, owning large chunks of companies like American Express and Coca-Cola.)


No doubt, there are subtleties of efficient market theory that I don't understand, and I look forward to learning more about its intricacies. But to those who lived through the recent stock market bubble with their eyes open, the theory appears to have some holes large enough for a thundering herd of bulls (or bears) to romp through. The market fever that drove stocks like Netscape, Yahoo and Amazon to utterly absurd heights surely can't be characterized by the word "efficiency." And the idea that publicly known information leads to an accurate appraisal of a corporation also doesn't seem to hold water, when so many companies specialize in jiggering their figures to beat analyst estimates and produce short-term spikes in the stock price.

One objection might be that efficient market theory doesn't work when companies are run by crooks, such as Enron and WorldCom, and so such examples must be discarded. But that ignores a larger reality: The system has been set up so that every company has reason to cook its books as much as it can get away with. The incentive that stock options give executives to maximize the short-term stock price at the expense of future earnings is just one example (and something that Buffett has historically railed against, earning him the enmity of Silicon Valley technology executives). Of equal, or greater, importance is the lack of oversight for the accounting firms that are supposed to make sure that the figures provided by publicly traded companies are accurate -- or, to extend the net even further, the ascendant ethos of deregulation, which assumes that, left to itself, the market will punish "bad" companies, weed out liars and cheats, and ensure the economy's health.

In a perfect world, efficient market theory may well be plausible. And in a perfect world, perhaps all our business leaders would conduct themselves with the probity and integrity of a Warren Buffett (although it seems unlikely that even in such a utopia, every multibillionaire would also be a registered Democrat who gives money to Planned Parenthood). But we don't live in a perfect world.


The question is, what is more within our grasp? Can we, as individuals, start acting like Warren Buffett, and follow the precepts for managing people outlined in "The Real Warren Buffett"? Or should we take the other route and attempt to ensure that people who aren't Warren Buffett aren't allowed to run amok through Wall Street, defrauding investors?

Maybe the answer is a little bit of both. But for those who would like to believe in efficient market theory, the path forward seems obvious. If you let people do what they want and, even worse, structure the system so that they benefit from not being forthcoming and honest, then you are not going to have an efficient market. Everybody knows that an unsupervised kindergarten turns into a nightmare of chaos and uncapped markers. Why is it so hard to understand that a truly free market, one that gives regular investors and Warren Buffetts equally fair opportunities to make informed investment decisions, requires tough, rigidly enforced rules?

Warren Buffett, as depicted in "The Real Warren Buffett," isn't forced to rap his underlings on the knuckles very often. But that isn't because his management strategy turns swine into pearls. It's because, after accumulating capital as a canny investor, he made smart decisions as to which companies he would purchase. If they weren't already being run by the kinds of people that he respected and trusted, he didn't, in the vast majority of cases, buy them.


He made a few mistakes, and like the good Nebraskan boy he is, he fessed up to them, taken his lumps, and moved on. But the rest of us don't have the luxury of doing business only with people we can trust -- especially if that business is in the form of making stock market investments based on inaccurate information. We need help -- we need a government that will crack the whip rather than wink and look the other way. Something tells me Warren Buffett might agree.

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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