"On The Shoulders Of Giants"
Note: TSOH Investment Research will be off next week for a short winter break. I’ll be back Monday, January 3rd, with the 2021 Portfolio Review, followed by deep dives on Roku and Ollie’s. Happy Holidays! As always, thank you for subscribing to the TSOH Investment Research service.
“If I was teaching a business school class, on the final exam, I would pass out information on an Internet company and ask each student to value it. Anybody that gave me an answer, I’d flunk. I don’t know how to do it.”
- Warren Buffett, Lecture at the University of Florida, October 15th, 1998
The 43rd edition of Graham & Doddsville included an interview with Gavin Baker, the CIO of Atreides Management. Before starting Atreides, Baker ran the OTC Fund at Fidelity from 2009 - 2017, outperforming 100% of the fund’s Morningstar peers during his tenure. Needless to say, Baker has had some success during his career. During the interview, when Baker was asked about his early days as an investor, he said something that struck a chord:
“I think a lot of the success I’ve had is due to a super lucky decision I made as a very, very young man. And that decision was to not walk away from tech. That may sound like a strange thing to say today, but in 2002, all the great investing minds of my generation walked away from tech because they were listening to Warren Buffett…. And the only reason I didn't listen was because of my personal interest in science fiction. That was lucky.”
I think there’s an important distinction here between what Buffett actually said over the years and what people thought he said, but the outcome is the same either way: a large number of individual investors, particularly in the value community, have been hesitant to consider certain companies (like tech stocks) and ideas (like cryptocurrencies) because they were “listening to Buffett”. As Baker notes, as it relates to something like tech stocks over the past 20 years, that has been a costly error. (As always, the purpose of this discussion is to learn and grow as investors, not to point fingers; for what it’s worth, I could be fairly accused of having made this mistake in the past.)
Here’s one lesson I’ve learned over time, which is as much personal as it is professional (and it speaks to Baker’s “super lucky decision”): while there’s a clear rationale for imitating individuals with a demonstrated track record of success in your field of interest, particularly when you’re still learning the ropes, you must be willing to think differently if you hope to grow beyond their shadow. Specifically, in our game, you must be willing to test the boundaries of your circle of competence to find the areas of interest (opportunity set) and the investment approaches that work for you (what’s best suited to Buffett’s mind and psychological make-up may not be most suitable for you).
I wrote about one example of how I’ve diverged from my mentor (or at least how I’ve interpreted Buffett’s words) in “Returns and Lessons Learned”:
The final example is Facebook, which I largely bought in October 2018 as a swap for PepsiCo (FB shares are up ~105% since the change, compared to a ~30% gain for PEP). I wanted to call out this transaction because it speaks to how I think about risk and reward. One of Warren Buffett’s most popular investing quips is “Rule #1: Don’t lose money. Rule #2: Never forget rule #1.” As a big fan of Warren, I want to be clear: I do not follow that rule (at least not at the level of an individual investment within the context of a portfolio).
If I did, I would not have swapped FB for PEP because I think the former has higher terminal value / duration risk than the latter. The reason why I still made that change is because I believed the potential upside from an investment in FB over the long run provided sufficient compensation relative to the risk incurred. As a subscriber, it’s important for you to have an appreciation for how I view the opportunity set and where I’m willing to accept incremental risk in exchange for incremental (expected) return.
This lesson applies to the trajectory of Buffett’s own career: if he had constrained himself to the preferred approach of his mentor, Ben Graham, it would've greatly limited his results (measured relative to his long-term objectives, which differed from Graham’s). Consider this exchange between Buffett and Munger at the 1997 Berkshire Hathaway shareholder meeting:
Munger: “The interesting thing for me is to watch Buffett, the former protégé… Buffett became way better than Graham. That is a natural outcome. It’s what Newton said, ‘If I’ve seen a little farther than other men, it’s by standing on the shoulders of giants.’ So, Warren may have stood on Ben’s shoulders, but he ended up seeing farther. And no doubt, somebody will come along in due course and do a lot better than we have.”
Buffett: “I enjoyed making money more than Ben, candidly.
With Ben, it really was incidental, at least by the time I knew him. It may have been different when he was younger. The game did not interest him more than a dozen other things may have interested him… I’ve probably thought way more about businesses than Ben ever did. He had other things that interested him. So I’ve pursued the game quite a bit differently than he did. And therefore, measuring the two records is not a proper measurement. He was doing victory laps while I still thought I was out there running against the whole field.”
Munger: “Graham had some blind spots, partly of a sort of ethical, professorial nature. He was looking for things to teach that would work for every man, that any intelligent layman could learn and do well.
Well, if that’s the limitation of what you’re looking for, they’ll be a lot of reality you won’t go into, because it’s too hard to figure out and too hard to explain. For Buffett, if there was money in it, he had no such restriction.”
That conversation emphasizes the importance of circumstances and incentives / objectives. Graham and Buffett had different goals by the time they’d met, and it would’ve been foolish for Buffett to limit himself based on what his mentor considered the “right” approach. Buffett recognized that “cigar butt” investing, the approach that had led him to returns in the 1950’s that were “by far the best of my life for both relative and absolute investment performance”, would face insurmountable hurdles as his asset base continued to grow - and thankfully for Berkshire shareholders, the student’s willingness to think differently allowed him to surpass the teacher.
As Munger explains, other (non-monetary) considerations had an impact on Buffett’s evolution as well: “It’s unpleasant to [own] lousy companies that you don’t like. It’s much more fun to watch somebody you like and admire succeeding than watching some jerk mismanage some company that’s very cheap. It’s a better life… You’re crazy if you’re rich to deliberately go out and do a lot of things you don’t have to.” Buffett had to personally learn this lesson with his investment in Dempster Mill, as Alice Schroder recounted in “The Snowball” (Buffett was ~30 years old at this time): “The people of Beatrice pulled out the pitchforks… He had not expected the ferocity, the personal vitriol. He had no idea that they would hate him… The experience scarred him. Instead of becoming toughened against animosity, he vowed never to let it happen again. He couldn’t take the whole town hating him.”