Decoding the Sage

Mr Yefei's book is an investment manager's delight, drawing freely from Mr Buffet's annual addresses to provide insights into the man's investment style

Inside the investments of Warren Buffet

Twenty Cases

Yefei Lu

Harper Business

293 pages

Rs 599 

Let’s say you’re a crack investment banker who's been presented with two opportunities. Both companies — one engaged in providing maps to fire insurers to help them assess underwriting risks, the other, a farm equipment maker specialising in windmills — were going great guns a few decades ago, but are well past their prime today. Sanborn Map Company has been steadily yielding its insurance business to carding, a new technology based on algorithmic calculations, while Dempster Mill Manufacturing Company is losing out to electrical pumps. Revenues and profits of both have been sliding the past few years. Would you still bet on them?

Let’s take another case. Here’s a frontrunner in the credit card and traveller’s cheque businesses with a formidable reputation. Its warehouse subsidiary has erroneously written receipts for a fraudulent transaction worth millions of dollars, and stares at bankruptcy. While the parent American Express’ liability isn’t clearly established, the President and CEO fears for its reputation and feels morally bound to make good the loss. In the process, he runs the risk of having his set-up go bust and invites the ire of its shareholders. Would you invest?

In his book Inside The Investments of Warren Buffett, author Yefei Lu explores the Sage of Omaha’s eye for numbers and general business acumen, and explains how they helped him determine that neither Sanborn nor Dempster was a dead business, though their fortunes were dwindling. Sanborn’s traditional mapping demanded revision services and still had several other avenues of business unaffected by carding. But what Mr Buffet saw, which others wouldn’t have, was a $7 million investment portfolio worth more than the entire company. It’s interesting to note that the Sage invested some 35 per cent of his partnership's net assets in Sanborn. Great value could be also extracted from Dempster’s aftersales and spare parts business which was capable of delivering recurring revenue for several years after the original product was sold.

Apart from American Express’ great operational strengths, it was the integrity and track record of the top man, Howard Clark, that impressed Buffett, prompting him to buy the Amex stock even as it was declining under the weight of a scam. 

Mr Yefei, a portfolio manager at Frankfurt-based investment company Shareholder Value Management AG, offers 20 case studies of Mr Buffett’s investments spread over three time zones. The first of these is the 1957-1968 period, which Mr Yefei calls the Partnership Years, and during which Mr Buffett started a career in investing with Buffett Partnership Ltd. Towards the end of this period, he’d acquire textile firm Berkshire Hathaway and make it his investment vehicle.

The second period (1968-90), or the Middle Years, sees Mr Buffett move away from his partnership and use Berkshire Hathaway as his investment vehicle. During these years, he began building his base in insurance, with National Indemnity, a disciplined speciality insurer more focused on bottom line than on unprofitable revenues, and GEICO, which saved on costs selling directly to customers instead of through insurance agents, and undercutting the market with cheaper premiums. The Sage also began investing increasingly in private companies such as See’s Candies, chosen, among other things, for its resilience in sticking to its recipe in the face of sugar-rationing, and Nebraska Furniture, which sold speciality products much cheaper than the competition. Mr Buffett's celebrated investments in this era included Washington Post and Coca-Cola, both of which were steadily gaining market share, and offered the prospect of multiple compounding even as market leaders in their respective domains.

The Late Years (1990-2014) saw Mr Buffett emerge as the household name he is today, entering the 1990s with an overall book value running into several billion dollars. While he continued to invest in private transactions, he began paying attention to mega corporations such as IBM, Wells Fargo, Burlington Northern and General Re, given the mammoth Berkshire Hathaway had become. Naturally, the investments were exponentially larger, and presented huge challenges along great potential in terms of his vehicle’s ability to provide the capital others couldn't.

So, what made Warren Buffett the last word in the realm of investments? Mr Yefei says regardless of the shift in strategy, he never lost sight of four fundamental pillars: Quality of information in financial statements and his interaction with the target company's management, consistency in the target company's growth, an opportunity-driven investment style and the company's management. 

Mr Yefei’s book is an investment manager’s delight, drawing freely from Mr Buffett's annual addresses to provide insights into the man’s investment style, which the author says wasn’t cast in stone when Mr Buffett started in 1957, but evolved with time. His book is embellished with charts, data and key financial ratios, which he uses to explain the logic behind the Sage’s investment decisions. For instance, the target companies in his earlier days traded at prices much below the value of the assets they held, and to which price-earnings ratio played second fiddle in Mr Buffett's mindset. So, while he would have paid a higher-than-warranted price for Sanborn based on price-earnings multiple, he bought it for much less than the value of its assets.

While the 20 cases in Mr Yefei’s book are more or less chronologically placed, the work is by no means a biography, and doesn't pretend to be one. That said, even if you aren't a financial wizard, pick it up for anecdotal value or simply to understand how someone as successful as Warren Buffett thinks. Only, don't get bamboozled by the financial calculations.