Compounding Machines

Mid-Continent Tab Card Co.

with 6 comments

On November 6 & 7, the University of Virginia hosted its first annual Value Investing Conference. From its website: “The mission of the Value Investing Conference is to annually assemble the investing public, professional investors, scholars, and students in the field of value investing for the purpose of highlighting and disseminating best practices, honoring best practitioners, and revealing new trends and developments in the field.”

One of the conference speakers was Alice Schroeder; author of the authorized biography of Warren Buffett entitled The Snowball. The video of the presentation can be found at the link below:

http://tinyurl.com/8o9xrk

During her presentation, Schroeder provided a fascinating case study of a private investment Buffett made in 1959 in a company called Mid-Continent Tab Card Company. At the risk of sounding technical, tab cards were something used in computers back in the day. At any rate, with over 50% profit margins, selling tab cards was IBM’s most profitable business in the 1950s. As a result of a settlement with the Justice Department, IBM was forced to divest of its tab card business. A couple of Buffett’s friends, Wayne Eaves and John Cleary, had started a tab card company themselves in the mid-to-late 1950s. It was an extremely profitable business. Tab cards were made on what was called a Carroll press. They were turning their capital over 7x per year while earning 40% net profit margins. In 1959 they were looking to grow this profitable business which required buying more carel presses.

So, in 1959 Eaves and Cleary approached Buffett to see if he had any interest in investing in the company. This is where Schroeder’s presentation gets interesting as she describes the process Buffett went through in deciding if he wanted to invest in the business and the return criteria he desired for putting up the money. I suspect the first thing that most analysts would do when presented with such an investment opportunity is to ask for management’s financial projections and then create a discounted cash flow model. According to Schroeder, Buffett did none of this. In fact, given complete access to all of Buffett’s files, she never once saw anything remotely resembling a financial model. Instead, he analyzed on a quarter-by-quarter and plant-by-plant basis, the historical profit and loss statements for both Mid-Continent and all relevant competitors. From there he acted like a horse handicapper figuring out which one or two factors would make the horse succeed or fail. In the case of Mid-Continent it was sales growth and cost advantages.  When presented to Buffett in 1959, the company had $1 million in sales, was growing at 70%+ per year and earning 36% profit margins. According to Schroeder, the ultimate decision to invest came down to the question, can I get a 15% return on $2 million of sales. The answer in his mind was yes, so Buffett invested $60,000 of his non-partnership money representing 20% of his net worth. This investment gave him 16% of the company’s stock plus some subordinated notes.

As one would expect the Mid-Continent investment turned out quite well for Buffett. Over time he put another $1 million in the company, which would later be renamed Data Documents. The company was sold in 1979 to Dictograph. Buffett held the investment for 18 years earning a 33% compounded annual return…sign me up!

What was interesting to me from this case study was that he did not seem to bother himself with projecting revenue and profits out five years, did not grind over whether to use a 10% or 12% discount rate, nor worry about which terminal multiple to use. There certainly was no investment banker’s “book.” Instead, he approached the investment wanting a 15% “equity coupon.”  From there, he had to decide for himself whether it was a cinch to get such a return while relying solely on analyzing historical profit and loss statements.

Discussion of this investment did not make it into The Snowball because it was deemed too technical for the general public. Let’s hope that Schroeder publishes a follow-up book with more stories similar to that of the Mid-Continent Tab Card Company.

Advertisements

Written by sdinvest

January 19, 2009 at 11:58 pm

Posted in Warren Buffett

6 Responses

Subscribe to comments with RSS.

  1. the approach is valid and very compelling as it places emphasis on relative cost advantage something missing in most analysts work which looks at a company, less than competitive sustainable advantage.

    nickgogerty

    January 23, 2009 at 11:57 pm

  2. Of course he didn’t need to do a DCF, the deal was so bloody cheap! He paid $60,000 for 16% of the company, which implies an enterprise value of $375,000 for a growing business that was generating $360,000 profit a year.

    raszut

    August 30, 2010 at 6:21 pm

    • A company valued at 1/3 of sales, growing at 70% per year, and 36% profit margins?????

      Where’s the downside? Who needs a DCF spreadsheet?

      invstmnt

      October 12, 2010 at 11:09 pm

  3. Very interesting anecdote. FYI, the actual name of the machine is a “Carroll Press,” named after the inventor:

    http://www-03.ibm.com/ibm/history/exhibits/builders/builders_carroll.html

    Thanks

    December 9, 2010 at 4:51 am

    • Thank you for the link…interesting history.

      sdinvest

      December 9, 2010 at 5:21 am

  4. The most interesting aspect of the case study was that Buffett was presented the deal twice.

    At first he said NO. It was a start up without a historical track record and with high catastrophe risk. The second time he said YES. By then, there was a historical rack record to analyze. Readers of Ben Graham’s Security Analysis, 1940 wouldn’t be surprised.

    Agree with you. Too bad this example didn’t make it to The Snowball. Such technical examples show how Buffett’s mind ticks.

    Satyajeet Mishra

    January 5, 2012 at 5:33 am


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: