Union Street Railway

Below you will find another case study from the Buffett with “more ideas than money” years. Thanks go out to a regular reader for sending me the Moody’s sheet.

During a question and answer session with University of Kansas students in 2005, one student asked what he would do differently given his belief that “it’s a huge structural advantage not to have a lot of money.” Buffett went on to say that with small capital he would look for “little anomalies, companies that are off the map – way off the map.” An example given was Union Street Railway of New Bedford, Massachusetts that was “selling at $30 when $100 is sitting in cash.”

You will see below page 1492 of the 1954 Moody’s Transportation Manual. At the time of this publication Buffett was three years removed from graduating from Columbia and was working for his father’s brokerage firm in Omaha. I believe it was around this time when he came across Union Street, an example he frequently provides students of a small, obscure cheap cigar butt-type investment.

Union Street operated a bus service near New Bedford, an area containing about 120,000 people. The company owned 113 buses in total (more about these in Alice Schroeder’s book). Union Street was a business in decline as evidenced by the drop in revenue passengers from 27 million in 1946 to 13.9 million in 1953, to the point where the business was operating in the red. Looking to the balance sheet you would see why an enterprising Graham-Dodd investor would be interested. You will see listed in current assets, cash and U.S. government securities totaling $969,363, or $52.79 per share. As Buffett mentioned the stock was selling around $30 per share, or $32 to $38.50 in 1953. If you look in non-current assets you will see two line items labeled “Special Deposits” and “Accid. Ins. Trust” which were $386,376 and $600,000 respectively, or $53.72 per share. Adding it all up, you had $106.50 per share in cash and cash-type items. The company had no debt to speak of. There were 18,363 shares out, so at $30 per share the market cap was $550,890, which is roughly $3.7 million in today’s dollars.

Incidentally, you may notice one of Union Street’s directors listed is Seabury Stanton. Stanton was running another New Bedford-based company at the time named Berkshire Hathaway. Like Ken Lewis unknowingly saved the U.S. economy, Stanton unknowingly saved Berkshire. As the story goes, Buffett, whom owned roughly 10% of the outstanding shares, came to an agreement with Stanton to tender all of his Berkshire shares to the company at $11.50. The following week, Stanton sent a letter indicating a tender for his stock at $11.375 per share. This low-ball offer angered Buffett leading him to continue buying up more Berkshire shares, eventually gaining control of the company. If Stanton would simply have tendered Buffett’s stock at the agreed upon price, we likely would never have heard of Berkshire Hathaway.

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Buffett Partnership – Part Two

Warren Buffett is frequently asked about a comment he made in a 1999 Business Week article to the effect that if he was managing $1 million or $10 million he would guarantee he could make a 50% annual return.  In fact, I was lucky enough to have the chance to ask him about it a few years ago during a q & a with my university.  He basically said that with a small amount of money under management, he would do exactly what he did in the 1950s after he got out of college and formed his partnership. In other words, he would probably not be looking at Coke, Burlington Northern, etc. He used his 1951 Moody’s Manual to discuss Western Insurance Securities which he discovered was selling for less than 1x earnings. He also had a 2005 Korean stock guide that was given to him by a friend. On a Sunday afternoon, he found 20 or so companies selling for 2-3x earnings. He put $100 million of his personal portfolio in these ideas.

In an earlier post (http://tinyurl.com/adwb5h) I discussed Berkshire Hathaway circa 1962. Here is a company named Grinnell Corporation. They made sprinkler systems, industrial humidification systems and plumbing materials. According to the 1962 year-end statement, the Buffett Partnership held 3,727 shares of Grinnell worth $277,697 at $74.50 per share. It was the 12^th largest position in the portfolio of about 50 stocks, accounting for 2.8% of assets. So why did Buffett own this stock? I have no way of knowing when he purchased the Grinnell shares, but the image below is from the 1962 Moody’s manual which is possibly the information Buffett studied before purchasing the shares. Grinnell seems to fit the Benjamin Graham description of a statistical bargain. At year-end 1961, the company had a tangible book value of $168 per share and a net current asset value (current assets – current liabilities) of $101 per share. So assuming the shares were purchased around the year-end 1962 price of $74.50, Buffett probably purchased the shares due at least in part to the fact that it was selling for about 26% below net working capital.

 

Mid-Continent Tab Card Co.

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.

Buffett Partnership, Ltd. – Dec. 31, 1962

I look forward to two things on the first Saturday in May.  First, the Berkshire Hathaway annual meeting in Omaha and second, buying the newest version of Andy Kilpatrick’s Warren Buffett biography, Of Permanent Value. I recommend buying this book as there is no more detailed biography available on Buffett.  You can buy it on Amazon, or as I plan to, you can have Andy sign a copy at the next Berkshire annual meeting.

One of the most interesting parts of the book for me is an image of the 1962 year end statement for Buffett Partnership, Ltd. The portfolio had a total value of $9,856,297 and about 50 long and 4 short positions. The top 5 positions accounted for 52.7% of the total portfolio value, while the top 10 positions represented 72% of the portfolio.

The reason the year-end statement was published in Kilpatrick’s book is that 1962 was the year Buffett first purchased shares in a New England textile company named Berkshire Hathaway. At the end of 1962 the Partnership owned 30,752 share of Berkshire at $7.56/share.  Note: If you’re keeping track at home…those 30,752 shares are worth about $3 billion today, or about a 22.8% compounded return over 46 years.

During the partnership years, Buffett would get his ideas from the Moody’s Manuals which contained a brief summary of basically every business in America.  In those days, he was not too concerned with the quality of a business as much as he was looking for statistical bargains. Heavily influenced by the teachings of Benjamin Graham, he was looking for stocks selling below estimated liquation value, or below net working capital. Buffett now refers to this process as looking for “used cigar butts.” They are soggy and repulsive, but they are free and you can usually get one good puff out of it before you move on to the next used cigar butt (the antithesis of looking for compounding machines). Berkshire was a cigar butt in 1962.

I was able to obtain a copy of the 1962 Moody’s Industrial Manual from the library.  Out of curiosity I wanted to see just how cheap some of the stocks were that Buffett was buying in the 1950s and 1960s. Below is the Berkshire Hathaway page which shows that at $7.56 per share, it was selling well below its net working capital of $12.35 per share.