How Warren Buffett’s Cities Service Preferred Investment Can Change Your Life

From Alice Schroeder’s biography “Snowball” about Warren Buffett:

By the age of twelve, Warren had saved $120. In the spring of 1942, he enlisted his sister Doris as a partner and purchased three shares of Cities Service Preferred. The stock plunged from $38.25 to $27. When the stock recovered to $40, Warren sold, netting a $5 profit for the two siblings. He was, however, shocked to see the stock then continue to rise until it hit $202 per share a short period of time later. Warren realized that if he had held off selling a little bit longer, he and his sister would have netted a profit of almost $500.

Alice Schroeder’s note: Warren learned three lessons and would call this episode one of the most important of his life. One lesson was not to overly fixate on what he had paid for a stock. The second was not to rush unthinkingly to grab a small profit. He learned those two lessons by brooding over the $492 he would have made had he been more patient. It had taken five years of work, since he was six years old, to save the $120 to buy this stock. Based on how much he currently made from selling golfballs or peddling popcorn and peanuts at the ballpark, he realized that it could take years to earn back the profit that he had ‘lost.’ He would never, never, never forget this mistake. And there was a third lesson, which was about investing other people’s money. If he made a mistake, it might get somebody upset at him. So he didn’t want to have responsibility for anybody else’s money unless he was sure that he could succeed.

In the field of high-quality blue chip investing, here’s what I think happens a lot: Most people are much more affected by making investment acts of commission rather than omission. They see Visa’s stock price go from $80 to $100 in a short period of time (or they see American Express’s stock price go from $30 to $50 quickly, there’s a lot of examples that you could use) and they internally say, “I want to capture this moment and etch it into stone as a success. If I sell a stock that appreciated $20, I can add that notch under my belt. It’s permanent.” The fear, of course, is the stock could collapse, fall 50%, the business deteriorates, and you’re left with the feeling of seeing what could have been a cemented success become a permanent failure. Obviously, that’s the outcome that is trying to be avoided when people talk about wanting to “lock in” gains.

But it is a narrow analysis because it ignores errors of omission—what if you had maintained your ownership and let the position ride? To use my favorite example, Visa would have crossed the $200 mark while still growing profits at 13% annually in a high quality, easy to understand kind of way.

For this article, I wanted to find out what would have happened if Buffett had continued to hold onto his Cities Service Preferred offering which eventually got folded into Occidental Petroleum in 1982. I had trouble calculating the figure because it turns out record books for Cities Service during WWII weren’t kept with facilitating article writing for bloggers seven decades later in mind, and coming up with the right figure is something I might be able to do if I were a finance professor at a university with a couple research assistants on hand, so all I could come up with this: based on price change alone, Buffett’s $250 investment in Cities Service would have, at a minimum, been worth $683,000. A $250 investment in 1942, by the way, was the equivalent of investing $3,500 today. So we are talking a 190x purchasing power increase during the seven decades that the investment would have been allowed to compound, and in truth, it would have been much, much higher once you factor in the income generated over seven decades, which I did not have the resources to factor in at all.

But I don’t need precision to learn a lesson. Think about how many times along the way it would have been tempting to engage in one of those Wall Street clichés like “take some off the table” or “lock in your gains” or “you can’t go broke taking a profit.” Think about how many people would have done just that with their $250 investment. Would you have sold at $500? $1,000? $10,000? $100,000? $500,000? It’s a shame that there is a behavioral quirk that makes people want to sell something that keeps on growing in order to lock in a gain, because the monster wealth occurs when you own something that is super high quality, and then after the twenty-year mark of compounding, the results start to go haywire to the point where you are making money faster than you can spend it.

I get a kick out of knowing that Buffett could have been a billionaire if he retired in the 1960s, and just held onto the Cities Service, Disney, American Express, and GEICO stock that he had accumulated (at one point in his life, Buffett had half his net worth in GEICO stock, a little known fact that will eventually get its own post on the site). The reason I get a kick out of it is because all of the energy was expended up front, and from then on, all he had to do was collect the dividends and he could have lived the entirety of his life doing whatever he wanted without any financial considerations affecting his ability to live life how he wanted.

If you own a great business, you need to get used to an increasing stock price and accept it. That sounds humorous in a “you will eat this cake and ice cream and you better love it!” kind of way, but it is a real obstacle that creates a trigger finger for long-term investors. If you picked a company that regularly grows profits, then the valuation of those profits will capitalize upon themselves as the profits grow, and that you create fertile soil for regret by selling too early. Incidentally, that’s partially why I focus on the income side of investing so much; if you are trying to build a high-quality source of income, you can avoid a lot of these temptations from the beginning because you’re focused on the highest quality of checks that get regularly sent to your account, rather than spending your life staring at changes in ticker symbol values on a screen.


Originally posted 2014-08-13 08:00:57.

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