With the exception of a brief position in silver that constituted less than 0.1% of 1% of Berkshire Hathaway’s overall assets, Warren Buffett has stayed far away from making purchases of outright commodities or collectibles during his fifty-one year stewardship of Berkshire Hathaway. Although a lot of people assume that Buffett came to his reluctance of collectible ownership rationally through historical studies of the collectibles markets, he actually learned this lesson through experience like the rest of us.
In 1959, Benjamin Graham was scheduled to speak at Beloit College about valuing individual common stock investments and bonds. Buffett wanted to see Graham speak in person, and so he called his friend Tom Knapp who worked at the Tweedy, Browne brokerage house that served as Graham’s broker. In fact, Knapp was the third partner, and back then it was called Tweedy, Browne & Knapp.
Buffett convinced Knapp to go with him, and on the drive from Nebraska to Wisconsin, Knapp suggested that the four-cent stamp “The 1954 Blue Eagle” was going to be taken out of circulation and would one day serve as a collector’s item. Buffett was convinced the $0.80 books of 1954 Blue Eagles could someday be worth tens of dollars each adjusted for inflation, paving the way for a possible 1,000% to 3,000% nominal gain which would create true investment gains of 700% to 2,500% after adjusting for the expected opportunity cost and inflation of waiting for the market to develop.
After they saw Graham speak at Beloit, Buffett and Knapp decided they would stop at post offices on the way back to Omaha and effectively corner the Northern and Midwestern market on the 1954 Blue Eagle stamp. The big haul came in Denver, where they purchased a 200,000 stamp supply for $8,000. That is the equivalent of about $55,000 in today’s dollars. In total, they bought almost 400,000 stamps for around $16,000, making a stamp investment somewhere around $100,000 in today’s dollars. This speaks to Buffett and Knapp’s investment in aggregate, rather than individually.
As the years went by, Buffett found himself encountering one teensy, tiny problem: the stamps never became a collector’s item! No one wanted 1954 Blue Eagle stamps in particular. They cornered the market, gave the stamps years to mature in value, and it never happened. Eventually, in 1982, Buffett sold the stamps at a 10% discount to a control mail dealer that acted as an arbitrageur for the industry. Knapp held on to his share of the 1954 Blue Eagle, ironically using four cent stamps as postage for the rest of his life.
Buffett was right to cut his losses in 1982–the stamps sell for $0.40 each today. But still, he sold his $8,000 investment in 1959 for $7,200 in 1982, which was truly a $4,000 loss when adjusting for inflation. To update the purchasing power equivalence to today’s terms, it would be like investing $50,000 in 2016 dollars to get what we currently understand as $25,000 in purchasing power–and waiting until 2039 to get it.
That loss from the stamp investment had an outsized influence on Warren Buffett’s approach to investing thereafter. You never hear about Warren Buffett paying art or ancient artifacts, even though Sotheby’s has facilitated a vibrant collectible’s trading market that has helped create a lot of wealth for those that accurately predicted America’s cultural trends regarding art.
Mark Twain said that once a cat sits on a hot stove, it will never again sit on either a hot stove or a cold stove. With the exception of a very small silver position that never constituted anything resembling a material portion of Berkshire Hathaway’s assets, Warren Buffett has returned to the arena of collectible investing after his 1954 Blue Eagle results from stamp speculation.
Stories like this remind me of the extraordinary advantage that productive assets have over non-productive assets. In the past, I compared gold against Coca-Cola stock. If you have 100 ounces of gold that you lock up in the bank vault, and visit it in fifty years, it will still only be 100 ounces of gold. There is nothing that “happened” to it. If you want it to be a successful investment, the only way you can make money on the deal is if the value of each ounce appreciates more.
With a productive business, you get a growth and cash-return kick that completely alters the equation. Sticking with 1959 as our reference point, if you bought 100 shares of KO stock and stuck the common stock certificate of ownership into a bank vault, you would have so much more today. Why? Because you benefited from four factors that are not present in the gold example. You benefitted from the fact that: (1) Coca-Cola increased the volume of products sold from 425 every single second in 1959 to 10,450 every second in 2016; (2) the price of a Coca-Cola soft drink increased at a rate that exceeded inflation by about 0.4% each year; (3) the company paid out consistent dividends between 1959 and 1963, and then raised the cash dividend payout to shareholders each year since then; (4) the company used retained earnings and borrowings to repurchase stock and boost the ownership claim of those original 100 shares.
These factors, in turn, drive the fifth factor commonality–an enterprise is going to be worth a lot more adjusted for inflation when it generates $9 billion in 2016 compared to generating $275 million in 1959.
The value of productive assets is even noticeable when the business is not growing profits rapidly like Coca-Cola. Take something GlaxoSmithKline, a British publicly traded firm that has not had a particularly strong decade. The price of the stock had done virtually nothing between 2005 and 2015. It hemmed and hawed between the $40s and $50s, hitting a high in the $60s and a low in the $30s over the course of the decade. No real capital appreciation to speak of. That is because the expiration of patents drove profits down from $8 billion to $5 billion as the managers couldn’t replace expiring cash cows with new sources of cash profits quickly enough.
But you know what? GlaxoSmithKline still returned over $20 in cash dividends to shareholders between 2005 and 2015. For holders of the American ADR, the dividend growth wasn’t straight up–there were years when the dividend shot up, stayed stagnant, and then declined, but the bottom-line is that shareholders have gotten to collect a lot of cash over the past ten years from the profits of this healthcare firm.
Despite its disappointment results from a profit growth and share price perspective, it is a very nice protector to receive $20 in income from a $45 share purchased in 2005. If you believe, as I do, that limiting the damage from bad deals can be just as important as maximizing the magnitude of gains from the good deals, then you can see why it is so attractive to remain within the realm of productive assets.
If someone reinvested GlaxoSmithKline stock from 2005 through 2015, even as the profits declined, the share count position would have turned every single share into 1.63 shares. The cash provided from the business used to grow the position more than offset the operating declines. If Glaxo traded at $45 per share in 2015, it really traded at $73.80 from the perspective of the 2005 investor because there are now 0.63 extra shares affecting the calculation. Adjusted for inflation, the value is $60.81 for a true purchasing power gain of $15 per share. As the business itself disappointed expectations by a good amount, you still built wealth. That is an attractive feature often seen in well-established productive assets.
I say this not to denigrate the collectible’s market. I know there are affluent people out there who have achieved crazy returns from buying art during a recession and then selling it during good times. In much the same way that there is a sharp difference between the quality of Coca-Cola and Alcoa, there is a big difference between buying a Picasso compared to buying a 1954 Blue Eagle.
But I still can’t imagine using art as a primary vehicle to build wealth unless that was your true specialized skill in life. And it should be worth noting that those who invest in art almost always have an antecedent investment in cash-generating assets that throw off the money that makes buying the art possible in the first place. I regard the inherent advantages of a productive cash-generating firm as a very, very strong presumption that should only be rebutted in extraordinary circumstances.
Originally posted 2016-03-13 18:45:02.