In 1963, Warren Buffett bought a block of American Express stock after the “Salad Oil Scandal” sent the shares down substantially—in a nutshell, one of American Express’s subsidiaries had used millions of dollars worth of salad oil as collateral to secure financing, and it turned out that the salad oil did not exist at all, putting American Express on the hook. Warren saw this as a buying opportunity, and paid the equivalent of $0.94 per share for the stock. It quickly went up to the equivalent of the $5 range within five years, and Buffett sold.
However, since 1968, American Express has increased another seventeen-fold. If Buffett hold on to his shares, he would have compounded his wealth at 13.1% annually since then (of course, we can’t fault Buffett for selling since he has compounded Berkshire’s book value at north of 19%, making him one of the only people walking this earth who could legitimately call 13% long-term annual returns a suboptimal allocation of funds decision).
I’m not sure how much Buffett put into the Buffett Partnership back then, but my best guess is that it was around $8.5 million or so. That would have grown into $5.3 billion today, or a little over 5% of the entire credit card giant.
It’s funny to see how the companies that Buffett discarded (American Express, Disney, McDonalds, etc.) have this tendency to offer 12% (or more) annual returns for very long periods of time even after Buffett sold.
I can’t remember if it was last year or the year before, but I read seeing a New York Times profile that chronicled many hedge funds that were delivering investors returns of only 8-9%, and then taking a giant 20% or so sized bite of the returns from that. I’m always struck by how needlessly complex they make it—spending all of their time sweating over tiny movements and coming up with strategies aimed at getting ahead, and yet, they fail to outperform the most boring, common-sense companies over long periods of time.
We know Mastercard, Visa, and American Express will be here twenty years from now. But how many investors do you think will buy the stock and sell it over the coming two decades, believing that they can get a better deal elsewhere? Meanwhile, the credit card giants will continue to compound at over 10% per year because the business is asset light (meaning it is easy to return cash to shareholders when the companies decide to do so), has strong brand equity (everyone knows what Visa, Mastercard, and American Express are), and operates in a business that has a very steep barrier to entry (you could give me a couple million dollars to create a competing credit card, and the only way I could get the local McDonalds to accept it would be if I bribed the franchise owner with the couple million dollars).
Excellent businesses have a tendency to return 10-13% over long periods of time, and you can actually capture the fullness of the return if you purchase the ownership stakes in a tax-deferred structure such as a Roth IRA). The simplicity of the strategy is its strength, but it is also a weakness in that doing nothing causes people to become restless because it’s so obvious. We all know Coca-Cola is the dominant soda in the world. We all know McDonalds is the dominant fast food restaurant. We all know Nestle is the dominant player when it comes to packaged goods. The path to long-term wealth is so easy and straightforward, that some people want to ignore it simply because it seems almost too obvious: You mean, I should just take this $10,000 windfall and put it all into Coca-Cola and sit on my keister for twenty years? Yes.
Originally posted 2014-01-08 08:40:57.