Warren Buffett’s 2014 letter to shareholders tells the amazing story of Buffett buying Berkshire Hathaway.
At the time Warren’s investing style, taught by Ben Graham, was to look for “cigar butt” stocks – stocks that were dirt cheap, but provided a “free puff” to investors willing to make the investment. Berkshire certainly could have filled that criteria, here is how Buffett tells the tale:
“ I purchased BPL’s first shares of Berkshire in December 1962, anticipating more closings and more repurchases. The stock was then selling for $7.50, a wide discount from per-share working capital of $10.25 and book value of $20.20. Buying the stock at that price was like picking up a discarded cigar butt that had one puff remaining in it. Though the stub might be ugly and soggy, the puff would be free. Once that momentary pleasure was enjoyed, however, no more could be expected.
Berkshire thereafter stuck to the script: It soon closed another two plants, and in that May 1964 move, set out to repurchase shares with the shutdown proceeds. The price that Stanton offered was 50% above the cost of our original purchases. There it was – my free puff, just waiting for me, after which I could look elsewhere for other discarded butts.
Instead, irritated by Stanton’s chiseling, I ignored his offer and began to aggressively buy more Berkshire shares.
By April 1965, BPL owned 392,633 shares (out of 1,017,547 then outstanding) and at an early-May board meeting we formally took control of the company.
Through Seabury’s and my childish behavior – after all, what was an eighth of a point to either of us? – he lost his job, and I found myself with more than 25% of BPL’s capital invested in a terrible business about which I knew very little. I became the dog who caught the car.”
So what did this cigar butt of a company look like in 1964, as Buffett decided to take control? According to Berkshire Hathaway Letters to Shareholders, which has copies of the Shareholder reports for 1965 – 1976 (which are not available on Berkshire’s website), and Berkshire’s latest Annual Report, here is what attracted Buffett:
Berkshire Hathaway’s Balance Sheet as of Oct 4th 1964, just before Buffett took control:
(click to enlarge)
Based on a share price of $7.50, Berkshire Hathaway had a market cap of just over $7.63 million.
With this, Berkshire reported a net income of $175,586 in 1964; Giving it the following:
Click any of the links below for explanation of the terms.
Price to Earnings (P/E) Ratio: 42
(Which may have just been an anomaly. The next fiscal year Berkshire would have a net income of $2.2 million, and based on the share price then, a P/E ratio of about 7.)
Working Capital per Share: $12.75. The company was trading for roughly half its working capital!
Return on Assets: 0.63%
Return on Equity: 0.79%
Current Ratio: 3.52
Quick Ratio: 1.49
Of course the rest is history. 50 years later, investors have seen greater than a 750,000% rise in Book Value – and greater than 1,000,000% in intrinsic value.
More on Buffett and Berkshire Hathaway
Our “This Day in Stock Market History” series covers a few specific dates in Buffett’s early history with Berkshire Hathaway in more detail:
May 6th, 1964 – Berkshire Hathaway offers to buy back Buffett’s 7% stake for $11.375 per share. The only reason Buffett did not accept? He was promised 16 cents more.
May 10th, 1965 – Warren Buffett gains controlling stake in Berkshire Hathway. Former President, Seabury Stanton, resigns.
February 22nd, 1967 – Berkshire Hathaway purchases National Indemnity Company and National Fire and Marine Insurance Company. The purchase was Buffett’s entrance into the insurance industry.
Read more on Buffett’s investment philosophy
Blog Post – A look at Buffett’s 1988 investment in Coca-Cola
Blog Post – 9 Examples of a Competitive Advantage (#9 is One of Buffett’s Favorite Type to Look For!)
Buffett’s Reading List
Warren Buffett is a notorious reader. Here’s a few books that he says have been his favorites.The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition)
Buffett frequently credits Ben Graham, and this book he wrote specifically, for changing his life.Business Adventures: Twelve Classic Tales from the World of Wall Street
Warren Buffett recommended Bill Gates read the book in 1991, and Bill Gates now says it is “the best book on business I have ever read.“