Cheap, Solid Microcaps Far Outperform the S&P 500

(Image: Zen Buddha Silence, by Marilyn Barbone)

July 15, 2018

The wisest long-term investment for most investors is an S&P 500 index fund.  It’s just simple arithmetic, as Warren Buffett and Jack Bogle frequently observe:

But you can do significantly better — roughly 7% per year (on average) — by systematically investing in cheap, solid microcap stocks.  The mission of the Boole Microcap Fund is to help you do just that.

Most professional investors never consider microcaps because their assets under management are too large.  Microcaps aren’t as profitable for them.  That’s why there continues to be a compelling opportunity for savvy investors.  Because microcaps are largely ignored, many get quite cheap on occasion.

Warren Buffett earned the highest returns of his career when he could invest in microcap stocks.  Buffett says he’d do the same today if he were managing small sums:

Look at this summary of the CRSP Decile-Based Size and Return Data from 1927 to 2015:

Decile Market Cap-Weighted Returns Equal Weighted Returns Number of Firms (year-end 2015) Mean Firm Size (in millions)
1 9.29% 9.20% 173 84,864
2 10.46% 10.42% 178 16,806
3 11.08% 10.87% 180 8,661
4 11.32% 11.10% 221 4,969
5 12.00% 11.92% 205 3,151
6 11.58% 11.40% 224 2,176
7 11.92% 11.87% 300 1,427
8 12.00% 12.27% 367 868
9 11.40% 12.39% 464 429
10 12.50% 17.48% 1,298 107
9+10 11.85% 16.14% 1,762 192

(CRSP is the Center for Research in Security Prices at the University of Chicago.  You can find the data for various deciles here:

The smallest two deciles — 9+10 — comprise microcap stocks, which typically are stocks with market caps below $500 million.  What stands out is the equal weighted returns of the 9th and 10th size deciles from 1927 to 2015:

Microcap equal weighted returns = 16.14% per year

Large-cap equal weighted returns = ~11% per year

In practice, the annual returns from microcap stocks will be 1-2% lower because of the difficulty (due to illiquidity) of entering and exiting positions.  So we should say that an equal weighted microcap approach has returned 14% per year from 1927 to 2015, versus 11% per year for an equal weighted large-cap approach.

Still, if you can do 3% better per year than the S&P 500 index (on average) — even with only a part of your total portfolio — that really adds up after a couple of decades.



By systematically implementing a value screen — e.g., low EV/EBIT or low P/E — to a microcap strategy, you can add 2-3% per year.



You can further boost performance by screening for improving fundamentals.  One excellent way to do this is using the Piotroski F_Score, which works best for cheap micro caps.  See:



In sum, over time, a quantitative value strategy — applied to cheap microcap stocks with improving fundamentals — has high odds of returning at least 7% (+/- 3%) more per year than an S&P 500 index fund.

If you’d like to learn more about how the Boole Fund can help you do roughly 7% better per year than the S&P 500, please call or e-mail me any time.

E-mail:  (Jason Bond)



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

You’re deluding yourself

(Image: Zen Buddha Silence, by Marilyn Barbone)

July 1, 2018

You’re deluding yourself.  I’m deluding myself.  Our brains just do this automatically, all the time.  We invent simple stories based on cause and effect.  Often this is harmless.  But sometimes it’s important to recognize that reality is far more unpredictable than we’d like.

We’re not wired to understand probabilities.  As Daniel Kahneman and Amos Tversky have demonstrated, even many professional statisticians are not good “intuitive statisticians.”  They’re usually only good if they slow down and work through the problem at hand step-by-step.  Otherwise, they too tend to create overly simplistic, overly deterministic stories.

(Photo by Wittayayut Seethong)

To develop better mental habits, a good place to start is by recognizing delusions and biases, which are widespread in business, politics, and economics.  To that end, here are four of the best books:

  • Thinking, Fast and Slow (Farrar, Straus and Giroux, 2011), by Daniel Kahneman
  • Poor Charlie’s Almanack (Walsworth, 3rd edition, 2005), by Charles T. Munger
  • The Halo Effect…and Eight Other Business Delusions That Deceive Managers (Free Press, 2007), by Phil Rosenzweig
  • Expert Political Judgment: How Good Is It? How Can We Know? (Princeton University Press, 2006), by Philip Tetlock

Tetlock’s work is particularly important.  He tracked over 27,000 predictions made in real time by 284 experts from 1984 to 2003.  Tetlock found that the expert predictions—on the whole—were no better than chance.  Many of these experts have deep historical knowledge of politics or economics, which can give us important insights and is often a precursor to scientific knowledge.  But it’s not yet science—the ability to make predictions.

Kahneman and Munger both show how our intuition uses mental shortcuts (heuristics) to jump to conclusions.  Often these conclusions are fine.  But not if probabilistic reasoning is needed to reach a good decision.

This blog post focuses on Rosenzweig’s book, which examines delusions in business, with particular emphasis on the Halo Effect.

Outline for this blog post:

  • The Halo Effect
  • Illusions and Delusions
  • How Little We Know
  • The Story of Cisco
  • Up and Down with ABB
  • Halos All Around Us
  • Research to the Rescue?
  • Searching for Stars, Finding Halos
  • The Mother of All Business Questions, Take Two
  • Managing Without Coconut Headsets



Rosenzweig quotes John Kay of the Financial Times:

The power of the halo effect means that when things are going well praise spills over to every aspect of performance, but also that when the wheel of fortune spins, the reappraisal is equally extensive.  Our search for excessively simple explanations, our desire to find great men and excellent companies, gets in the way of the complex truth.

(Image by Ileezhun)

Rosenzweig explains the essence of the Halo Effect:

If you select companies on the basis of outcomes—whether success or failure—and then gather data that are biased by those outcomes, you’ll never know what drives performance.  You’ll only know how high performers or low performers are described.

Rosenzweig describes his book as “a guide for the reflective manager,” a way to avoid delusions and to think critically.  It’s quite natural for us to construct simple stories about why things happen.  But many events—including business success and failure—don’t happen in a straightforward way.  There’s a large measure of uncertainty (chance) involved.

Rosenzweig adds:

Of course, for those who want a book that promises to reveal the secret of success, or the formula to dominate their market, or the six steps to greatness, there are plenty to choose from.  Every year, dozens of new books claim to reveal the secrets of leading companies… Others tell you how to become an innovation powerhouse, or craft a failsafe strategy, or devise a boundaryless organization, or make the competition irrelevant.

But if anything, the world is getting more unpredictable:

In fact, for all the secrets and formulas, for all the self-proclaimed thought leadership, success in business is as elusive as ever.  It’s probably more elusive than ever, with increasingly global competition and technological change moving at faster and faster rates—which might explain why we’re tempted by promises of breakthroughs and secrets and quick fixes in the first place.  Desperate circumstances push us to look for miracle cures.

Rosenzweig explains that business managers are under great pressure to increase profits.  So they naturally look for clear solutions that they can implement right away.  Business writers and experts are happy to supply what is demanded.  However, reality is usually far more unpredictable than is commonly assumed.



Science is the ability to predict things:  if x, then y (with probability z).  (If we’re talking about physics—other than quantum mechanics—then z = 100% in the vast majority of cases.)  But the sciences that deal with human behavior still haven’t discovered enough to make many predictions.  There are specific experiments or circumstances where good predictions can be made—such as where to place specific items in a retailer to maximize sales.  And good research has uncovered numerous statistical correlations.

But on the whole, there’s still much unpredictability in business and in human behavior generally.  There’s still not much scientific knowledge.

Rosenzweig says some of the biggest recent business blockbusters contain several delusions:

For all their claims of scientific rigor, for all their lengthy descriptions of apparently solid and careful research, they operate mainly at the level of storytelling.  They offer tales of inspiration that we find comforting and satisfying, but they’re based on shaky thinking.  They’re deluded.

Rosenzweig explains that most management books seek to understand what leads to high performance.  By contrast, Rosenzweig asks why it is so difficult to understand high performance.  We suffer from many delusions.  Our intuition leads us to construct simple stories to explain things, even when those stories are false.

(Image by Edward H. Adelson, via Wikimedia commons)

Look at squares A and B just above:  Are they the same color?  Or is one square lighter than the other?

A and B are exactly the same color.  However, our visual system automatically uses contrast.  If it didn’t, then as Steven Pinker has pointed out, we would think a lump of coal in bright sunlight was white.  We would think a lump of snow inside a dark house was black.  We don’t make these mistakes because our visual system works in part by contrast.  Kathryn Schulz mentions this in her excellent book, Being Wrong (HarperCollins, 2010).

This use of contrast is a heuristic—a shortcut—used by our visual system.  This happens automatically.  And usually this heuristic helps us, as in Pinker’s examples.

The important point is that our intuition (part of our mental system) is like our visual system Our intuition also uses heuristics.

  • If we are asked a difficult question, our intuition substitutes an easier question and then answers that question.  This happens automatically and without our conscious awareness. 
  • Similarly, our intuition constructs simple stories in terms of cause and effect, even if reality is far more complex and random.  This happens automatically and without our conscious awareness.

(Image by Edward H. Adelson, via Wikimedia Commons)

This second image is the same as the previous one—except this one has two vertical grey bars.  This helps (to some extent) our eyes to see that squares A and B are exactly the same color.

Rosenzweig mentions that some rigorous research of business has been conducted.  But this research often reaches far more modest conclusions than what we seek.  As a result, it’s not popular or well-known.  For instance, there may be a 0.2 correlation between certain approaches of a CEO and business performance.  That’s a huge finding—20% of business performance is based on specific CEO behavior.

But that means 80% of business performance is due to other factors, including chance.  That’s not the type of information people in business want to hear when they’re busy and under pressure.



In January 2004, after a disastrous holiday season, Lego—the Danish toymaker—fired its chief operating officer, Poul Ploughman.  Rosenzweig points out that when a company does well, we tend to automatically think its leaders did the right things and should be praised or promoted.  When a company does poorly, we tend to jump to the conclusion that its leaders did the wrong things and should be replaced.

But reality is far more complex.  Good leadership may represent 20-30% of the reason a company is doing well now, but luck may be an even bigger factor.  Similarly, bad leadership may be responsible for 20-30% of a company’s poor performance, whereas bad luck—unforeseeable events—may be a bigger factor.

(Photo by Marco Clarizia)

As humans, we’re driven to construct stories in which success and failure are completely explainable—without reference to luck—based on the actions of people and systems.  This satisfies our psychological need to see the world as a predictable place.

However, reality is unpredictable to an extent.  We understand far less than we think.  Luck usually plays a large role in business success and failure.

When Lego hired Ploughman, it was seen as a coup.  Ploughman helped Lego expand into electronic toys.  When the initial results of this expansion were not positive, Lego’s CEO Kjeld Kirk Kristiansen lost patience and fired Ploughman.

The business press reported that Lego had “strayed from its core.”  However, the company tried to expand because its traditional operations were not as profitable as before.  If the company’s attempted expansion had been more profitable, the business press would have reported that Lego “wisely expanded.”

(Photo of lego bricks by Benjamin D. Esham)

When it comes to business performance, there are many factors—including luck.  A company may move forward on an absolute basis, but fall behind relative to competitors.  Also, consumer tastes are unpredictable.

  • A company may attempt expansion and fail, but the decision may have been wise based on available information.  Regardless, observers are likely to say the company “unwisely strayed from its core.”
  • Or a company may try to expand and succeed, but it may have been a stupid decision based on available information.  Regardless, observers are likely to claim that the company “brilliantly expanded.”

To understand better how businesses succeed, we should try to understand what factors are involved in good decisions, even though good decisions often don’t work and bad decisions sometimes do.  We want to avoid outcome bias, where our evaluation of the quality of a decision is colored by whether the result was favorable or not.

Science is:  if x, then y (with probability z).  This is a slightly modified definition (I added “with probability z”) Rosenzweig borrowed from physicist Richard Feynman.

In some areas of business, scientists have discovered reliable statistical correlations.  For instance, this set of behaviors—a, b, and c—has a 0.10 correlation with revenues.  If you do a, b, and c—holding all else constant—then revenues will increase approximately 10%.

The difficult thing about studying business is that often you cannot run controlled experiments.  Of course, sometimes you can.  For instance, you can experiment with where to place various items in a store (or chain of stores).  You can compare results and gain good statistical information.  Also, there are promotions and advertising campaigns that you can test.  And you can track consumer behavior online.

But frequently you cannot run controlled experiments.  As Rosenzweig observes, you can’t do 100 acquisitions, and manage half of them one way, the other half another way, and then compare the results.

There’s nothing wrong with stories, which are satisfying explanations we construct about various events.  But stories are not science, and it’s important to keep the distinction straight, especially when we’re trying to understand why things happen.

An even better term than pseudo-science is Feynman’s term, Cargo Cult Science.  Rosenzweig quotes Feynman:

In the South Seas, there is a cult of people.  During the war, they saw airplanes land with lots of materials, and they want the same thing to happen now.  So they’ve arranged to make things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head like headphones and bars of bamboo sticking out like antennas—he’s the controller—and they wait for the airplanes to land.  They’re doing everything right.  The form is perfect.  But it doesn’t work.  No airplanes land.  So I call these things Cargo Cult Science, because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential, because the planes don’t land.

(Photo of Richard Feynman in 1984, by Tamiko Thiel)

Rosenzweig concludes:

The business world is full of Cargo Cult Science, books and articles that claim to be rigorous scientific research but operate mainly at the level of storytelling.  In later chapters, we’ll look at some of this research—some that meet the standard of science but aren’t satisfying as stories, and some that offer wonderful stories but are doubtful as science.  As we’ll see, some of the most successful business books of recent years, perched atop the bestseller list for months on end, cloak themselves in the mantle of science, but have little more predictive power than a pair of coconut headsets on a tropical island.

It’s not that stories have nothing to teach us.  For instance, experts may develop deep historical knowledge that offers us useful insights into human behavior.  And such knowledge is often an antecedent to scientific knowledge.

But we have to be careful not to confuse stories with science.  Otherwise, it’s very easy and natural to delude ourselves that we understand something scientifically, when in fact we don’t.  Our intuition creates simple stories of cause and effect just as automatically as our visual system is unable to avoid optical illusions.

(Holy grail or two girls, by Micka)



Rosenzweig tells the story of Cisco.  Sandra K. Lerner and Leonard Bosack met in graduate school, fell in love, and got married.  After graduating, they each took jobs managing computer networks at different corners of the Stanford campus.  They wanted to communicate, and they invented a multiprotocol router.  Rosenzweig:

Like many start-ups, Cisco began by operating out of a basement and at first sold its wares to friends and professional acquaintances.  Once revenues approached $1 million, Lerner and Bosack went in search of venture capital.  The man who finally said yes was Donald Valentine at Sequoia Capital, the seventy-seventh moneyman they approached, who invested $2.5 million for a third of the stock and management control.  Valentine began to professionalize Cisco’s management, bringing in as CEO an industry veteran, John Morgridge.  Sales grew rapidly, from $1.5 million in 1987 to $28 million in 1989, and in February 1990, Cisco went public.

Valentine and Morgridge brought on John Chambers as a sales executive in 1991.  Chambers had worked at IBM and Wang Labs, and was ready to work at a smaller company where he might have more of an impact.  Chambers came up with a plan for Cisco to dominate the market for computer infrastructure.  Over the next three years, Cisco acquired two dozen companies.

(Cisco Logo, via Wikimedia Commons)

Chambers became CEO in 1995 and Cisco continued acquiring companies.  Cisco’s revenues reached $4 billion in 1997.  Rosenzweig:

Cisco rode the crest of the internet wave in 1998… Cisco had a 40 percent share of the $20 billion data-networking equipment industry—routers, hubs, and devices that made up the so-called plumbing of the Internet—and a massive 80 percent share of the high-end router market.  But Cisco wasn’t just growing revenues.  It was profitable, too.  At a time when even the most admired Internet start-ups, like, were losing money, Cisco posted operating margins of 60 percent.  This wasn’t some dot-com with a business plan, way out there in the blue, riding on a smile and a shoeshine.  It wasn’t panning for Internet gold, it was selling picks and shovels to miners who were lining up around the corner to buy them…

Cisco reached $100 billion market capitalization in just twelve years.  It had taken Microsoft twenty years (the previous record).

Accounts explaining Cisco’s success nearly always gave credit to John Chambers.  He’d overcome dyslexia to go to law school.  And Chambers said he learned from working at IBM and Wang that if you don’t react to shifts in technology, your work will be lost and the lives of employees disrupted.  Cisco wouldn’t make that mistake, Chambers declared.

Cisco had a disciplined, detailed process for making acquisitions, and an even more disciplined process for integrating acquisitions into Cisco’s operations.  Cisco had made “a science” of acquisitions.  And it cared a lot about the human side—turnover rate for acquired employees was only 2.1% versus an industry average of 20%.

After the Internet stock bubble burst, business reporters completely reversed their opinion of Cisco on every major point:

  • Customer service—from excellent to poor
  • Forecasting ability—from outstanding to terrible
  • Innovation—from nearly perfect to visibly flawed
  • Acquisitions—from scientific process to binge buying
  • Senior leadership—from amazing to arrogant

Business reporters recalled that Chambers had claimed that Cisco “was faster, smarter, and just plain better than competitors.”  Rosenzweig says this is fascinating because only business reporters had said this when Cisco was doing well.  Chambers himself never said it, but now business writers seemed to recall that he had.

Rosenzweig points out that it was possible that Cisco had changed.  But that’s not what business reporters were saying.  They viewed Cisco through an entirely different lens, now that the company was struggling.

The essence of the Halo Effect: If a company is performing well, then it’s easy to view virtually everything it does through a positive lens.  If a company is doing poorly, then it’s natural to view virtually everything it does through a negative lens.  The story of Cisco certainly fits this pattern.

As Rosenzweig remarks, the fundamental problem is twofold:

  • We have little scientific knowledge of what leads to business success or failure.
  • But we do know about revenues, profits, and the stock price.  If these observable measures are positive, we intuitively jump to the conclusion that the company must be doing many things well.  If these observable measures are declining, we conclude that the company must be doing many things poorly.



ABB is a Swedish-Swiss industrial company that was created in 1988 by the merger of two leading engineering companies, Sweden’s ASEA and Switzerland’s Brown Boveri.

(ABB Logo, via Wikimedia Commons)

Rosenzweig thought it would be interesting to look at a non-American, non-Internet company.  The Halo Effect is still clearly visible in the accounts of ABB’s rise and fall.

When it came to ABB’s rise, from the late 1980’s to the late 1990’s, we see that business experts drew similar conclusions.  First, the CEO, Percy Barnevik, was widely and highly praised.  Rosenzweig describes Barnevik as a “Scandinavian who combined old world manners and language skills with American pragmatism and an orientation for action.”  Barnevik was described in the press as very driven, but also unpretentious and accessible.  He met frequently with all levels of ABB management.  He was a speed reader and highly analytical.  Away from work, he climbed mountains and went for long jogs (lasting up to 10 hours).  On top of all this, Barnevik was viewed as humble, not arrogant.  By 1993, Barnevik had become a legend.

Another explanation for ABB’s success was its culture.  Despite its conservative Swedish and Swiss roots, ABB had a strong bias for action.  Barnevik said so on several occasions, asserting that the only unacceptable thing was to do nothing.  He claimed that if you do 50 things, and 35 are in the right direction, that is enough.

A third explanation was that the company was designed to be globally efficient, but still able to compete in local markets.  Barnevik wanted people in different locations to be able to launch new products, make design changes, or alter production methods.  ABB had a matrix structure, with fifty-one business areas and forty-one country managers.  This resulted in 5,000 profit centers, with each one empowered to achieve high performance and accountable to do so.

In 1996, ABB was named Europe’s Most Respected Company for the third year in a row by the Financial Times.  Kevin Barham and Claudia Heimer, of Ashridge Management Centre in England, published a 382-page book about ABB.  They identified five reasons for ABB’s success:  customer focus, connectivity, communication, collegiality, and convergence.  They placed ABB in the same category as Microsoft and General Electric.

In 1997, Barnevik stepped down as CEO, replaced by Goran Lindahl.  Then the company transitioned towards businesses based on intellectual capital.  ABB entered new areas, like financial services.  It exited the trains and trams business, as well as the nuclear fuels business.  Rosensweig asks if ABB was “straying from its core.”  Not at all because ABB was still seen as a success.  Lindahl was CEO of the year in 1999 according to the American publication, Industry Week.  Lindahl was the first European to get this award.

In November 2000, Lindahl abruptly stepped down, saying he wanted to be replaced by someone with more expertise in IT.  Jürgen Centerman became the new CEO.

ABB’s performance entered a steep decline.  Centerman was replaced by Jürgen Dormann in September 2002.  Dormann sold the company’s petrochemicals business and its structured finance business.  ABB focused on automation technologies and power technologies.  But the company’s market cap dipped below $4 billion, down from a peak of $40 billion.

When ABB was on the rise in terms of performance, it was described as bold and daring because of its bias for action and experimentation.  Now, with performance being poor, ABB was described as impulsive and foolish.  Moreover, whereas ABB’s decentralized strategy had been praised when ABB was rising, now the same strategy was criticized.  As for Barnevik, while he had previously been described as bold and visionary, now he was called arrogant and imperial.

Most interesting of all, notes Rosenzweig, is that neither the company nor Barnevik was thought to have changed.  It was only how they were characterized that had changed—clear examples of the Halo Effect.

Rosenzweig writes:

…one of the main reasons we love stories is that they don’t simply report disconnected facts but make connections about cause and effect, often ascribing credit or blame to individuals.  Our most compelling stories often place people at the center of events… Once widely revered, Percy Barnevik was now an exemplar of arrogance, of greed, of bad leadership.



During World War I, the American psychologist Edward Thorndike studied how superiors rated their subordinates.  Thorndike noticed that good soldiers were good on nearly every attribute, whereas underperforming soldiers were bad on nearly every attribute.  Rosenzweig comments:

It was as if officers figured that a soldier who was handsome and had good posture should also be able to shoot straight, polish his shoes well, and play the harmonica, too.

Thorndike called this the Halo Effect.  Rosenzweig:

There are a few kinds of Halo Effect.  One refers to what Thorndike observed, a tendency to make inferences about specific traits on the basis of a general impression.  It’s difficult for most people to independently measure separate features; there’s a common tendency to blend them together.  The Halo Effect is a way for the mind to create and maintain a coherent and consistent picture, to reduce cognitive dissonance.

(Image by Aliaksandra Molash)

Rosenzweig gives the example of George W. Bush.  After the September 11 attacks in 2001, Bush’s approval ratings rose sharply, not surprisingly as the public rallied behind him.  But Bush’s ratings on other factors, such as his management of the economy, also rose significantly.  There was no logical reason to think Bush’s handling of the economy was suddenly much better after the attacks.  This is an instance of the Halo Effect.

By October 2005, the situation had reversed.  Support for the Iraq War waned, and people were upset about the government response to Hurricane Katrina.   Bush’s overall ratings were at 37 percent.  His rating was also lower in every individual category.

Rosenzweig then explains another kind of Halo Effect:

…the Halo Effect is not just a way to reduce cognitive dissonance.  It’s also a heuristic, a sort of rule of thumb that people use to make guesses about things that are hard to assess directly.  We tend to grasp information that is relevant, tangible, and appears to be objective, and then make attributions about other features that are more vague or ambiguous.

Rosenzweig later adds:

All of which helps explain what we saw at Cisco and ABB.  As long as Cisco was growing and profitable and setting records for its share price, managers and journalists and professors inferred that it had a wonderful ability to listen to its customers, a cohesive corporate culture, and a brilliant strategy.  And when the bubble burst, observers were quick to make the opposite attribution.  It all made sense.  It told a coherent story.  Same for ABB, where rising sales and profits led to favorable evaluations of its organization structure, its risk-taking culture, and most clearly the man at the top—and then to unfavorable evaluations when performance fell.

Rosenzweig recounts an experiment by professor Barry Staw.  Various groups of people were asked to forecast future sales and earnings based on a set of financial data.  Then some groups were told they’d done a good job, while other groups were told the opposite.  But this was done at random, completely independent of actual performance.

Later, each group was asked about how it had functioned as a group.  Groups that had been told that they did well on their forecasts reported that their group had been cohesive, with good communication, openness to change, and good motivation.  Groups that had been told that they didn’t do well on their forecasts reported that they lacked cohesion, had poor communication, and were unmotivated.

Staw’s experiment is a clear demonstration of the Halo Effect.

  • If people believe that a group is effective—irrespective of whether the group can be measured as such—then they attribute one set of characteristics to it.
  • If people believe that a group is ineffective—irrespective of whether the group can be measured as such—then they attribute the opposite set of characteristics to it.

This doesn’t mean that cohesiveness, motivation, etc., is unimportant for group communication.  Rather, it means that people typically cannot assess these types of qualities with much (or any) objectivity, especially if they already have a belief about how a given group has performed in some task.

When it’s hard to measure something objectively, people tend to look for something that is objective and use that as a heuristic, inferring that harder-to-measure attributes must be similar to whatever is objective (like financial peformance).

As yet another example, Rosenzweig mentions that IBM’s employees were viewed as smart, creative, and hardworking in 1984 when IBM was doing well.  In 1992, after IBM had faltered, the same people were described as complacent and bureauratic.

As we’ve seen, the Halo Effect is particularly frequent when people try to judge how good a leader is.  Just as we don’t have much scientific knowledge for how a company can succeed, we also don’t have much scientific knowledge about what makes a good leader.  Experts, when they look at a company that is doing well, tend to think that the leader has many good qualities such as courage, clear vision, and integrity.  When the same experts examine a company that is doing poorly, they tend to conclude that the leader lacks courage, vision, and integrity.  This happens even when experts are looking at the same company and that company is doing the same things.

(Image by Kirsty Pargeter)

When Microsoft was doing well, Bill Gates was described as ambitious, brilliant, and visionary.  When Microsoft appeared to falter in 2001, after Judge Thomas Penfield Jackson ordered Microsoft to be broken up, Bill Gates was described as arrogant and stubborn.

Rosenzweig gives two more examples:  Fortune’s World’s Most Admired Companies, and the Great Places to Work Institute’s Best Companies to Work For index.  Both lists appear to be significantly impacted by the Halo Effect.  Companies that have been doing well financially tend to be viewed and described much more favorably on a range of metrics.

Rosenzweig closes the chapter by noting that the Halo Effect is the most basic delusion, but that there are several more delusions he will examine in the coming chapters.




The Halo Effect shapes how we commonly talk about so many topics in business, from decision processes to people to leadership and more.  It shows up in our everyday conversations and in newspaper and magazine articles.  It affects case studies and large-sample surveys.  It’s not so much the result of conscious distortion as it is a natural human tendency to make judgments about things that are abstract and ambiguous on the basis of other things that are salient and seemingly objective.  The Halo Effect is just too strong, the desire to tell a coherent story too great, the tendency to jump on bandwagons too appealing.

The most fundamental business question is:

What leads to high business performance?

The Halo Effect is far from inevitable, despite being very common.  There are researchers who use careful statistical tests to isolate the effects of independent variables on dependent variables.

The dependent variables relate to company performance.  And we have good data on that, from revenues to profits to return on capital.

As for the independent variables, some of these, such as R&D spending, are not tainted.  Much trickier is what happens inside a company, such as quality of management, customer orientation, company culture, etc.

Rosenzweig explores the question of whether customer focus leads to better company performance.  It probably does.  However, in order to measure the effect of customer focus on performance objectively, we should not look at magazine and newspaper articles—since these are impacted by the Halo Effect.  Nor should we ask company employees about their customer focus.  How a company is performing—well or poorly—will impact the opinions of managers and employees regarding customer focus.

Similar logic applies to the question of how corporate culture impacts business performance.  Surveys of managers and employees will be tainted by the Halo Effect.  Yes, corporate culture impacts business performance.  But to figure out the statistical correlation, we have to be sure to avoid data likely to be skewed by the Halo Effect.

Delusion Two: The Delusion of Correlation and Causality

Rosenzweig gives the example of employee turnover and company performance.  If there is a statistical correlation between the two, then what does that mean?  Does lower employee turnover lead to higher company performance?  That sounds reasonable.  On the other hand, does higher company performance lead to lower employee turnover?  That could very well be the case.

Potential confusion about correlation versus causality is widespread when it comes to the study of business.

One way to get some insight into potential causality is to conduct a longitudinal study, looking at independent variables in one period and hypothetically dependent variables in some later period.  Rosenzweig:

One recent study, by Benjamin Schneider and colleagues at the University of Maryland, used a longitudinal design to examine the question of employee satisfaction and company performance to try to find out which one causes which.  They gathered data over several years so they could watch both changes in satisfaction and changes in company performance.  Their conclusion?  Financial performance, measured by return on assets and earnings per share, has a more powerful effect on employee satisfaction than the reverse.  It seems that being on a winning team is a stronger cause of employee satisfaction; satisfied employees don’t have as much of an effect on company performance.  How were Schneider and his colleagues able to break the logjam and answer the question of which leads to which?  By gathering data over time.

Delusion Three: The Delusion of Single Explanations

Rosenzweig describes two studies that were carefully conducted, one on the effect of market orientation on company performance, and the other on the effect of CSR—corporate social responsibility—on company performance.  The studies were careful in that they didn’t just ask for opinions.  They asked about different activities in which the company did or did not engage.

The conclusion of the first study was that market orientation is responsible for 25 percent of company performance.  The second study concluded that CSR is responsible for 40 percent of company performance.  Rosenzweig asks: Does that mean that market orientation and CSR together explain 65 percent of company performance?  Or do the variables overlap to an extent?  The problem with studying a single cause of company performance is that you don’t know if part of the effect may be due to some other variable you’re not measuring.  If a company is well-managed, then wouldn’t that be seen in market orientation and also in CSR?

(Photo by Jörg Stöber)

We could throw human resource management—HRM—into the mix, too.  Same goes for leadership.  One study found that good leadership is responsible for 15 percent of company performance.  But is that in addition to market orientation, CSR, and HRM?  Or do these things overlap to an extent?  It’s likely that there is significant overlap among these four variables.

One problem is that many researchers would like to tell a clear story about cause and effect.  Admitting that many key variables likely overlap means that the story is much less clear.  People—especially if busy or pressured—prefer simple stories where cause and effect seem obvious.

Furthermore, many important questions are at the intersection of different fields.  Rosenzweig gives the example of decision making, which involves psychology, sociology, and economics.  The trouble is that an expert in marketing will tend to exaggerate the importance of marketing.  An expert in CSR will tend to exaggerate the importance of CSR.  And so forth for other specialties.



Rosenzweig lists the eight practices of America’s best companies according to In Search of Excellence: Lessons from America’s Best-Run Companies, published by Tom Peters and Bob Waterman in 1982:

  • A bias for action—a preference for doing something—anything—rather than sending a question through cycles and cycles of analyses and committee reports.
  • Staying close to the customer—learning his preferences and catering to them.
  • Autonomy and entrepreneurship—breaking the corporation into small companies and encouraging them to think independently and competitively.
  • Productivity through people—creating in all employees the awareness that their best efforts are essential and that they will share in the rewards of the company’s success.
  • Hands-on, value-driven—insisting that executives keep in touch with the firm’s essential business.
  • Stick to the knitting—remaining with the business the company knows best.
  • Simple form, lean staff—few administrative layers, few people at the upper levels.
  • Simultaneous loose-tight properties—fostering a climate where there is dedication to the central values of the company combined with a tolerance for all employees who accept those values.

Rosenzweig points out that this list looks familiar:  Care about your customers.  Have strong values.  Create a culture where people can thrive.  Empower your employees.  Stay focused.

If these look correlated, says Rosenzweig, that’s because they are.  The best companies do all of them.  Of course, again there’s the Halo Effect.  If you isolate the top-performing companies (43 of them in this case), and then ask managers and employees about customer focus, values, culture, leadership, focus, etc., then you won’t know what caused what.  Did clear strategy, good organization, strong corporate culture, and customer focus lead to the high performance?  Or do people view high-performing companies as doing well in these areas?

(Image by Eriksvoboda)

When the book was published in 1982, there was a widespread concern among American businesses that Japanese companies were better overall.  Peters and Waterman made the point that the leading American businesses were doing well in a variety of key areas.  This message was viewed not only as inspirational, but even as patriotic.  It was the right story for the times.

Many thought that In Search of Excellence contained scientific knowledge:  if x, then y (with probability z).  People thought that if they implemented the principles highlighted by Peters and Waterman, then they would be successful in business.

However, just two years later, some of the excellent companies did not seem as excellent as before.  Some were blamed for changing—not sticking to their knitting.  Others were blamed for NOT changing—not being adaptable enough, not taking action.  More generally, some were blamed for overemphasizing certain principles, while underemphasizing other principles.

Rosenzweig examined the profitability of 35 of the 43 excellent companies—the 35 companies for which data were available because these companies were public.  He found that, in the five years after 1982, 30 out of 35 had a decline in profitability.  If these were truly excellent companies, then such a decline for 30 of 35 doesn’t make sense.

(Image by Dejan Lazarevic)

Rosenzweig observes that it’s possible that the previous success of these companies was due to more than the eight principles identified by Peters and Waterman.  And so changes in other variables may explain the subsequent declines in profitability.  It’s also possible—because Peters and Waterman identified 43 highly successful companies and then interviewed managers at those companies—that the Halo Effect came into play.  The eight principles may reflect attributions that people tend to make about currently successful companies.

Delusion Four: The Delusion of Connecting the Winning Dots

You can’t choose a sample based only on the dependent variable you’re trying to test.  The dependent variable in this case is successful companies.  If all you look at is successful companies, then you won’t be able to compare successful companies directly to unsuccessful companies in order to learn about their respective causes—the independent variables.  Rosenzweig refers to this error as the Delusion of Connecting the Winning Dots.  You can connect the dots any way you wish, but following this approach, you can’t learn about the independent variables that lead to success.

Like many areas of social science, it’s not easy.  You can’t run an experiment where you take 100 companies, and manage half of them one way, and half of them another way, and then compare results.

(Image by Macrovector)

Jim Collins and Jerry Porras isolated 18 companies based on excellent performance over a long period of time.  Also, for each of these companies, Collins and Porras identified a similar company that had been less successful.  This at least could avoid the error that Peters and Waterman made.  As Collins and Porras said, if all you looked at were successful companies, you might find that they all reside in buildings.

Collins, Porras, and their team read more than 100 books and looked at more than 3,000 documents.  All told, they had a huge amount of data.  They certainly worked very hard.  But that in itself does not increase the scientific validity of their study.

Collins and Porras claimed to have found “timeless principles,” which they listed:

  • Having a strong core ideology that guides the company’s decisions and behavior
  • Building a strong corporate culture
  • Setting audacious goals that can inspire and stretch people—so-called big hairy audacious goals, or BHAGs
  • Developing people and promoting them from within
  • Creating a spirit of experimentation and risk taking
  • Driving for excellence

Unfortunately, much of the data came from books, the business press, and company documents, all likely to contain Halos.  They also conducted interviews with managers, who were asked to look back on their success and explain the reasons.  These interviews were probably tinged by Halos in many cases.  Some of the principles identified may have led to success.  However, successful companies were also likely to be described in these terms.  The Halo Effect hadn’t been dealt with by Collins and Porras.

Rosenzweig looked at profitability over the subsequent five years.  Eleven companies saw profits decline.  One was unchanged.  Only five of the best companies had profits increase.  It seems the “master blueprint for long-term prosperity” is largely a delusion, writes Rosenzweig.

(Graph by Experimental)

It’s not just some of the companies, but most of the companies that saw profits decline.  Characterizations of the “best” companies were probably impacted significantly by the Halo Effect.  The very fact that these companies had been doing well for some time led many to see them as having positive attributes across the board.

Delusion Five: The Delusion of Rigorous Research

As noted, psychologist Philip Tetlock tracked the predictions of 284 leading experts over two decades.  Tetlock looked at over 27,000 predictions in real time of the form:  more of x, no change in x, or less of x.  He found that these predictions were no better than random chance.

Many experts have deep knowledge—historical or otherwise—that can give us valuable insights into human affairs.  Some of this expertise is probably accurate.  But until we have testable predictions, it’s difficult to say which hypotheses are true and to what degree.

We should never forget the difference between scientific knowledge and other types of knowledge, including stories.  It’s very easy for us humans to be overconfident and deluded, especially if certain stories are the result of “many years of hard work.”

Delusion Six: The Delusion of Lasting Success

Richard Foster and Sarah Kaplan looked at companies in the S&P 500 from 1957 to 1997.  By 1997, only 74 out of the original largest 500 companies were still in the S&P 500.  Of those 74 survivors, how many outperformed the S&P 500 over those 40 years?  Only 12.

Foster and Kaplan conclude:

KcKinsey’s long-term studies of corporate birth, survival, and death in America clearly show that the corporate equivalent of El Dorado, the golden company that continually performs better than the markets, has never existed.  It is a myth.  Managing for survival, even among the best and most revered corporations, does not guarantee strong long-term performance for shareholders.  In fact, just the opposite is true.  In the long run, the markets always win.

It’s not that busines success is completely random.  Of course not.  But there is usually a large degree of luck involved.  More fundamentally, capitalism is about competition through innovation, or creative destruction, as the great Austrian economist Joseph Schumpeter called it.  There is some inherent unpredictability—or luck—in this endless process.

Delusion Seven: The Delusion of Absolute Performance

Kmart improved noticeably from 1994 to 2002, but Wal-Mart and Target were ahead at the beginning of that period, and they improved even faster than Kmart.  Thus, although it would seem Kmart was doing the right things in terms of absolute performance, Kmart was falling even further behind in terms of relative performance.

In 2005, GM was making much better cars than in the 1980s.  But its market share kept slipping, from 35 percent in 1990 to 25 percent in 2005.  GM’s competitors were improving faster.

Rosenzweig sums it up:

The greater the number of rivals, and the easier for competitors to enter the market, and the more rapidly technology changes, the more difficult it is to sustain success.  That’s an uncomfortable truth, because it admits that some elements of business performance are outside of our control.  It’s far more appealing to downplay the relative nature of performance or ignore it completely.  Telling a company it can achieve high performance, regardless of what competitors do, makes for a more attractive story.

Delusion Eight: The Delusion of the Wrong End of the Stick

In Good to Great, Collins argues that a company can decide to become great and follow the blueprint in the book.  Part of the recipe is to be like a Hedgehog—to have a narrow focus and pursue it with great discipline.  The problem, again, is that the role of chance—or factors outside one’s control—is not considered.  (The terms “Hedgehog” and “Fox” come from an essay by Isaiah Berlin.  The Hedgehog knows one big thing, whereas the Fox knows many things.)

(Image by Marek Uliasz)

Statistically, it’s possible that, on the whole, more Hedgehogs than Foxes failed.  You could still argue that the potential upside for becoming a great company is so large that it’s worth taking the risk of being like a Hedgehog.  But Collins doesn’t mention risk, or chance, at all.

Of course, we’d all prefer a story where greatness is purely a matter of choice.  But it’s rarely that simple and luck nearly always plays a pivotal role.

Delusion Nine: The Delusion of Organizational Physics

For many questions in business, we can’t run experiments.  That said, with enough care, important statistical correlations can be discovered.  Other things can be measured even more precisely.

But to think that the study of business is like the science of physics is a delusion, at least for now.

It’s reasonable to suppose that, with enough scientific knowledge in neuroscience, genetics, psychology, economics, artificial intelligence, and related areas, eventually human behavior may become largely predictable.  But there’s a long way to go.



By nature, we prefer stories where business success is entirely a result of choosing to do the right things, while not reaching success must be due to a failure to do the right things.  But stories like this neglect the role of chance.  Rosenzweig writes:

…all the emphasis on steps and formulas may obscure a more simple truth.  It may further the fiction that a specific set of steps will lead, predictably, to success.  And if you never achieve greatness, well, the problem isn’t with our formula—which was, after all, the product of rigorous research, of extensive data exhaustively analyzed—but with you and your failure to follow the formula.  But in fact, the truth may be considerably simpler than these formula suggest.  They may divert our attention from a more powerful insight—that while we can do many things to improve our chances of success, at its core business performance contains a large measure of uncertainty.  Business performance may actually be simpler than it is often made out to be, but may also be less certain and less amenable to engineering with predictable outcomes.

There is a simpler way to think about business performance—suggested by Michael Porter—without neglecting the role of chance.  Strategy is doing certain things different from rivals.  Execution is people working together to create products by implementing the strategy.  This is a reasonable way to think about business performance as long as you also note the role of chance.

It’s usually hard to know how potential customers will behave.  There are, of course, many examples where, contrary to expectations, a product was embraced or rejected.  Moreover, even if you correctly understand customers, competitors may come up with a better product.

There’s also the issue of technological change, which can be a significant source of unpredictability in some industries.

(Illustration by T. L. Furrer)

Clayton Christensen has demonstrated—in The Innovator’s Dilemma—that frequently companies fail because they keep doing the right things, giving customers what they want.  Meanwhile, competitors develop a new technology that, at first, is not profitable—which is part of why the company “doing the right things” ignores it.  But then, unpredictably, some of these new technologies end up being popular and also profitable.

One good question is:  What should a company do when its core comes under pressure?  Should it redouble its focus on the core, like a Hedgehog?  Or should it be adaptable, like a Fox?  There are no good answers at the moment, says Rosenzweig.  There are too many variables.  Chance—or uncertainty—plays a key role.

Rosenzweig continues:

In the meantime, we’re left with the brutal fact that strategic choice is hugely consequential for a company’s performance yet also inherently risky.  We may look at successful companies and applaud them for what seem, in retrospect, to have been brilliant decisions, but we forget that at the time those decisions were made, they were controversial and risky.  McDonald’s bet on franchising looks smart today, but in the 1950s it was a leap in the dark.  Dell’s strategy of selling direct now seems brilliant but was attempted only after multiple failures with conventional channels.  Or, recalling companies we discussed in earlier chapters, remember Cisco’s decision to assemble a full range of product offerings through acquisitions or ABB’s bet on leading rationalization of the European power industry through consolidation and cost cutting.  The managers who took those choices appraised a wide variety of factors and decided to be different from their rivals.  We remember all of these decisions because they turned out well, but success was not inevitable.  As James March of Stanford and Zur Shapira of New York University explained, “Post hoc reconstruction permits history to be told in such a way that ‘chance,’ either in the sense of genuinely probabilistic phenomena or in the sense of unexplained variation, is minimized as an explanation.”  But chance DOES play a role, and the difference between a brilliant visionary and a foolish gambler is usually inferred after the fact, an attribution based on outcomes.  The fact is, strategic choices always involve risk.  The task of strategic leadership is to gather appropriate information and evaluate it thoughtfully, then make choice that, while risky, provide the best chances for success in a competitive industry setting.

(Image by Donfiore)

As for execution, certain practices do correlate with modestly higher performance.  If leaders can identify the few areas where better execution is needed, then some progress can be made.

But inherent unpredictability is hidden by the Halo Effect.  If a company succeeds, it’s easy to say it executed well.  If a company fails, it’s natural to conclude that execution was poor.  Often to a large extent, these conclusions are driven by the Halo Effect, even if there is some truth to them.

In brief, smart strategic choices and good execution—plus good luck—may lead to success, at least temporarily.  But success brings challengers, some of whom will take greater risks that may work.  There’s no formula to guarantee success.  And if success is achieved, there’s no way to guarantee continued success over time.



Given that there’s no simple formula that brings business success, what should we do?  Rosenzweig answers:

A first step is to set aside the delusions that color so much of our thinking about business performance.  To recognize that stories of inspiration may give us comfort but have little more predictive power than a pair of coconut headsets on a tropical island.  Instead, managers would do better to understand that business success is relative, not absolute, and that competitive advantage demands calculated risks.  To accept that few companies achieve lasting success, and that those that do are perhaps best understood as having strung together several short-term successes rather than having consciously pursued enduring greatness.  To admit that, as Tom Lester of the Financial Times so neatly put it, “the margin between success and failure is often very narrow, and never quite as distinct or as enduring as it appears at a distance.”  By extension, to recognize that good decisions don’t always lead to favorable outcomes, that unfavorable outcomes are not always the result of mistakes, and therefore to resist the natural tendency to make attributions based solely on outcomes.  And finally, to acknowledge that luck often plays a role in company success.  Successful companies aren’t “just lucky”—high performance is not purely random—but good fortune does play a role, and sometimes a pivotal one.

Rosenzweig mentions Robert Rubin as a good example of someone who learned to make decisions in terms of scenarios and their probabilities.

(Image by Elnur)

Rubin worked for eight years in the Clinton administration, first as director of the White House National Economic Council and later as secretary of the Treasury.  Prior to working in the Clinton administration, Rubin toiled for twenty-six years at Goldman Sachs.

Rubin first learned about the fundamental uncertainties of the world when he studied philosophy as an undergraduate.  He learned to view every proposition with skepticism.  Later at Goldman Sachs, Rubin saw first-hand that one had to consider possible outcomes and their associated probabilities.

Rubin spent years in risk arbitrage.  Many times Goldman made money, but roughly one out of every seven times, Goldman lost money.  Sometimes the loss would greatly exceed Goldman’s worst-case scenario.  But occasionally large and painful losses didn’t mean that Goldman’s decision-making process was flawed.  In fact, if Goldman wasn’t taking some losses, then they almost certainly weren’t taking enough risk.

(Photo by Alain Lacroix)

Rosenzweig asks:  If a large and painful loss doesn’t mean a mistake, then what does?

We have to take a close look at the decision process itself, setting aside the eventual outcome.  Had the right information been gathered, or had some important data been overlooked?  Were the assumptions reasonable, or had they been flawed?  Were calculations accurate, or had there been errors?  Had the full set of eventualities been identified and their impact estimated?  Had Goldman Sachs’s overall risk portfolio been properly considered?

Once again, a profitable outcome doesn’t necessarily mean the decision was good.  An unprofitable outcome doesn’t necessarily mean the decision was bad.  If you’re making decisions under uncertainty—probabilistic decisions—the only way to improve is to evaluate the process of decision-making independently of specific outcomes.

Of course, often important decisions for an individual business are quite infrequent.  Rosenzweig highlights important lessons for managers:

  • If independent variables aren’t measured independently, we may find ourselves standing hip-deep in Halos.
  • If the data are full of Halos, it doesn’t matter how much we’ve gathered or how sophisticated our analysis appears to be.
  • Success rarely lasts as long as we’d like—for the most part, long-term success is a delusion based on selection after the fact.
  • Company performance is relative, not absolute.  A company can get better and fall further behind at the same time.
  • It may be true that many successful companies bet on long shots, but betting on long shots does not often lead to success.
  • Anyone who claims to have found laws of business physics either understands little about business, or little about physics, or both.
  • Searching for the secrets of business success reveals little about the world of business but speaks volumes about the searchers—their aspirations and their desires for certainty.

Getting rid of delusions is a crucial step.  Furthermore, writes Rosenzweig, a wise manager knows:

  • Any good strategy involves risk.  If you think your strategy is foolproof, the fool may well be you.
  • Execution, too, is uncertain—what works in one company with one workforce may have different results elsewhere.
  • Chance often plays a greater role than we think, or than successful managers usually like to admit.
  • The link between inputs and outcomes is tenuous.  Bad outcomes don’t always mean that managers made mistakes; and good outcomes don’t always mean they acted brilliantly.
  • But when the die is cast, the best managers act as if chance is irrelevant—persistence and tenacity are everything.

Of course, none of this guarantees success.  But the sensible goal is to improve your chances of success.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Value Investing: The Most Important Thing

(Image:  Zen Buddha Silence by Marilyn Barbone.)

June 17, 2018

Value investing can be a relatively low risk way for some investors to beat the market over time.  Yet it often takes a decade to get the hang of it.  Even then, you have to keep improving indefinitely.  But the great thing is that you can keep improving indefinitely as long as your health stays good.  In addition to learning from experience, an excellent way to progress is by studying the best value investors.

Howard Marks is not only a great value investor.  But he also has written an outstanding book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor (Columbia University Press, 2011).  Like most classics, Marks’s book is worth re-reading periodically.

This blog post is intended for two groups:

  • People who already have some experience with value investing.  It’s worth regularly reviewing the teachings of the masters.
  • People who are interested in learning about value investing.

Here’s an outline.  Each section can be read independently:

  • A Value Investing Philosophy
  • Second-Level Thinking
  • Understanding Market Efficiency
  • Value
  • The Relationship Between Price and Value
  • Understanding Risk
  • Recognizing Risk
  • Controlling Risk
  • Being Attentive to Cycles
  • Awareness of the Pendulum
  • Combating Negative Influences
  • Contrarianism
  • Finding Bargains
  • Patient Opportunism
  • Knowing What You Don’t Know
  • Having a Sense of Where We Stand
  • Appreciating the Role of Luck
  • Investing Defensively


The title of the book is based on the fact that Marks wrote a series of memos to clients identifying “the most important thing.”  Looking back, Marks realized that there were many “most important things.”

The thing I find most interesting about investing is how paradoxical it is: how often the things that seem most obvious—on which everyone agrees—turn out not to be true. — Howard Marks



A value investing philosophy takes time to develop, as Marks notes:

A philosophy has to be the sum of many ideas accumulated over a long period of time from a variety of sources.  One cannot develop an effective philosophy without having been exposed to life’s lessons.  In my life I’ve been quite fortunate in terms of both rich experiences and powerful lessons.

Good times teach only bad lessons: that investing is easy, that you know its secrets, and that you needn’t worry about risk.  The most valuable lessons are learned in tough times.

(Photo by Yuryz)



Marks first points out how variable the investing landscape is:

No rule always works.  The environment isn’t controllable, and circumstances rarely repeat exactly.  Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable.

The goal for an investor is to do better than the market over time.  Otherwise, the best option for most investors is simply to buy and hold low-cost broad market index funds.  Doing better than the market requires an identifiable edge:

Since other investors may be smart, well-informed and highly computerized, you must find an edge they don’t have.  You must think of something they haven’t thought of, see things they miss or bring insight they don’t possess.  You have to react differently and behave differently.  In short, being right may be a necessary condition for investment success, but it won’t be sufficient.  You must be more right than others… which by definition means your thinking has to be different.

(Photo by Andreykuzmin)

Marks gives some examples of second-level thinking:

First-level thinking says, ‘It’s a good company; let’s buy the stock.’ Second-level thinking says, ‘It’s a good company, but everyone thinks it’s a great company, and it’s not.  So the stock’s overrated and overpriced; let’s sell.’

First-level thinking says, ‘The outlook calls for low growth and rising inflation. Let’s dump our stocks.’   Second-level thinking says, ‘The outlook stinks, but everyone else is selling in panic.  Buy!’

First-level thinking says, ‘I think the company’s earnings will fall; sell.’ Second-level thinking says, ‘I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy.’

Marks explains that first-level thinking is generally simplistic.  By contrast, second-level thinking requires thinking of the full range of possible future outcomes, along with estimating probabilities for each possible outcome.  Second-level thinking means understanding what the consensus thinks, why you have a different view, and the likelihood that one’s contrarian view is correct.  Marks observes that second-level thinking is far more difficult than first-level thinking, thus few investors truly engage in second-level thinking.  First-level thinkers cannot expect to outperform the market.

To outperform the average investor, you have to be able to outthink the consensus.  Are you capable of doing so?  What makes you think so?



Marks holds a view of market efficiency similar to that of Warren Buffett:  The market is usually efficient, but it is far from always efficient.

(Illustration by Lancelotlachartre)

Marks says that the market reflects the consensus view, but the consensus is not always right:

In January 2000, Yahoo sold at $237.  In April 2001 it was $11.  Anyone who argues that the market was right both times has his or her head in the clouds; it has to have been wrong on at least one of those occasions.  But that doesn’t mean many investors were able to detect and act on the market’s error.

Marks summarizes his view:

The bottom line for me is that, although the more efficient markets often misvalue assets, it’s not easy for any one person—working with the same information as everyone else and subject to the same psychological influences—to consistently hold views that are different from the consensus and closer to being correct.  That’s what makes the mainstream markets awfully hard to beat—even if they aren’t always right.

Marks makes an important point about riskier investments:

Once in a while we experience periods when everything goes well and riskier investments deliver the higher returns they seem to promise.  Those halcyon periods lull people into believing that to get higher returns, all they have to do is make riskier investments.  But they ignore something that is easily forgotten in good times: this can’t be true, because if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier.

Marks notes that inefficient prices imply that for each investor who buys at a cheap price, another investor must sell at that cheap price.  Inefficiency essentially implies that each investment that beats the market implies another investment that trails the market by an equal amount.

Generally it is exceedingly difficult to beat the market.  To highlight this fact, Marks asks a series of questions:

  • Why should a bargain exist despite the presence of thousands of investors who stand ready and willing to bid up the price of anything that is too cheap?
  • If the return appears so generous in proportion to the risk, might you be overlooking some hidden risk?
  • Why would the seller of the asset be willing to part with it at a price from which it will give you an excessive return?
  • Do you really know more about the asset than the seller does?
  • If it’s such a great proposition, why hasn’t someone else snapped it up?

Market inefficiency alone, argues Marks, is not a sufficient condition for outperformance:

All that means is that prices aren’t always fair and mistakes are occurring: some assets are priced too low and some too high.  You still have to be more insightful than others in order to regularly buy more of the former than the latter.  Many of the best bargains at any point in time are found among the things other investors can’t or won’t do.

(Photo by Marijus Auruskevicius)

Marks ends this section by saying that a key turning point in his career was when he concluded that he should focus on relatively inefficient markets.

Important Note:  One area of the stock market that is remarkably inefficient is microcap stocks, especially when compared with midcap or largecap stocks.  See:

A few comments about deep value investing:

In order to buy a stock that is very cheap in relation to its intrinsic value, some other investor must be willing to sell the stock at such an irrationally low price.  Sometimes such sales happen due to forced selling.  The rest of the time, the seller must be making a mistake in order for the value investor to make a market-beating investment.

And yet many deep value approaches are fully quantitative, relying on statistical rules for stock selection.  The quantitative deep value investor does not typically make a detailed judgment on each individual stock—a judgment which would imply that the buyer is correct and the seller is incorrect in the individual case.  Rather, the quantitative deep value investor forms a portfolio of the statistically cheapest stocks.  All of the studies have shown that a basket of quantitatively cheap stocks does better than the market over time, and is less risky (especially during down markets).

Blog post on quantitative deep value investing:

A concentrated deep value approach, by contrast, involves the effort to select the most promising and the cheapest individual stocks available.  Warren Buffett and Charlie Munger—both inspired in part by Philip Fisher—followed this approach when they were managing smaller amounts of capital.  They would usually have between 3 and 8 positions making up nearly the entire portfolio.



Marks begins by saying that “buy low; sell high” is one of the oldest rules in investing.  But since selling will occur in the future, how can you figure out a price today that will be lower than some future price?  What’s needed is an ability to accurately assess the intrinsic value of the asset.  The intrinsic value of a stock can be derived from the price that an informed buyer would pay for the entire company, based on net asset value or normalized earnings.  Writes Marks:

The quest in value investing is for cheapness.  Value investors typically look at financial metrics such as earnings, cash flow, dividends, hard assets and enterprise value and emphasize buying cheap on these bases.  The primary goal of value investors, then, is to quantify the company’s current value and buy its securities when they can do so cheaply.

(Photo by Farang)

Marks notes that a successful value investment requires a non-consensus view on net asset value or normalized earnings.  Successful growth investing, by contrast, requires a non-consensus view on future earnings (based on growth).  Sometimes the rewards for growth investing are higher, but a value investing approach is much more repeatable and achievable.

Buying assets below fair value, however, does not mean those assets will outperform right away.  Value investing requires having a firmly held view because quite often after buying, cheap assets will continue to underperform the market.  Marks elaborates:

If you liked it at 60, you should like it more at 50… and much more at 40 and 30.  But it’s not that easy.  No one’s comfortable with losses, and eventually any human will wonder, ‘Maybe it’s not me who’s right.  Maybe it’s the market.’…

Thus, successful value investing requires not only the consistent ability to identify assets available at cheap prices; it also requires the ability to ignore various signals (many of which are subconscious) flashing the message that one is wrong.  As Marks writes:

Value investors score their biggest gains when they buy an underpriced asset, average down unfailingly and have their analysis proved out.  Thus, there are two essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold that view strongly enough to be able to hang in and buy even as price declines suggest that you’re wrong.  Oh yes, there’s a third: you have to be right.



Many investors make the mistake of thinking that a good company is automatically a good investment, while a bad company is automatically a bad investment.  But what really matters for the value investor is the relationship between price and value:

For a value investor, price has to be the starting point.  It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price.  And there are few assets so bad that they can’t be a good investment when bought cheaply enough.

In the 1960’s, there was a group of stocks called the Nifty Fifty—companies that were viewed as being so good that all you had to do was buy at any price and then hold for the long term.  But it turned out not to be true for many stocks in the basket.  Moreover, the early 1970’s led to huge declines:

Within a few years, those price/earnings ratios of 80 or 90 had fallen to 8 or 9, meaning investors in America’s best companies had lost 90 percent of their money.  People may have bought into great companies, but they paid the wrong price.

Marks explains the policy at his firm Oaktree:

‘Well bought is half sold.’  By this we mean we don’t spend a lot of time thinking about what price we’re going to be able to sell a holding for, or to whom, or through what mechanism.  If you’ve bought it cheap, eventually those questions will answer themselves.  If your estimate of intrinsic value is correct, over time an asset’s price should converge with its value.

Marks, similar to Buffett and Munger, holds that psychology plays a central role in value investing:

Whereas the key to ascertaining value is skilled financial analysis, the key to understanding the price/value relationship—and the outlook for it—lies largely in insight into other investor’s minds.  Investor psychology can cause a security to be priced just about anywhere in the short run, regardless of its fundamentals.  

The safest and most potentially profitable thing is to buy something when no one likes it.  Given time, its popularity, and thus its price, can only go one way: up.

A successful value investor must build systems or rules for self-protection because all investors—all humans—suffer from cognitive biases, which often operate subconsciously.

(Illustration by Alain Lacroix)

Marks again on the importance of cheapness:

Of all the possible routes to investment profit, buying cheap is clearly the most reliable.  Even that, however, isn’t sure to work.  You can be wrong about the current value.  Or events can come along that reduce value.  Or deterioration in attitudes or markets can make something sell even further below its value.  Or the convergence of price and intrinsic value can take more time than you have…

Trying to buy below value isn’t infallible, but it’s the best chance we have.



As Buffett frequently observes, the future is always uncertain.  Prices far below probable intrinsic value usually only exist when the future is highly uncertain.  When there is not much uncertainty, asset prices will be much higher than otherwise.  So high uncertainty about the future is the friend of the value investor.

(Photo by Alain Lacroix)

On the other hand, in general, assets that promise higher returns entail higher risk.  If a potentially higher-returning asset was obviously as low risk as a U.S. Treasury, then investors would rush to buy the higher-returning asset, thereby pushing up its price to the point where it would promise returns on par with a U.S. Treasury.

A successful value investor has to determine whether the potential return on an ostensibly cheap asset is worth the risk.  High risk is not necessarily bad as long as it is properly controlled and as long as the potential return is high enough.  But if the risk is too high, then it’s not the type of repeatable bet that can produce long-term success for a value investor.  Repeatedly taking too much risk virtually guarantees long-term failure.

Consider the Kelly criterion.  If the probability of success and the returns from a potential investment can be quantified, then the Kelly criterion tells you exactly how much to bet in order to maximize the long-term compound returns from a long series of such bets.  Betting any other amount than what the Kelly criterion says will inevitably lead to less than the maximum potential returns.  Most importantly, betting more than what the Kelly criterion says guarantees negative long-term returns.  Repeatedly overbetting guarantees long-term failure.

This is part of why Howard Marks, Warren Buffett, Charlie Munger, Seth Klarman and other great value investors often point out that minimizing big mistakes is more important for long-term success in investing than hitting home runs.

Again, while riskier investments promise higher returns, those higher returns are not guaranteed, otherwise riskier investments wouldn’t be riskier!  The probability distribution of potential returns is wider for riskier investments, typically including some large potential losses.  A certain percentage of future outcomes will be negative for riskier investments.

(Photo by Wittayayut Seethong)

Marks agrees with Buffett and Munger that the best definition of risk is the potential to experience loss.

Of course, even the best investors are generally right only two-thirds of the time, while they are wrong one-third of the time.  Thus, following a successful long-term value investing framework where you consistently and carefully pays cheap prices for assets still entails being wrong once every three tries, whether due to a mistake, bad luck, or unforeseen events.

More Notes on Deep Value

Investors are systematically too pessimistic about companies that have been doing poorly, and systematically too optimistic about companies that have been doing well.  This is why a deep value approach, if applied systematically, is very likely to produce market-beating returns over a long enough period of time.

Marks explains:

Dull, ignored, possibly tarnished and beaten-down securities—often bargains exactly because they haven’t been performing well—are often ones value investors favor for high returns…. Much of the time, the greatest risk in these low-luster bargains lies in the possibility of underperforming in heated bull markets.  That’s something the risk-conscious value investor is willing to live with.

Measuring Risk-Adjusted Returns

Marks mentions the Sharpe ratio—or excess return compared to the standard deviation of the return.  While far from perfect, the Sharpe ratio is a solid measure of risk-adjusted return for many public market securities.

It’s important to point out again that risk can no more be objectively measured after an investment than it can be objectively measured before the investment.  Marks:

The point is that even after an investment has been closed out, it’s impossible to tell how much risk it entailed.  Certainly the fact that an investment worked doesn’t mean it wasn’t risky, and vice versa.  With regard to a successful investment, where do you look to learn whether the favorable outcome was inescapable or just one of a hundred possibilities (many of them unpleasant)?  And ditto for a loser: how do we ascertain whether it was a reasonable but ill-fated venture, or just a wild stab that deserved to be punished?

Did the investor do a good job of assessing the risk entailed?  That’s another good question that’s hard to answer.  Need a model?  Think of the weatherman.  He says there’s a 70 percent chance of rain tomorrow.  It rains; was he right or wrong?  Or it doesn’t rain; was he right or wrong?  It’s impossible to assess the accuracy of probability estimates other than 0 and 100 except over a very large number of trials.

Marks believes (as do Buffett, Munger, and other top value investors) that there is some merit to the expected value framework whereby you attempt to identify possible future scenarios and the probabilities of their occurrence:

If we have a sense for the future, we’ll be able to say which outcome is most likely, what other outcomes also have a good chance of occurring, how broad the range of possible outcomes is and thus what the ‘expected result’ is.  The expected result is calculated by weighing each outcome by its probability of occurring; it’s a figure that says a lot—but not everything—about the likely future.

Again, though, having a reasonable estimate of the future probability distribution is not enough.  You must also make sure that your portfolio can withstand a run of bad luck; and you must recognize when you have experienced a run of good luck.  Marks quotes his friend Bruce Newberg (with whom he has played cards and dice): “There’s a big difference between probability and outcome.  Probable things fail to happen—and improbable things happen—all the time.”  This is one of the most important lessons to know about investing, asserts Marks.

(via Wikimedia Commons)

Marks defines investment performance in the context of risk:

… investment performance is what happens when a set of developments—geopolitical, macro-economic, company-level, technical and psychological—collide with an extant portfolio.  Many futures are possible, to paraphrase Dimson, but only one future occurs.  The future you get may be beneficial to your portfolio or harmful, and that may be attributable to your foresight, prudence or luck.  The performance of your portfolio under the one scenario that unfolds says nothing about how it would have fared under the many ‘alternative histories’ that were possible.

A portfolio can be set up to withstand 99 percent of all scenarios but succumb because it’s the remaining 1 percent that materializes.  Based on the outcome, it may seem to have been risky, whereas the investor might have been quite cautious.

Another portfolio may be structured so that it will do very well in half the scenarios and very poorly in the other half.  But if the desired environment materializes and it prospers, onlookers can conclude that it was a low-risk portfolio.

The success of a third portfolio can be entirely contingent on one oddball development, but if it occurs, wild aggression can be mistaken for conservatism and foresight.

It’s tough to quantify risk without a large number of repeated trials under similar circumstances.  Marks:

Risk can be judged only by sophisticated, experienced second-level thinkers.

The past seems very definite: for every evolving set of possible scenarios, only one scenario happened at each point along the way.  But that does not at all mean that the scenarios that actually occurred were the only scenarios that could have occurred.

Furthermore, most people assume that the future will be like the past, especially the more recent past.  As Ray Dalio suggests, the biggest mistake most investors make is to assume that the recent past will continue into the future.

Marks also reminds us that the “worst-case” assumed by most investors is typically not negative enough.  Marks relates a funny story his father told about a gambler who bet everything on a race with only one horse in it.  How could he lose?  “Halfway around the track, the horse jumped over the fence and ran away.  Invariably things can get worse than people expect.”  Taking more risk usually leads to higher returns, but not always.  “And when risk bearing doesn’t work, it really doesn’t work, and people are reminded what risk’s all about.”



(Photo by Shawn Hempel)

The main source of risk, argues Marks, is high prices.  When stock prices move higher, for instance, most investors feel more optimistic and less concerned about downside risk.  But value investors have the opposite point of view: risk is typically very low when stock prices are very low, while risk tends to increase significantly when stock prices have increased significantly.

Most investors are not value investors:

So a prime element in risk creation is a belief that risk is low, perhaps even gone altogether.  That belief drives up prices and leads to the embrace of risky actions despite the lowness of prospective returns.

Marks emphasizes that recognizing risk—which comes primarily from high prices—has nothing to do with predicting the future, which cannot be done with any sort of consistency when it comes to the overall stock market or the economy.

Marks also highlights, again, how the psychology of eager buyers—who are unworried about risk—is precisely what creates greater levels of risk as they drive prices higher:

Thus, the market is not a static arena in which investors operate.  It is responsive, shaped by investors’ own behavior.  Their increasing confidence creates more that they should worry about, just as their rising fear and risk aversion combine to widen risk premiums at the same time as they reduce risk.  I call this the ‘perversity of risk.’

In a nutshell:

When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all.  Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.

And, of course, as demonstrated by the experience of Nifty Fifty investors, when everyone believes something embodies no risk they usually bid it up to the point where it’s enormously risky.  No risk is feared, and thus no reward for risk bearing—no ‘risk premium’—is demanded or provided.  That can make the thing that’s most esteemed the riskiest.

This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky.  But high quality assets can be risky, and low quality assets can be safe.  It’s just a matter of the price paid for them…



Outstanding investors, in my opinion, are distinguished at least as much for their ability to control risk as they are for generating return.

Great investors generate high returns with moderate risk, or moderate returns with low risk.  If they generate high returns with “high risk,” but they do so consistently for many years, then perhaps the high risk “either wasn’t really high or was exceptionally well-managed.”  Mark says that great investors such as Buffett or Peter Lynch tend to have very few losing years over a relatively long period of time.

It’s important, notes Marks, to see that risk leads to loss only when lower probability negative scenarios occur:

… loss is what happens when risk meets adversity.  Risk is the potential for loss if things go wrong.  As long as things go well, loss does not arise.  Risk gives rise to loss only when negative events occur in the environment.

We must remember that when the environment is salutary, that is only one of the environments that could have materialized that day (or that year).  (This is Nassim Nicholas Taleb’s idea of alternative histories…)  The fact that the environment wasn’t negative does not mean that it couldn’t have been.  Thus, the fact that the environment wasn’t negative doesn’t mean risk control wasn’t desirable, even though—as things turned out—it wasn’t needed at that time.

The absence of losses does not mean that there was no risk.

(Photo by Michele Lombardo)

Only a skilled investor can look at a portfolio during good times and tell how much risk has been taken.

Bottom line: risk control is invisible in good times but still essential, since good times can so easily turn into bad times.

Marks says that an investment manager adds value by generating higher than market returns for a given level of risk.  Achieving the same return as the market, but with less risk, is adding value.  Achieving better than market returns without undue risk is also adding value.

Many value investors, such as Marks and Buffett, somewhat underperform during up markets, but far outperform during down markets.  The net result over a long period of time is market-beating performance with very little incremental risk.  But it does take some time in order to see the value added.

Controlling the risk in your portfolio is a very important and worthwhile pursuit.  The fruits, however, come only in the form of losses that don’t happen.  Such what-if calculations are difficult in placid times.

On the other hand, the intelligent acceptance of recognized risk for profit underlies some of the wisest, most profitable investments—even though (or perhaps due to the fact that) most investors dismiss them as dangerous speculations.

Marks’ firm Oaktree invests in high yield bonds.  High yield bonds can be good investments over time if the prices are low enough:

I’ve said for years that risky assets can make for good investments if they’re cheap enough.  The essential element is knowing when that’s the case.  That’s it: the intelligent bearing of risk for profit, the best test for which is a record of repeated success over a long period of time.

Risk bearing per se is neither wise nor unwise, says Marks.  Investing in the more aggressive niches with risk properly controlled is ideal.  But controlling risk always entails being prepared for bad scenarios.

Extreme volatility and loss surface only infrequently.  And as time passes without that happening, it appears more and more likely that it’ll never happen—that assumptions regarding risk were too conservative.  Thus, it becomes tempting to relax rules and increase leverage.  And often this is done just before the risk finally rears its head…

Marks quotes Nassim Taleb:

Reality is far more vicious than Russian roulette.  First, it delivers the fatal bullet rather infrequently, like a revolver that would have hundreds, even thousands of chambers instead of six.  After a few dozen tries, one forgets about the existence of the bullet, under a numbing false sense of security… Second, unlike a well-defined precise game like Russian roulette, where the risks are visible to anyone capable of multiplying and dividing by six, one does not observe the barrel of reality… One is thus capable of unwittingly playing Russian roulette—and calling it by some alternative ‘low risk’ name.

A good example, which Marks does mention, is large financial institutions in 2004-2007.  Virtually no one thought that home prices could decline on a nationwide scale, since they had never done so before.

Of course, it’s also possible to be too conservative.

You can’t run a business on the basis of worst-case assumptions.  You wouldn’t be able to do anything.  And anyway, a ‘worst-case assumption’ is really a misnomer; there’s no such thing, short of a total loss.  Now, we know the quants shouldn’t have assumed there couldn’t be a nationwide decline in home prices.  But once you grant that such a decline can happen… what should you prepare for?  Two percent?  Ten?  Fifty?

(Photo by Donfiore)

Marks continues:

If every portfolio was required to be able to withstand declines on the scale we’ve witnessed this year [2008], it’s possible no leverage would ever be used.  Is that a reasonable reaction?

Even if we realize that unusual, unlikely things can happen, in order to act we make reasoned decisions and knowingly accept that risk when well paid to do so.  Once in a while, a ‘black swan’ will materialize.  But if in the future we always said, ‘We can’t do such-and-such, because the outcome could be worse than we’ve ever seen before,’ we’d be frozen in inaction.

Marks sums it up:

… It’s by bearing risk when we’re well paid to do so—and especially by taking risks toward which others are averse in the extreme—that we strive to add value for our clients.



  • Rule number one: most things will prove to be cyclical.
  • Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.

Marks explains:

… processes in fields like history and economics involve people, and when people are involved, the results are variable and cyclical.  The main reason for this, I think, is that people are emotional and inconsistent, not steady and clinical.

Objective factors do play a large part in cycles, of course—factors such as quantitative relationships, world events, environmental changes, technological developments and corporate decisions.  But it’s the application of psychology to these things that causes investors to overreact or underreact, and thus determines the amplitude of the cyclical fluctuations.

(Image by Anhluong.tdnb, via Wikimedia Commons)

Because people inevitably overreact or underreact, both business activity and stock prices overshoot on the upside and on the downside:

Economies will wax and wane as consumers spend more or less, responding emotionally to economic factors or exogenous events, geopolitical or naturally occurring.  Companies will anticipate a rosy future during the up cycle and thus overexpand facilities and inventories; these will become burdensome when the economy turns down.  Providers of capital will be too generous when the economy’s doing well, abetting overexpansion with cheap money, and then they’ll pull the reins too tight when things cease to look as good.  Investors will overvalue companies when they’re doing well and undervalue them when things get difficult.



Marks holds that there are two risks in investing:

  • the risk of losing money
  • the risk of missing opportunity

Most investors consistently do the wrong thing at the wrong time:  when prices are high, most investors rush to buy;  when prices are low, most investors rush to sell.  Thus, the value investor can profit over time by following Warren Buffett’s advice:

Be fearful when others are greedy.  Be greedy when others are fearful.


Stocks are cheapest when everything looks grim.  The depressing outlook keeps them there, and only a few astute and daring bargain hunters are willing to take new positions.



(Photo by Nikki Zalewski)

Like Buffett and Munger, Marks believes that temperament, or the ability to master your emotions, is more important than intellect for success in investing:

Many people possess the intellect needed to analyze data, but far fewer are able to look more deeply into things and withstand the powerful influence of psychology.  To say this another way, many people will reach similar cognitive conclusions from their analysis, but what they do with those conclusions varies all over the lot because psychology influences them differently.  The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.  Investor psychology includes many separate elements, which we will look at in this chapter, but the key thing to remember is that they consistently lead to incorrect decisions.  Much of this falls under the heading of ‘human nature.’

Marks writes about the following psychological tendencies:

  • Greed
  • Fear
  • Self-deception
  • Conformity to the crowd
  • Envy
  • Ego or overconfidence
  • Capitulation

How might these psychological tendencies have been useful in our evolutionary history? 

When food was often scarce, being greedy by hoarding food made sense.  When a movement in the grass frequently meant the presence of a dangerous predator, immediate fear—triggered by the amygdala even before the conscious mind is aware of it—was essential for survival.  When hunting for food was dangerous, often with low odds of success, self-deception—accompanied by various naturally occurring chemicals—helped hunters to persevere over long periods of time, regardless of danger and injury.  (Chemical reactions would cause an injured hunter not to feel much pain.)  If everyone in your tribe was running away as fast as possible, following the crowd was usually the most rational response.  If a starving hunter saw another person with a huge pile of food, envy would trigger a strong desire to possess it.  This would often lead to a hunting expedition with a heightened level of determination.  When hunting a dangerous prey, with low odds of success, ego or overconfidence would cause the hunter to be convinced that he would succeed.  From the point of view of the community, having self-deceiving and overconfident hunters was a net benefit because the hunters would persevere despite difficulties, injuries, and even deaths.

How do these psychological tendencies cause people to make errors in modern activities such as investing?

Greed causes people to follow the crowd by paying high prices for stocks in the hope that there will be even higher prices in the future.  Fear causes people to sell or to avoid ugly stocks—stocks trading at low multiples because the businesses in question are facing major difficulties.

As humans, we have an amazingly strong tendency towards self-deception:

  • The first principle is that you must not fool yourself, and you are the easiest person to fool. – Richard Feynman
  • Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true. – Demosthenes, as quoted by Charlie Munger

There have been many times in history when self-deception was probably crucial for the survival of a given individual or community.  I’ve mentioned hunters pursuing dangerous prey.  A much more recent example might be Winston Churchill, who was firmly convinced—even when virtually all the evidence was against it—that England would defeat Germany in World War II.  Churchill’s absolute belief helped sustain England long enough for both good luck and aid to arrive:  the Germans ended up overextended in Russia, and huge numbers of American troops (along with mass amounts of equipment) arrived in England.

Thus, like other psychological tendencies, self-deception often plays a constructive role.  However, when it comes to investing, self-deception is generally harmful, especially as the time horizon is extended so that luck virtually disappears.

Conformity to the crowd is another psychological tendency that many (if not most) investors seem to display.  Marks notes the famous experiment by Solomon Asch.  The subject is shown lines of obviously different lengths.  But in the same room with the subject are shills, who unbeknownst to the subject have already been instructed to say that two lines of obviously different lengths actually have the same length.  So the subject of the experiment has to decide between the obvious evidence of his eyes—the two lines are clearly different lengths—and the opinion of the crowd.  A significant number (36.8 percent) ignored their own eyes and went with the crowd, saying that the two lines had equal length, despite the obvious fact that they didn’t.

(The experiment involved a control group in which there were no shills.  Almost every subject—over 99 percent—gave the correct answer under these circumstances.)

Greed, conformity, and envy together operate powerfully on the brains of many investors:

Time and time again, the combination of pressure to conform and the desire to get rich causes people to drop their independence and skepticism, overcome their innate risk aversion and believe things that don’t make sense.

A good example from history is the tulip mania in Holland, during which otherwise rational people ended up paying exorbitant sums for colorful tulip bulbs.  See:

At the peak of tulip mania, in March 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman.

The South Sea Bubble is another example, during which even the extremely intelligent Isaac Newton, after selling out early for a solid profit, could not resist buying in again as prices seemed headed for the stratosphere.  Newton and many others lost huge sums when prices inevitably returned to earth.

Envy may have been useful for hunter-gatherers.  But today envy has a very powerful and often negative effect on most human brains.  And as Charlie Munger always points out, envy is particularly stupid because it’s a sin that, unlike other sins, is no fun at all.  There are many people who could easily learn to be very happy—grateful for blessings, grateful for the wonders of life itself, etc.—who become miserable because they fixate on other people who have more of something, or who are doing better in some way.  Envy is fundamentally irrational and stupid, but it is powerful enough to consume many people.  Buffett: “It’s not greed that drives the world, but envy.”  Envy and jealousy have caused the downfall of human beings for millenia.  This certainly holds true in investing.

Ego and overconfidence are powerful psychological tendencies that humans have.  Overconfidence will kill any investor eventually.  The antidote is humility and objectivity.  Many of the best investors—from Warren Buffett to Ray Dalio—are fundamentally humble and objective.  And women tend to be better investors than men on the whole because women are not as overconfident.  Marks writes:

[Thoughtful] investors can toil in obscurity, achieving solid gains in the good years and losing less than others in the bad years.  They avoid sharing in the riskiest behavior because they’re so aware of how much they don’t know and because they have their egos in check.  This, in my opinion, is the greatest formula for long-term wealth creation—but it doesn’t provide much ego gratification in the short run.  It’s just not that glamorous to follow a path that emphasizes humility, prudence, and risk control.  Of course, investing shouldn’t be about glamour, but often it is.

Capitulation is a final phenomenon that Marks emphasizes.  In general, people become overly negative about a stock that is deeply out of favor because the business in question is going through hard times.  Moreover, when overly negative investors are filled with fear and when they see everyone selling in a panic, they themselves often sell near the very bottom.  Often these investors know analytically that the stock is cheap, but their emotions (fear of loss, conformity to the crowd, etc.) are too strong, so they disbelieve their own sound logic.  The rational, contrarian, long-term value investor does just the opposite:  he or she buys near the point of maximum pessimism (to use John Templeton’s phrase).

Similarly, most investors become overly optimistic when a stock is near its all-time highs.  They see many other investors who have done well with the sky-high stock, and so they tend to buy at a price that is near the all-time highs.  Again, many of these investors—like Isaac Newton—know analytically that buying a stock when it is near its all-time highs is often not a good idea.  But greed, envy, self-deception, crowd conformity, etc. (fear of missing out, dream of a sure thing), overwhelm their own sound logic.  By contrast, the rational, long-term value investor does the opposite:  he or she sells near the point of maximum optimism.

Marks gives a marvelous example of psychological excess from the tech bubble of 1998-2000:

From the perspective of psychology, what was happening with IPOs is particularly fascinating.  It went something like this: The guy next to you in the office tells you about an IPO he’s buying.  You ask what the company does.  He says he doesn’t know, but his broker told him it’s going to double on the day of issue.  So you say that’s ridiculous.  A week later he tells you it didn’t double… it tripled.  And he still doesn’t know what it does.  After a few more of these, it gets hard to resist.  You know it doesn’t make sense, but you want protection against continuing to feel like an idiot.  So, in a prime example of capitulation, you put in for a few hundred shares of the next IPO… and the bonfire grows still higher on the buying from new converts like you.



(Illustration by Sasinparaksa)

Sir John Templeton:

To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest profit.

Superior value investors buy when others are selling, and sell when others are buying.  Value investing is simple in concept, but it is very difficult in practice.

Of course, it’s not enough just to be contrarian.  Your facts and your reasoning also have to be right, as Buffett points out:

You’re neither right nor wrong because the crowd disagrees with you.  You’re right because your data and reasoning are right—and that’s the only thing that makes you right.  And if your facts and reasoning are right, you don’t have to worry about anybody else.

Only by being right about the facts and the reasoning can a long-term value investor hold (or add to) a position when everyone else continues to sell.  Getting the facts and reasoning right still involves being wrong roughly one-third of the time, whether due to bad luck, unforeseen events, or a mistake.  But getting the facts and reasoning right leads to ‘being right’ roughly two-third of the time.

A robust process correctly followed should produce positive results—on both an absolute and relative basis—over most rolling five-year periods, and over nearly all rolling ten-year periods.

It’s never easy to consistently follow a careful, contrarian value investing approach.  Marks quotes David Swensen:

Investment success requires sticking with positions made uncomfortable by their variance with popular opinion… Only with the confidence created by a strong decision-making process can investors sell speculative excess and buy despair-driven value.

… Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.

Marks puts it in his own words:

The ultimately most profitable investment actions are by definition contrarian:  you’re buying when everyone else is selling (and the price is thus low) or you’re selling when everyone else is buying (and the price is high).  These actions are lonely and… uncomfortable.

(Illustration by Sangoiri)

Marks writes about the paradoxical nature of investing:

The thing I find most interesting about investing is how paradoxical it is: how often the things that seem most obvious—on which everyone agrees—turn out not to be true.

The best bargains are typically only available when pessimism and uncertainty are high.  Many investors say, ‘We’re not going to try to catch a falling knife; it’s too dangerous… We’re going to wait until the dust settles and the uncertainty is resolved.’  But waiting until uncertainty gets resolved usually means missing the best bargains, as Marks says:

The one thing I’m sure of is that by the time the knife has stopped falling, the dust has settled and the uncertainty has been resolved, there’ll be no great bargains left.  When buying something has become comfortable again, its price will no longer be so low that it’s a great bargain.  Thus, a hugely profitable investment that doesn’t begin with discomfort is usually an oxymoron.

It’s our job as contrarians to catch falling knives, hopefully with care and skill.  That’s why the concept of intrinsic value is so important.  If we hold a view of value that enables us to buy when everyone else is selling—and if our view turns out to be right—that’s the route to the greatest rewards earned with the least risk.



It cannot be too often repeated:

A high-quality asset can constitute a good or bad buy, and a low-quality asset can constitute a good or bad buy.  The tendency to mistake objective merit for investment opportunity, and the failure to distinguish between good assets and good buys, gets most investors into trouble.

What is the process by which some assets become cheap relative to intrinsic value?  Marks explains:

  • Unlike assets that become the subject of manias, potential bargains usually display some objective defect. An asset class may have weaknesses, a company may be a laggard in its industry, a balance sheet may be over-levered, or a security may afford its holders inadequate structural protection.
  • Since the efficient-market process of setting fair prices requires the involvement of people who are analytical and objective, bargains usually are based on irrationality or incomplete understanding.  Thus, bargains are often created when investors either fail to consider an asset fairly, or fail to look beneath the surface to understand it thoroughly, or fail to overcome some non-value-based tradition, bias or stricture.
  • Unlike market darlings, the orphan asset is ignored or scorned. To the extent it’s mentioned at all by the media and at cocktail parties, it’s in unflattering terms.
  • Usually its price has been falling, making the first-level thinker ask, ‘Who would want to own that?’ (It bears repeating that most investors extrapolate past performance, expecting the continuation of trends rather than the far-more-dependable regression to the mean.  First-level thinkers tend to view price weakness as worrisome, not as a sign that the asset has gotten cheaper.)
  • As a result, a bargain asset tends to be one that’s highly unpopular. Capital stays away from it or flees, and no one can think of a reason to own it.

(Illustration by Chris Dorney)

Where is the best place to look for underpriced assets?  Marks observes that a good place to start is among things that are:

  • little known and not fully understood;
  • fundamentally questionable on the surface;
  • controversial, unseemly or scary;
  • deemed inappropriate for ‘respectable’ portfolios;
  • unappreciated, unpopular and unloved;
  • trailing a record of poor returns; and
  • recently the subject of disinvestment, not accumulation.

Marks puts it briefly:

To boil it all down to just one sentence, I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality.  That means the best opportunities are usually found among things most others won’t do.  After all, if everyone feels good about something and is glad to join in, it won’t be bargain-priced.

Marks started a fund for high yield bonds—junk bondsin 1978.  One rating agency described high yield bonds as “generally lacking the characteristics of a desirable investment.”  Marks remarks:

if nobody owns something, demand for it (and thus the price) can only go up and…. by going from taboo to even just tolerated, it can perform quite well.

In 1987, Marks formed a fund to invest in distressed debt:

Who would invest in companies that already had demonstrated their lack of financial viability and the weakness of their management?  How could anyone invest responsibly in companies in free fall?  Of course, given the way investors behave, whatever asset is considered worst at a given point in time has a good likelihood of being the cheapest.  Investment bargains needn’t have anything to do with high quality.  In fact, things tend to be cheaper if low quality has scared people away.



(Illustration by Marek)

Marks makes the same point that Buffett and Munger often make: Most of the time, by far the best thing to do is absolutely nothing.  Finding one good idea a year is enough to get outstanding returns over time.  Marks offers:

So here’s a tip: You’ll do better if you wait for investments to come to you rather than go chasing after them.  You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own.  An opportunist buys things because they’re offered at bargain prices.  There’s nothing special about buying when prices aren’t low.

Marks took five courses in Japanese studies as an undergraduate business major in order to fulfill his requirement for a minor.  He learned the Japanese value of mujo:

mujo means cycles will rise and fall, things will come and go, and our environment will change in ways beyond our control.  Thus we must recognize, accept, cope and respond.  Isn’t that the essence of investing?

… What’s past is past and can’t be undone.  It has led to the circumstances we now face.  All we can do is recognize our circumstances for what they are and make the best decisions we can, given the givens.

Marks quotes Buffett, who notes that there are no called strikes in investing:

Investing is the greatest business in the world because you never have to swing.  You stand at the plate; the pitcher throws you General Motors at 47!  U.S. steel at 39!  And nobody calls a strike on you.  There’s no penalty except opportunity.  All day you wait for the pitch you like; then, when the fielders are asleep, you step up and hit it.

It’s dumb to invest when the opportunities are not there.  But when the overall market is high, there are still a few ways to do well as a long-term value investor.  If you are able to ignore short-term volatility and focus on the next five to ten years, then you can probably find some undervalued stocks, especially if you look at microcaps.  At some point—the precise timing of which is unpredictable—there will be a bear market.  But that would create many bargains for the long-term value investor.



John Kenneth Galbraith:

We have two classes of forecasters: Those who don’t know—and those who don’t know they don’t know.

Marks, like Buffett, Munger, and most other top value investors, thinks that financial forecasting simply cannot be done with any sort of consistency.  But Marks has two caveats:

The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage.  With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economies.  Thus, I suggest people try to ‘know the knowable.’

An exception comes in the form of my suggestion, on which I elaborate in the next chapter, that investors should make an effort to figure out where they stand at a moment in time in terms of cycles and pendulums.  That won’t render the future twists and turns knowable, but it can help one prepare for likely developments.

Marks has tracked (in a limited way) many macro predictions, including of U.S. interest rates, the U.S. stock market, and the yen/dollar exchange rate.  He found quite clearly that most forecasts were not correct.

(Illustration by Maxim Popov)

I can elaborate on two examples that I spent much time on (when I should have stayed focused on finding individual companies available at cheap prices):

  • shorting the U.S. stock market
  • shorting the Japanese yen

See my detailed discussion of these two “can’t lose” investments here:

Every year, there are many people making financial forecasts, and so purely as a matter of chance, a few forecasters will be correct in a given year.  But the ones correct this year are almost never the ones correct the next time around, because what they’re trying to predict can’t be predicted with any consistency.  Marks writes thus:

I am not going to try to prove my contention that the future is unknowable.  You can’t prove a negative, and that certainly includes this one.  However, I have yet to meet anyone who consistently knows what lies ahead macro-wise…

One way to get to be right sometimes is to always be bullish or always be bearish; if you hold a fixed view long enough, you may be right sooner or later.  And if you’re always an outlier, you’re likely to eventually be applauded for an extremely unconventional forecast that correctly foresaw what no one else did.  But that doesn’t mean your forecasts are regularly of any value…

It’s possible to be right about the macro-future once in a while, but not on a regular basis.  It doesn’t do any good to possess a survey of sixty-four forecasts that includes a few that are accurate; you have to know which ones they are.  And if the accurate forecasts each six months are made by different economists, it’s hard to believe there’s much value in the collective forecasts.

Marks gives one more example: How many predicted the crisis of 2007-2008?  Of those who did predict it—there was bound to be some from pure chance alone—how many of those then predicted the recovery starting in 2009 and continuing until today (mid-2018)?  The answer is “very few.”  The reason, observes Marks, is that those who got 2007-2008 right “did so at least in part because of a tendency toward negative views.”  They probably were negative well before 2007-2008, and more importantly, they probably stayed negative afterwards, during which the U.S. stock market increased (from the lows) roughly 300% as the U.S. economy expanded from 2009 to today (mid-2018).

Marks has a description for investors who believe in the value of forecasts.  They belong to the “I know” school, and it’s easy to identify them:

  • They think knowledge of the future direction of economies, interest rates, markets and widely followed mainstream stocks is essential for investment success.
  • They’re confident it can be achieved.
  • They know they can do it.
  • They’re aware that lots of other people are trying to do it too, but they figure either (a) everyone can be successful at the same time, or (b) only a few can be, but they’re among them.
  • They’re comfortable investing based on their opinions regarding the future.
  • They’re also glad to share their views with others, even though correct forecasts should be of such great value that no one would give them away gratis.
  • They rarely look back to rigorously assess their record as forecasters.

Marks contrasts the confident “I know” folks with the guarded “I don’t know” folks.  The latter believe you can’t predict the macro-future, and thus the proper goal for investing is to do the best possible job analyzing individual securities.  If you belong to the “I don’t know” school, eventually everyone will stop asking you where you think the market’s going.  Marks:

You’ll never get to enjoy that one-in-a-thousand moment when your forecast comes true and the Wall Street Journal runs your picture.  On the other hand, you’ll be spared all those times when forecasts miss the mark, as well as the losses that can result from investing based on overrated knowledge of the future.

Marks continues by noting that no one likes investing on the assumption that the future is unknowable.  But if the future IS largely unknowable, then it’s far better as an investor to acknowledge that fact than to pretend otherwise.

(Photo by Elnur)

Furthermore, says Marks, the biggest problems for investors tend to happen when investors forget the difference between probability and outcome (i.e., the limits of foreknowledge):

  • when they believe the shape of the probability distribution is knowable with certainty (and that they know it),
  • when they assume the most likely outcome is the one that will happen,
  • when they assume the expected result accurately represents the actual result, or
  • perhaps most important, when they ignore the possibility of improbable outcomes.

In a word:

Overestimating what you’re capable of knowing or doing can be extremely dangerous—in brain surgery, transocean racing or investing.  Acknowledging the boundaries of what you can know—and working within those limits rather than venturing beyond—can give you a great advantage.

Or as Warren Buffett has written:

Intelligent investing is not complex, though that is far from saying that it is easy.  What an investor needs is the ability to correctly evaluate selected businesses.  Note that word ‘selected’:  You don’t have to be an expert on every company, or even many.  You only have to be able to evaluate companies within your circle of competence.  The size of that circle is not very important;  knowing its boundaries, however, is vital.



Marks believes that market cycles—inevitable ups and downs—cannot be predicted as to extent and (especially) as to timing, but have a profound influence on us as investors.  The only thing we can predict is that market cycles are inevitable.

Marks holds that as investors, we can have a rough idea of market cycles.  We can’t predict what will happen exactly or when.  But we can at least develop valuable insight into various future events.

So look around, and ask yourself:  Are investors optimistic or pessimistic?  Do the media talking heads say the markets should be piled into or avoided?  Are novel investment schemes readily accepted or dismissed out of hand?  Are securities offerings and fund openings being treated as opportunities to get rich or possible pitfalls?  Has the credit cycle rendered capital readily available or impossible to obtain?  Are price/earnings ratios high or low in the context of history, and are yield spreads tight or generous?  All of these things are important, and yet none of them entails forecasting.  We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.

Marks likens the process of assessing the current cycle with “taking the temperature” of the market.  Again, one can never precisely time market turning points, but one can at least become aware of when markets are becoming overheated, or when they’ve become unusually cheap.

(Image by Walta, via Wikimedia Commons)

It may be more difficult today to take the market’s temperature because of the policy of low interest rates in many of the world’s major economies.  This obviously distorts all asset prices.  As Buffett remarked recently, if U.S. rates were going to stay very low for many decades into the future, U.S. stocks would eventually be much higher than they are today.  Zero rates indefinitely would easily mean price/earnings ratios of 50 or more.

If you are able to buy enough cheap stocks, while maintaining a focus on the next five or ten years, and if you are psychologically prepared for the occasional bear market—the precise timing of which is always unpredictable—then you will be in good position.

It can also help if you find cheap stocks that have low or even negative correlation with the broad stock market:

  • Gold mining stocks have often been negatively correlated with the broad market.  The great economist and value investor J. M. Keynes recommended having a gold mining stock—as long as you know the company well—in your portfolio .
  • Oil stocks have low correlation with the broad stock market.  Many oil-related stocks are very cheap today as long as you can hold for at least five years.
  • Cheap turnarounds also have low correlation with the broad stock market.  If the company is turned around, the stock is likely to do well even in a bear market.



Luck—chance or randomness—influences investment outcomes.  Marks considers Nassim Taleb’s Fooled by Randomness to be essential reading for investors.  Writes Marks:

Randomness (or luck) plays a huge part in life’s results, and outcomes that hinge on random events should be viewed as different from those that do not.

(Albrecht Durer’s Wheel of Fortune from Sebastien Brant’s Ship of Fools (1494) via Wikimedia Commons)

Marks quotes Taleb:

If we have heard of [history’s great generals and inventors], it is simply because they took considerable risks, along with thousands of others, and happened to win.  They were intelligent, courageous, noble (at times), had the highest possible obtainable culture in their day—but so did thousands of others who live in the musty footnotes of history.

A central concept from Taleb is that of “alternative histories.”  What actually has happened in history is merely a small subset of all the things that could have happened, at least as far as we know.  As long as there is a component of indeterminacy in human behavior (not to mention the rest of reality), you must usually assume that many “alternative histories” were possible.

As an investor, given a future that is currently unknowable in many respects, you need to develop a reasonable set of scenarios along with estimated probabilities for each scenario.  And, when judging the quality of past decisions, you should think carefully about various possible histories.  What actually happened is a small subset of what could have happened.

Thus, the fact that a stratagem or action worked—under the circumstances that unfolded—doesn’t necessarily prove that the decision behind it was wise.

Marks says he agrees with all of Taleb’s important points:

  • Investors are right (and wrong) all the time for the ‘wrong reason.’ Someone buys a stock because he or she expects a certain development; it doesn’t occur; the market takes the stock up anyway; the investor looks good (and invariably accepts credit).
  • The correctness of a decision can’t be judged from the outcome.  Nevertheless, that’s how people assess it.  A good decision is one that’s optimal at the time it’s made, when the future is by definition unknown.  Thus, correct decisions are often unsuccessful, and vice versa.
  • Randomness alone can produce just about any outcome in the short run.  In portfolios that are allowed to reflect them fully, market movements can easily swamp the skillfulness of the manager (or lack thereof).  But certainly market movements cannot be credited to the manager (unless he or she is the rare market timer who’s capable of getting it right repeatedly).
  • For these reasons, investors often receive credit they don’t deserve.  One good coup can be enough to build a reputation, but clearly a coup can arise out of randomness alone.  Few of these “geniuses” are right more than once or twice in a row.
  • Thus, it’s essential to have a large number of observations—lots of years of data—before judging a given manager’s ability.

Over the long run, the rational investor learns, refines, and sticks with a robust investment process that reliably produces good results.  In the short run, when a good process sometimes leads to bad outcomes (often due to bad luck but sometimes due to a mistake), you must simply be stoic and patient.

Marks continues:

The actions of the ‘I know’ school are based on a view of a single future that is knowable and conquerable.  My ‘I don’t know’ school thinks of future events in terms of a probability distribution.  That’s a big difference.  In the latter case, we may have an idea which one outcome is most likely to occur, but we also know there are many other possibilities, and those other outcomes may have a collective likelihood much higher than the one we consider most likely.

Marks concludes:

  • We should spend our time trying to find value among the knowable—industries, companies and securities—rather than base our decisions on what we expect from the less-knowable macro world of economies and broad market performance.
  • Given that we don’t know exactly which future will obtain, we have to get value on our side by having a strongly held, analytically derived opinion of it and buying for less when opportunities to do so present themselves.
  • We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.
  • To improve our chances of success, we have to emphasize acting contrary to the herd when it’s at extremes, being aggressive when the market is low and cautious when it’s high.
  • Given the highly indeterminate nature of outcomes, we must view strategies and their results—both good and bad—with suspicion until proved over a large number of trials.



Unlike professional tennis, where a successful outcome depends on which player hits the most winners, successful investing generally depends on minimizing mistakes more than it does on finding winners.

… investing is full of bad bounces and unanticipated developments, and the dimensions of the court and the height of the net change all the time.  The workings of economies and markets are highly imprecise and variable, and the thinking and behavior of the other players constantly alter the environment.  Even if you do everything right, other investors can ignore your favorite stock;  management can squander the company’s opportunities;  government can change the rules;  or nature can serve up a catastrophe.

Marks argues that successful investing is a balance between offense and defense, and that this balance often differs for each individual investor.  What’s important is to stick with an investment process that works over the long term:

… Few people (if any) have the ability to switch tactics to match market conditions on a timely basis.  So investors should commit to an approach—hopefully one that will serve them through a variety of scenarios.  They can be aggressive, hoping they’ll make a lot on the winners and not give it back on the losers.  They can emphasize defense, hoping to keep up in good times and excel by losing less than others in bad times.  Or they can balance offense and defense, largely giving up on tactical timing but aiming to win through superior security selection in both up and down markets.

Marks continues:

And by the way, there’s no right choice between offense and defense.  Lots of possible routes can bring you to success, and your decision should be a function of your personality and leanings, the extent of your belief in your ability, and the peculiarities of the markets you work in and the clients you work for.

Marks argues that defense can be viewed as aiming for higher returns, but through the avoidance of mistakes and through consistency, rather than through home runs and occasional flashes of brilliancy.

Avoiding losses first involves buying assets at cheap prices (well below intrinsic value).  Another element to avoiding losses is to ensure that your portfolio can survive a bear market.  If the five-year or ten-year returns appear to be high enough, an investor still may choose to play more offense than defense, even when the broad market appears to be high.  But you must be fully prepared—psychologically and in your portfolio—for stocks that are already very cheap to get cut in half or worse during a bear market.

Again, some investors can accept higher volatility in exchange for higher long-term returns.  Know thyself.  You must really think through all the possible scenarios, because things can get much worse than you can imagine during bear markets.  And bear markets are inevitable, though unpredictable.

There is usually a trade-off between potential return and potential downside.  Choosing to aim for higher long-term returns means accepting higher downside volatility over shorter periods of time.

It’s important to keep in mind that many investors fail not due to lack of home runs, but due to having too many strikeouts.  Overbetting—either betting too often (investing in too many different stocks) or betting too much (having position sizes that are too large)—is thus a common cause of failure for long-term investors.  We know from the Kelly criterion that overbetting guarantees negative long-term returns.  Therefore, it’s wise for most investors to aim for consistency—a high batting average based on many singles and doubles—rather than to aim for the maximum number of home runs.

Put differently, it is easier for most investors to minimize losses than it is to hit a lot of home runs.  Thus, most investors are more likely to achieve long-term success by minimizing losses and mistakes, than by hitting a lot of home runs.

As Marks concludes:

Investing defensively can cause you to miss out on things that are hot and get hotter, and it can leave you with your bat on your shoulder in trip after trip to the plate.  You may hit fewer home runs than another investor… but you’re also likely to have fewer strikeouts and fewer inning-ending double plays.

Defensive investing sounds very erudite, but I can simplify it: Invest scared!  Worry about the possibility of loss.  Worry that there’s something you don’t know.  Worry that you can make high-quality decisions but still be hit by bad luck or surprise events.  Investing scared will prevent hubris;  will keep your guard up and your mental adrenaline flowing;  will make you insist on adequate margin of safety;  and will increase the chances that your portfolio is prepared for things going wrong.  And if nothing does go wrong, surely the winners will take care of themselves.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees.   


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

The Warren Buffett Way

(Image:  Zen Buddha Silence by Marilyn Barbone.)

June 3, 2018

Would you like to improve as an investor?  One of the best things you can do is to study great investors like Warren Buffett.

Robert Hagstrom has written an excellent book—The Warren Buffett Way (Wiley, 2014)—explaining Buffett’s approach to investing.  Hagstrom’s goal is to help investors improve.

Here is the outline for this blog post:

  • A Five-Sigma Event: The World’s Greatest Investor
  • The Education of Warren Buffett
  • Buying a Business: The Twelve Immutable Tenets
  • Common Stock Purchases: Nine Case Studies
  • Portfolio Management: The Mathematics of Investing
  • The Psychology of Investing
  • The Value of Patience
  • The World’s Greatest Investor


(Photo by USA International Trade Administration)



Buffett has always maintained that he won the ovarian lottery.

My wealth has come from a combination of living in America, some lucky genes, and compound interest.  My luck was accentuated by my living in a market system that sometimes produces distorted results, though overall it serves our country well.

Buffett keeps things in perspective by saying that he happens to work “in an economy that rewards someone who saves lives of others on a battlefield with a medal, rewards a great teacher with thank-you notes from parents, but rewards those who can detect mispricing of securities with sums reaching into the billions.”

Buffett was entrepreneurial from a young age.  He would buy a six-pack of coke for 25 cents, then sell each one for 6 cents.  He had two paper routes during the time he lived in Washington, D.C., when his father was a congressman from Nebraska.  He and a buddy bought used pinball machines, and made a profit from them.

(Photo by Shahroozporia, via Wikimedia Commons)

But Buffett didn’t figure out the right way to invest for some time.  He tried charting.  He read books on technical analysis.  He got hot tips from brokers.  Finally, he came across a copy of The Intelligent Investor, by Benjamin Graham.  Buffett then realized that the strategy of value investing explained by Graham was a reliable way to succeed at investing over time.

Buffett attended graduate school at Columbia University in order to study under Graham.  Once in Graham’s class, everyone saw that Buffett was the brightest and most knowledgeable student.  The class was like a conversation between Graham and Buffett.  Buffett got an A+ in the course, the first A+ Graham had given in 22 years of teaching.

Upon graduating from Columbia, Buffett was not able to work for Graham at Graham-Newman right away.  At the time, Graham was only hiring Jewish analysts because they were being discriminated against elsewhere.  Buffett periodically sent Graham stock ideas until Graham finally hired him.

Two years later in 1956, after Graham retired, Buffett returned to Omaha.  Buffett launched a limited investment partnership, which included some family and friends as investors.  At the outset, the partnership had $105,000 under management.

Buffett’s goal was to beat the Dow Jones Industrial Average by 10 percentage points a year.  Approximately thirteen years later, Buffett had beaten the Dow Jones Average by over 22 percentage points a year.

In the early 1960s there was a corporate scandal.  The Allied Crude Vegetable Oil Company, led by Tino De Angelis, found that it could get loans based on its inventory of salad oil.  De Angelis built a refinery in New Jersey with 139 five-story storage tanks.  Because oil floats on top of water, De Angelis filled the tanks with water with just a few feet of oil on the top.  The inspectors didn’t notice for some time.

American Express lost $58 million in the salad oil scandal, and its stock dropped over 50 percent.  Buffett went to restaurants in Omaha, and discovered that there was no decrease in usage of the American Express Green Card.  Buffett also visited banks and learned that the scandal was having no impact on the use of American Express Travelers Cheques.

(Amex Logo, by American Express via Wikimedia Commons)

The strong brand of American Express was still intact.  The stock had plummeted based on a huge, but temporary problem.  So Buffett invested 40 percent of the partnership in American Express.  The shares nearly tripled over the next two years.

By 1965, Buffett had acquired—via the partnership—a controlling interest in Berkshire Hathaway, a struggling New England textile company.  When Buffett closed his investment partnership in 1969, he himself kept his stock in Berkshire Hathaway and limited partners received some stock in Berkshire Hathaway.  Buffett advised limited partners on how to invest in municipal bonds.  (Buffett thought that stocks were not a very good value in 1969.)  Or limited partners could invest with Bill Ruane, Buffett’s friend from Columbia University and Graham-Newman.  Meanwhile, Berkshire Hathaway, despite excellent management from Ken Chace, had disappointing results for many years.  Buffett only kept Berkshire Hathaway open out of concern for the workers.

The textile mills were the largest employer in the area;  the workforce was an older age group that possessed relatively nontransferable skills;  management had shown a high degree of enthusiasm;  the unions were being reasonable;  and, very importantly, Buffett believed that some profits could be realized from the textile business.

But Berkshire Hathaway continued to struggle.  Buffett siphoned off cash from the business in order to invest in better businesses.  (Had the cash been reinvested in Berkshire, the returns would have been below the cost of capital, thus destroying value.)  Later, Buffett reluctantly closed Berkshire Hathaway because unending losses would otherwise have been the result.

(Hathaway Mills, Photo by Marcbela via Wikimedia Commons)

In 1967, with the excess cash from the textile operations, Berkshire Hathaway purchased two insurance companies headquartered in Omaha:  National Indemnity Company and National Fire & Marine Insurance Company.  As Hagstrom writes, this was the beginning of Berkshire Hathaway’s legendary success story.

Instead of having the float from the insurance operations invested mostly in bonds, Buffett invested much of the float in stocks.  Over time, due to Buffett’s great skill in investing, investment assets grew significantly in value.  Importantly, the underlying insurance operations themselves were profitable because they were disciplined in pricing their policies.  The profitability of the insurance operations meant that the float had a very low cost.

Going forward, Buffett was open to investing in more insurance companies.  By 1991, Berkshire owned nearly half of GEICO.  GEICO was a very profitable auto insurer.  GEICO had structurally lower costs than its competitors because GEICO sold direct to customers, without needing agents or branch offices.

Buffett bought other insurance companies over time, including large reinsurers.  Hagstrom notes that Buffett’s best acquisition was a person—Ajit Jain.  Jain has brilliantly managed the Berkshire Hathaway Reinsurance Group over the years.  Buffett said of Ajit:

His operation combines capacity, speed, decisiveness, and most importantly, brains in a manager that is unique in the insurance business.

Over several decades, Buffett invested in a focused portfolio of common stocks.  He also acquired a number of private businesses.  He views both types of investment the same way:  he looks to pay a good price for a simple business, run by able and honest management, with good economics.

Hagstrom notes Buffett’s track record:

Over the past 48 years, starting in 1965, the year Buffett took control of Berkshire Hathaway, the book value of the company has grown from $19 to $114,214 per share, a compounded gain of 19.7 percent;  during that period, the Standard & Poor’s (S&P) 500 index gained 9.4 percent, dividends included.

The margin of outperformance combined with the length of the track record is simply unparalleled in the investment world.  But Hagstrom argues that other investors can improve by studying Buffett’s career.  Hagstrom quotes Buffett:

What we do is not beyond anyone else’s competence.  I feel the same way about managing that I do about investing:  it is just not necessary to do extraordinary things to get extraordinary results.



Hagstrom writes that Buffett was influenced primarily by three investors:  Benjamin Graham, Philip Fisher, and Charlie Munger.

At age 20, Graham graduated from Columbia University and was offered several positions at the university (in literature, mathematics, and philosophy).  Graham was clearly a genius.  Perhaps based partly on his experience of poverty—his father had died while Graham was young, leaving the family in a difficult financial situation—Graham decided to work on Wall Street rather than work in academia.

Graham’s first job was as a messenger—for $12 a week—for the brokerage firm of Newburger, Henderson & Loeb.  Five years later, in 1919, Graham was earning $600,000 a year (almost $8 million in 2012 dollars) as a partner in the firm.

Graham launched Graham-Newman in 1926.  In 1929-1932, Graham-Newman lost most of its value.  Graham personally was financially ruined.

From 1929 to 1934, Graham, while teaching at Columbia University and in cooperation with another professor, David Dodd, produced Security Analysis, which continues to be the bible for value investors to this day.  Graham was slowly rebuilding his fortune, and the philosophy of value investing—as expressed in Security Analysis—was the key.

(Ben Graham, by Equim43 via Wikimedia Commons)

Graham realized that many investors try to get good results over short periods of time.  He saw that short-term movements in stock prices are largely random and unpredictable, but that over time, a stock price follows the earnings of a company.  Graham thus distinguished between speculation and investing.  Speculation meant trying to predict stock prices over the short term, whereas investing means buying below probable intrinsic value—based on net asset value or earnings power.

Intrinsic value is based on net asset value or earnings power.  As long as the investor pays a price below intrinsic value, the investor has a margin of safety.  The margin of safety offers protection against errors by the investor and against bad luck (or unforeseen negative events).  Simultaneously, the margin of safety represents the profit the investor can earn in those cases where he or she is right and the stock price approaches intrinsic value.

Graham preferred to focus on net asset value.  If you take the current assets of the company and subtract all liabilities, and if the stock price can be bought below that level, there is a strong margin of safety present.  This is Graham’s net-net approach.  It is meant to be applied to a basket of stocks.

The net-net approach is inherently safer than buying stocks at a discount to their earnings power.  It is generally more difficult to estimate the earnings power of a company than to estimate the net-net value.  (The net-net value is simply an extremely conservative measure of liquidation value.)

Thus Graham placed much more emphasis on quantitative cheapness than he did on qualitative factors like competitive position and management capability.  If you keep buying stocks at a huge discount to net asset value, you are nearly certain to get good results over time.  On the other hand, if you keep buying stocks at a discount to earnings power, you cannot be as certain because in many cases future earnings may turn out to be different than expected.

In brief, Graham offered two methods for investors to succeed:  buying below net current asset value and buying at a low price-to-earnings ratios (P/E).  In either case, the stock in question is deeply out of favor.

Every business, at any given time, is either in one of two states:  it is experiencing problems or it will be experiencing problems.  When a business runs into problems, the stock price typically will decline and the company will fall out of favor.  The key is that most business problems are temporary and not permanent, at least when viewed over the subsequent 3 to 5 years.

When a company runs into problems, investors usually overreact and sell the stock to much lower levels than is justified by net asset value or earnings power.  By systematically buying a basket of these oversold stocks, you can do well over time.

Philip Fisher

Fisher believed in a concentrated portfolio of five to eight stocks.  Fisher would conduct ‘scuttlebutt’ research, which involved speaking with customers, suppliers, competitors, and industry experts.  Fisher wanted to understand the quality of management and the strength of the company’s competitive position.

(Philip A. Fisher)

If you can buy stock in a company that has a strong competitive position based on continued innovation, and that is run by able and honest managers, then you’ll do well over time.  Fisher also insisted that the sales force of the company in question be strong.  This should be ensured by strong management.  As well, Fisher made sure the company had good profits.

Good managers focus on building shareholder value.  And they are honest about their mistakes and about the real difficulties being encountered by the business.

Charlie Munger

Charlie Munger was from Omaha, like Buffett.  As a kid, Munger had worked for the grocery store run by Warren Buffett’s grandfather.

Munger’s grandfather was a federal judge and his father was a lawyer.  Munger became a successful lawyer in Los Angeles after graduating from Harvard Law School.

One of Buffett’s early investors, Dr. Edwin Davis, had decided to invest in the Buffett Partnership because Buffett reminded him of Charlie Munger.  A few years later, in 1959, Dr. David arranged a meeting between Buffett and Munger.  This was the beginning of an extraordinary partnership.

(Charlie Munger at the 2010 Berkshire Hathaway shareholders meeting.  Photo by Nick Webb)

Munger realized that it is better to pay a fair price for a wonderful company than a wonderful price for a fair company.  Buffett had recently invested in several statistically cheap companies:

My punishment was an education in the economies of short-line farm implementation manufacturers (Dempster Mill Manufacturing), third-place department stores (Hochschild-Kohn), and New England textile manufacturers (Berkshire Hathaway).

These were three situations of paying a wonderful price for a fair company.  Only the investment in Dempster worked, thanks to a turnaround specialist, Harry Bottle, whom Munger had introduced to Buffett.  The Dempster investment easily could have failed.  Hochschild-Kohn didn’t work.  Berkshire Hathaway—the textile manufacturer—eventually went out of business.

Note:  Buffett took cash out of the textile business and made a long series of highly successful investments.  This was the beginning of Buffett and Munger creating today’s Berkshire Hathaway.  The old textile business was closed.

In 1972, Berkshire Hathaway acquired See’s Candies at a large premium to book value.  This stock was not at all statistically cheap.  But it was a wonderful company at a fair price, which Munger argued made excellent sense.

Over the ensuing decades, See’s Candies produced an extraordinarily high return on invested capital (ROIC) and return on equity (ROE).  Thus even though Buffett and Munger paid nearly three times book value, the investment turned out to be a grand slam.  Charlie said it was ‘the first time we paid for quality.’

The success of the See’s Candies investment is what made Buffett open to making a large investment in Coca-Cola in the late 1980s.  Buffett invested about one billion dollars in Coca-Cola—about a third of Berkshire’s portfolio—even though the P/E and the P/CF were high.  The key was that Coca-Cola could develop and maintain a very high ROE (and ROIC).

A Blending of Influences

From Graham, Buffett learned the importance of a margin of safety.  Buffett learned that it is important to estimate the intrinsic value of the business, and then pay a price well below that value.  Buffett also learned from Graham that stock price fluctuations are largely random and should be ignored except when they create bargains.  Thirdly, Buffett learned from Graham the importance of being an independent thinker.  As Graham said:

You’re neither right nor wrong because the crowd disagrees with you.  You’re right because your data and reasoning are right.

From Fisher, Buffett learned to concentrate his portfolio in his best ideas:  it is safer to own a few ideas with which you are thoroughly familiar than to own many ideas without knowing much about them.  Buffett also learned from Fisher the value of ‘scuttlebutt’ research, which meant interviewing customers, suppliers, competitors, and industry experts.  Finally, Buffett learned that a high-quality company can increase its intrinsic value over a long period of time.

Charlie Munger figured out on his own that it made sense to pay a fair price for a wonderful company.  Even paying a large premium to book value, you could still have a significant margin of safety relative to a long future of compounding intrinsic value.

Thus it was primarily Munger’s influence that got Buffett to agree to purchase See’s Candies at a large premium to book value.  Munger also became an expert in psychology, which impacted Buffett.

Hagstrom sums up the three influences:

Graham gave Buffett the intellectual basis for investing—the margin of safety—and helped him learn to master his emotions in order to take advantage of market fluctuations.  Fisher gave Buffett an updated, workable methodology that enabled him to identify good long-term investments and manage a focused portfolio over time.  Charlie helped Buffett appreciate the economic returns that come from buying and owning great businesses.  [And] Charlie helped educate Buffett on the psychological missteps that often occur when individuals make financial decisions.



Buffett uses the same basic approach whether he is acquiring the business outright or buying a piece of the business via shares of stock.  Owning the entire company allows Buffett to control the capital allocation of the business.  On the other hand, because the stock market is so large, there are many more opportunities to find bargains among public equities than among private businesses.  Hagstrom quotes Buffett:

When investing, we view ourselves as business analysts, not as market analysts, not as macroeconomic analysts, and not even as security analysts.

Thus Buffett acts primarily as a businessperson, whether he is acquiring a company or buying stock.

Hagstrom has distilled Buffett’s investment approach into twelve key tenets:

Business Tenets

  • Is the business simple and understandable?
  • Does the business have a consistent operating history?
  • Does the business have favorable long-term prospects?

Management Tenets

  • Is management rational?
  • Is management candid with its shareholders?
  • Does management resist the institutional imperative?

Financial Tenets

  • Focus on return on equity (ROE), not earnings per share (EPS).
  • Calculate ‘owner earnings.’
  • Look for companies with high profit margins.
  • For every dollar retained, make sure the company has created at least one dollar of market value.

Market Tenets

  • What is the value of the business?
  • Can the business be purchased at a significant discount to its value?


Business Tenets

  • Is the business simple and understandable?
  • Does the business have a consistent operating history?
  • Does the business have favorable long-term prospects?

Buffett holds that most business success stories involve companies doing the same things they have been doing for decades.  This often does involve ongoing innovation, but in the context of a business that already has a sustainable competitive advantage.

Investment success is not how much you know, but how well you understand the limits of what you know (and what you can know).  Buffett:

Invest in your circle of competence.  It’s not how big the circle is that counts;  it’s how well you define the parameters.

Buffett is looking for a company with a sustainable competitive advantage demonstrated in a consistent operating history and expected to last well into the future.  This doesn’t guarantee success in every case, but it does maximize the probability of success over time.

Buffett looks for great businesses or franchises:

He defines a franchise as a company providing a product or service that is (1) needed or desired, (2) has no close substitute, and (3) is not regulated.  These traits allow the company to hold its prices, and occasionally raise them, without the fear of losing market share or unit volume.  This pricing flexibility is one of the defining characteristics of a great business;  it allows the company to earn above-average returns on capital.

(Image by Marek Uliasz)


The key to investing is determining the competitive advantage of any given company and, above all, the durability of the advantage.  The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

Buffett again:

[The] definition of a great company is one that will be great for 25 to 30 years.


Management Tenets

  • Is management rational?
  • Is management candid with its shareholders?
  • Does management resist the institutional imperative?

Buffett looks for honest and able managers who behave like owners.  Such managers understand that their mission is to build business value over time.

Allocating capital in a rational way is central to maximizing the value of the business over time.  Particularly for mature companies, which Buffett often prefers based on their predictability, the allocation of excess cash can have a large impact on the value of the business.

The key is to get a return on invested capital (ROIC)—or return on equity (ROE)—that exceeds the cost of capital.  (ROE is close to ROIC for companies with low or no debt, which Buffett has always preferred.)  If there is no project that promises a sufficiently high return on capital, then the managers should consider buying back stock or paying dividends.  Buying back stock only creates value when the stock price is below intrinsic value.

When considering projects that may have a high ROIC (or high ROE), it’s vital that managers are thinking independently.

(Photo by  Marijus Auruskevicius)

Similarly, managers should never simply copy what other managers in the same industry are doing.  This is a recipe for disaster.  But it happens often enough.  Buffett and Munger call it the institutional imperativethe lemming-like tendency of managers to imitate the behavior of others, no matter how silly or irrational.  Buffett and Munger think the institutional imperative is responsible for several problems:

(1) [The organization] resists any change in its current direction;  (2) just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds;  (3) any business craving of the leader, however foolish, will quickly be supported by detailed rate-of-return and strategic studies prepared by his troops;  and (4) the behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Jack Ringwalt was the head of National Indemnity when Berkshire acquired it in 1967.  There were times when Ringwalt would simply stop selling insurance altogether if the rates on policies didn’t make sense.  Buffett learned this lesson well, both for Berkshire’s many insurance operations and in general.

Management candor is essential.  Good managers admit their mistakes and confront their problems rather than hiding behind GAAP (generally accepted accounting principles).


Financial Tenets

  • Focus on return on equity (ROE), not earnings per share (EPS).
  • Calculate ‘owner earnings.’
  • Look for companies with high profit margins.
  • For every dollar retained, make sure the company has created at least one dollar of market value.

Buffett does not take yearly results too seriously.  He focuses on five-year averages.  There is too much randomness in periods shorter than five years.

ROE (or ROIC) is more important than EPS.  As noted earlier, a company only creates value over time to the extent that its ROIC exceeds its cost of capital.  Often the cost of capital can be understood as the opportunity cost of capital, or the next best investment opportunity with a similar level of risk.

In calculating ROE—or ROIC—Buffett excludes extraordinary items.  He seeks to isolate the underlying performance of the business.

The intrinsic value of any business is all future free cash flow (FCF) discounted back to the present.  Buffett uses the term owner earnings in place of FCF.  It equals net income plus depreciation, depletion, and amortization, and minus capital expenditures.  (There may also be adjustments for changes in working capital.)

Buffett’s favorite managers minimize costs just like they breathe.  They do it automatically at all times.


Market Tenets

  • What is the value of the business?
  • Can the business be purchased at a significant discount to its value?

The value of any business is all future FCF discounted back to the present.  This definition was first explained by John Burr Williams in The Theory of Investment Value.

Buffett compares valuing a business to valuing a bond.  You know the coupon and maturity date for the bond, so you know the future cash flows.  Then you discount those future cash flows back to the present using an appropriate discount rate.

Buffett nearly always insists on a ‘coupon-like’ certainty for the future cash flows of a business in which he invests.  Therefore, Buffett uses the rate of the long-term U.S. government bond as his discount rate.  (If rates are very low, as today, Buffett often uses 6% as the discount rate.)

Hagstrom quotes Buffett:

[Irrespective] of whether a business grows or doesn’t, displays volatility or smoothness in earnings, or carries a high price or low in relation to its current earnings and book value, the investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase.

Buffett wrote in the 1981 Berkshire Hathaway Letter to Shareholders:

[We have made mistakes as to:]  (1) the management we have elected to join;  (2) the future economics of the business;  or (3) the price we have paid. We have made plenty of such mistakes—both in the purchase of non-controlling and controlling interests in businesses.  Category (2) miscalculations are the most common.

Ben Graham taught that you only buy when there is a margin of safety between the price you pay and the intrinsic value of the business.  A margin of safety simultaneously lowers the risk of the investment AND increases the potential return.  The notion that lowering your risk can increase your return is directly contrary to what is taught in modern finance, where higher returns always require higher risks.

Buffett has adopted Graham’s view that investing means becoming a part owner of a business.  Investing is not trading pieces of paper.  Graham:

Investing is most intelligent when it is most businesslike.

Buffett says these are “the nine most important words ever written about investing.”  For Buffett, becoming a part owner of a public business by buying stock is no different than becoming a part owner—or full owner—of a private business.  Buffett notes:

I am a better investor because I am a businessman, and a better businessman because I am an investor.



The Washington Post Company

Millionaire financier Eugene Meyer bought the Washington Post for $825,000 at an auction held to pay off creditors.  Much later, Philip Graham, a brilliant Harvard-educated lawyer, took over management of the paper.  Graham had married Meyer’s daughter Katharine.  Graham transformed the Washington Post from a single newspaper into a media and communications company.

(Photo by Michael Fleischhacker, via Wikimedia Commons)

After Graham’s tragic suicide, control of the paper passed to Katharine Graham.  She learned quickly that she had to make decisions.  She made two great decisions:  hiring Ben Bradlee as managing editor and then inviting Warren Buffett to become a director.  Bradlee persuaded Katharine Graham to publish the Pentagon Papers and to pursue the Watergate investigation.  This earned the paper a reputation for award-winning journalism.  Meanwhile, Buffett taught Katharine Graham how to run a successful business.  (Buffett later tutored Katharine’s son, Don Graham.)

Simple and Understandable

For Buffett, the newspaper business was simple and understandable.  Buffett has said that if he were not an investor, he probably would be a journalist.

Consistent Operating History;  Favorable Long-Term Prospects

The Washington Post had a consistent operating history and favorable long-term prospects.  Newspapers had outstanding economics at the time.  (This was in the early 1970s, well before the advent of the internet.)  Even mediocre newspapers were generally quite profitable.  People and businesses wanting to get a message out to the community would typically use the newspaper to do so.  Moreover, newspapers had low capital needs, which meant a high ROIC and high profit margins.

Buy at Attractive Prices

In 1973, the total market value of the Washington Post Company was $80 million.  Buffett held that most security analysts, media brokers, and media executives at the time would have estimated WPC’s value at $400 or $500 million.  Assuming a $400 million intrinsic value, Buffett was buying at 20 percent of intrinsic value.

Return on Equity and Profit Margins

When Buffett purchased a stake in the WPC, its return on equity (ROE) was 15.7 percent.  Within five years, ROE had doubled.  WPC maintained a high ROE over the next ten years.  At the same time, WPC had paid down most of its debt.

By 1988, pretax margin reached a high of 31.8 percent, compared to 16.9 percent for its newspaper peer group and 8.6% for S&P Industrials.

Management Rationality

Using the gobs of excess cash, between 1975 and 1991, the Washington Post Company repurchased an incredible 43 percent of its shares at relatively low prices.

GEICO Corporation

Leo Goodwin, an insurance accountant, founded the Government Employees Insurance Company (GEICO) in 1936.  His idea was to insure only preferred-risk drivers and to sell this insurance directly by mail, bypassing the need for agents or branch offices.  Direct selling eliminated overhead expenses equal to 10 to 25 percent of every premium dollar.  Goodwin also realized that government employees had fewer accidents than the general public.

(GEICO logo by Dream out loud, via Wikimedia Commons)

Goodwin partnered with a Fort Worth, Texas, banker Cleaves Rhea.  Goodwin invested $25,000 for a 25% stake in the business, while Rhea invested $75,000 for a 75% stake in the business.  In 1948, the Rhea family decided to sell its interest.  Ben Graham decided to buy half Rhea’s stock for $720,000.  David Kreeger, a Washington, D.C., lawyer and Lorimer Davidson, a Baltimore bond salesperson, bought the other half.

Lorimer Davidson joined GEICO’s management team and became chairman in 1958.  By 1970, GEICO not only had written policies that would lead to underwriting losses;  but it also had inadequate reserves.  Norman Gidden was tapped to run the company when Davidson retired.

GEICO attempted to grow out of its problems.  By 1974, GEICO was facing a potential underwriting loss of $140 million (it turned out to be $126 million).  The stock fell from $61 to $5, and was heading lower.  GEICO had lost underwriting and cost control discipline.

In 1976, John J. Byrne, a 43-year-old marketing executive from Travelers Corporation, took over as president of GEICO.  Meanwhile, the stock drifted down to $2.

Warren Buffett invested $4.1 million at an average price of $3.18.

Simple and Understandable

Back in 1950, Ben Graham—Buffett’s teacher at Columbia University—was a director of GEICO.  One Saturday, Buffett went to visit the company in Washington, D.C., to try to learn.  A janitor let him in the building, and Buffett ended up getting a 5-hour tutorial from Lorimer Davidson, who was the only executive in the office that day.

Later, when Buffett returned to Omaha and his father’s brokerage firm, he recommended GEICO to the firm’s clients.  Buffett himself invested $10,000, two-thirds of his net worth.  He sold a year later at a 50 percent profit.  Buffett would not invest again in GEICO until 1976.

Buffett owned Kansas City Life and Massachusetts Indemnity & Life Insurance.  In 1967, Buffett purchased a controlling interest in National Indemnity.  Over the next decade, Buffett learned the insurance business from Jack Ringwalt, the CEO of National Indemnity.

Buffett’s expertise in insurance is what gave him the confidence to invest heavily in GEICO.  Between 1976 and 1980, Berkshire invested $47 million in GEICO, 7.2 million shares at an average price of $6.67.  The stake was worth $105 million by 1980, representing Buffett’s largest holding.

Consistent Operating History;  Favorable Long-Term Prospects

Buffett’s large investment in GEICO seemed to violate the consistent operating history tenet, since GEICO was a turnaround.  But Buffett had determined that the essential competitive advantage of the business—providing low-cost agentless insurance—was still intact.  Thus, Buffett judged that the problems in 1976, though huge, would ultimately be temporary.

Management Candor and Rationality

Byrne drastically reduced costs.  The number of policyholders went from 2.7 million to 1.5 million.  GEICO went from being the 18th largest insurer to 31st a year later.  But GEICO went from losing $126 million in 1976 to earning an impressive $58.6 million (on $463 million in revenues) in 1977.

Byrne continued to reduce costs.  The company stumbled in 1985.  But Byrne was very candid about it, and the company quickly recovered.  By this point, Byrne had developed a reputation not only for great leadership, but also for candor with shareholders.

From 1983 to 1992, GEICO used excess cash to repurchase 30 million shares, reducing total shares outstanding by 30 percent.  GEICO also increased the dividend.

Return on Equity and Profit Margins

In 1980, the ROE at GEICO was 30.8 percent, almost twice as high as the peer group average.  Buying back stock and paying dividends helped maintain a high ROE by reducing capital.

GEICO’s combined ratio of corporate expenses and underwriting losses was significantly better than the industry average.

Capital Cities/ABC

(Wikimedia Commons)

In 1954, Lowell Thomas, the famous journalist;  his business manager, Frank Smith;  and a group of associates bought Hudson Valley Broadcasting Company, which included an Albany television and AM radio station.  At the time, Tom Murphy was a product manager at Lever Brothers.

Frank Smith was a golfing partner of Murphy’s father.  Smith hired Murphy to manage the company’s television station.  In 1957, the company purchased a Raleigh-Durham television station.  The company was renamed Capital Cities Broadcasting, since Albany and Raleigh were capital cities.

In 1960, Murphy hired Dan Burke to manage the Albany station.  During the next several decades, Murphy and Burke ran Capital Cities.  They made more than 30 acquisitions in broadcasting and publishing.

In the late 1960s, Murphy met Buffett.  Murphy invited Buffett to join the board of Cap Cities.  Buffett declined, but he and Murphy became good friends.

In early 1985, Murphy obtained an initial agreement for a merger between Cap Cities and ABC.  Although Murphy had always done his own deals up until then, this time he brought his friend Warren Buffett.  They worked out the largest media merger in history (up to that point).  Berkshire Hathaway agreed to purchase three million newly issued shares of Cap Cities at $172.50 per share.  Murphy asked Buffett again to join the board, and this time Buffett agreed.

Simple and Understandable

Having served on the Washington Post Company board for more than a decade, Buffett had a very good understanding of television broadcasting, and newspaper and magazine publishing.

Consistent Operating History;  Favorable Long-Term Prospects

Both Cap Cities and ABC had more than 30 years of profitable histories.  ABC averaged 17 percent ROE from 1975 through 1984.  Cap Cities, in the decade before its purchase of ABC, averaged 19 percent ROE.  (Both companies also had low debt.)

Hagstrom explains the economics:

Once a broadcasting tower is built, capital reinvestment and working capital needs are minor and inventory investment is nonexistent.  Movies and programs can be bought on credit and settled later when advertising dollars roll in.  Thus, as a general rule, broadcasting companies produce above-average returns on capital and generate substantial cash in excess of their operating needs.

In 1985, the basic economics were above average.

Determine the Value

Berkshire’s $517 million investment in Cap Cities was the single largest investment Buffett ever made up until then.  This was not a cheap price.  Buffett joked, ‘I doubt if Ben’s up there applauding me on this one.’

Much of Buffett’s investment depended on Murphy.  Operating margins at Cap Cities were 28 percent, but were only 11 percent at ABC.  Murphy could improve the margins at ABC.

In essence, Murphy was Buffett’s margin of safety.  Murphy and Burke used a decentralized management style, hiring the best people and then leaving them alone to do their job.  Managers were expected to operate their businesses as if they owned them.  Moreover, Murphy excelled at minimizing costs, while Burke excelled at ongoing operations.

The Institutional Imperative and Rationality

Despite enormous free cash flow, Murphy remained very disciplined about not overpaying for acquisitions.  He would sometimes wait for years until the right property at the right price became available.

Because the stock of Cap Cities/ABC was cheap for several years, Murphy repurchased a large number of shares.  Murphy also reduced the company’s debt that had resulted from the ABC acquisition.

Buffett viewed Cap Cities/ABC as the best-managed public company in the United States.  He assigned all voting rights for the ensuing 11 years to Murphy and Burke as long as at least one of them managed the company.

The Coca-Cola Company

(Wikimedia Commons)

Hagstrom writes:

By the spring of 1989, Berkshire Hathaway shareholders learned that Buffett had spent $1.02 billion buying Coca-Cola shares.  He had bet a third of the Berkshire portfolio, and now owned 7 percent of the company.  It was the single-largest Berkshire investment to date, and already Wall Street was scratching its head.  Buffett had paid five times book value and over 15 times earnings, then a premium to the stock market, for a hundred-year-old company that sold soda pop.  What did the Wizard of Omaha see that everyone else missed?

As a kid, Buffett would buy six Cokes for 25 cents, then resell them at 5 cents each.  And in 1986, Buffett announced that Cherry Coke would be the official soft drink at Berkshire Hathaway’s annual meetings.  But it wasn’t until 1988 that Buffett began buying shares.

Simple and Understandable

The company sells a concentrate to bottlers, who combine it with other ingredients and then sell the finished product to retail outlets.  The company also sells soft drink syrups to restaurants and fast-food retailers.

Consistent Operating History;  Favorable Long-Term Prospects

Buffett explained in an interview with Melissa Turner of the Atlanta Constitution his reasoning:  If he could make one investment and then go away for ten years without access to any information about the investment, what would he buy?  As far as remaining a worldwide leader and experiencing big ongoing unit growth, there was nothing (in 1989) like Coke.

Furthermore, the chairman and CEO of Coke, Roberto Goizueta, and the president Donald Keough, were doing an outstanding job erasing mistakes that had been made in the 1970s.  Robert Woodruff, the company’s 91-year-old patriarch, hired Roberto Goizueta in 1980.  Goizueta cut costs and demanded that any business owned by Coca-Cola maximize return on assets.

High Profit Margins and ROE

Under Goizueta and Keough, pretax margins rose from 12.9 percent to a record 19 percent by 1988.  Goizueta sold any business that did not generate good ROE.  By 1988, the company’s ROE reached 31 percent, up from 20 percent during the 1970s.

Management Candor and Rationality

Under Goizueta’s leadership, Coke’s mission became crystal clear:  maximize shareholder value over time.  This would be achieved by optimizing profit margins and ROE.

Meanwhile, Goizueta announced that the company would repurchase shares, which were trading at a discount to the company’s now-higher intrinsic value.

The Institutional Imperative

Hagstrom describes Goizueta’s leadership:

When Goizueta took over Coca-Cola, one of his first moves was to jettison the unrelated businesses that Paul Austin had developed, and return the company to its core business:  selling syrup.  It was a clear demonstration of Coca-Cola’s ability to resist the institutional imperative.

Reducing the company to a single-product business was undeniably a bold move…

… Because the economic returns of selling syrup far outweighed the economic returns of the other businesses, the company was now reinvesting its profits in its highest-return business.

Determine the Value

Buffett paid 5 times book value, 15 times earnings, and 12 times cash flow.  This was at a time when long-term bonds were yielding 9 percent.  Hagstrom:

…The company was earning 31 percent on equity while employing relatively little in capital investment.  Buffett has explained that price tells you nothing about value.  The value of Coca-Cola, he said, like that of any other company, is determined by the total owner earnings expected to occur over the life of the business, discounted by the appropriate interest rate.

Owner earnings is the term Buffett uses for free cash flow (FCF).  We can use a two-stage discount model to calculate the present value in 1988.  Assuming 15 percent growth in owner earnings for the next 10 years, and then 5 percent growth thereafter, and assuming a 9 percent discount rate, intrinsic value for Coca-Cola would be $48.377 billion.  That’s compared to the 1988 market value of $14.8 billion.

At year-end 1999, the market value of Coke was $143 billion, and Berkshire’s original $1.02 billion investment was worth $11.6 billion.

General Dynamics

In 1990, General Dynamics was the country’s second-largest defense contractor behind McDonnell Douglas Corporation.  General Dynamics produced missile systems in addition to air defense systems, space-launched vehicles, and fighter planes for the U.S. armed forces.

(Wikimedia Commons)

In January 1991, General Dynamics appointed William Anders as CEO.  Within six months, the company had raised $1.25 billion by selling noncore businesses.  With the cash, the company first paid down its debt.  Then as excess cash flow continued, General Dynamics purchased 13.2 million shares at prices between $65.37 and $72.25, reducing its shares outstanding by 30 percent.

Although Buffett initially had purchased General Dynamics as an arbitrage—in anticipation of stocks buybacks—Buffett later noticed that Anders was very focused on maximizing shareholder value.  So Buffett held the stake:

From July 1992 through the end of 1993, for its investment of $72 per share, Berkshire received $2.60 in common dividends, $50 in special dividends, and a share price that rose to $103.  It amounted to a 116 percent return over 18 months.

Wells Fargo & Company

In October 1990, Buffett announced that Berkshire had purchased five million shares in Wells Fargo, investing $289 million at an average price of $57.88 per share.  This turned into a battle between bulls like Buffett and bears like the Feshbach brothers.

(Wikimedia Commons)

Buffett knew a lot about the business of banking.  In 1969, Berkshire Hathaway purchased 98 percent of the holdings of Illinois National Bank and Trust Company.  Gene Abegg, the chairman of Illinois National Bank, taught Buffett about the banking business.  Buffett learned that banks were profitable if they issued loans intelligently and curtailed costs.

Favorable Long-Term Prospects

When assets are 20 times equity, which is normal in banking, even a small mistake can cause the bank to go bankrupt.  But if management does a good job, a bank can earn 20 percent on equity, which is above the average of most businesses.  Also, Buffett believed he had the best management team in Carl Reichardt and Paul Hazen.  Buffett:  “In many ways, the combination of Carl and Paul reminds me of another—Tom Murphy and Dan Burke at Capital Cities/ABC.”

Munger explained:  ‘It’s all a bet on management.  We think they will fix the problems faster and better than other people.”


Reichardt was legendary for relentlessly lowering costs.  He never let up, always searching for ways to improve profitability.

American Express Company

(Wikimedia Commons)

Buffett:  “I find that a long-term familiarity with a company and its products is often helpful in evaluating it.”  Hagstrom explains:

With the exception of selling bottles of Coca-Cola for a nickel, delivering copies of the Washington Post, and recommending that his father’s clients buy shares of GEICO, Buffett has had a longer history with American Express than any other company Berkshire owns.  You may recall that in the mid-1960s, the Buffett Limited Partnership invested 40 percent of its assets in American Express shortly after the company’s losses in the salad oil scandal.  Thirty years later, Berkshire accumulated 10 percent of American Express shares for $1.4 billion.

Consistent Operating History

American Express was essentially the same business when Berkshire invested as it had been when the Buffett partnership invested.  Travel Related Services (TRS) made up 72 percent of American Express’s sales.  American Express Financial Advisors represented 22 percent of sales.  American Express Bank was about 5%.

Under James Robinson, the company used excess cash to acquire related business.  Although IDS (renamed American Express Financial Advisors) had proved to be a profitable purchase, Robinson’s $4 billion investment in Shearson-Lehman was a financial drain and prompted Robinson to contact Buffett.  Buffett was willing to buy $300 million in preferred shares.  But Buffett was not ready to invest in the common shares until he saw more management rationality.


In 1992, Harvey Golub took over as CEO.  Golub clearly recognized the brand value of the American Express Card.  Over the next two years, Golub sold off American Express’s underperforming assets, and restored profitability and high ROE.  By 1994, American Express management was focused on making the American Express Card the “world’s most respected service brand.”

Golub also set financial targets:  to increase EPS by 12 to 15 percent annually and to achieve an 18 to 20 percent ROE.  Management was also planning to repurchase 20 million shares of its common stock.

In the summer of 1994, Buffett converted Berkshire’s preferred issue into American Express common stock.  And he began to acquire even more shares of common stock.  Berkshire owned 27 million shares at an average price of $25 by the end of the year.  When American Express finished repurchasing 20 million shares, it announced that it would repurchase an additional 40 million shares, or 8 percent of the stock outstanding.  By March 1995, Buffett had added another 20 million shares, which increased Berkshire’s ownership to a bit less than 10 percent of American Express.

Determine the Value

Assuming 12 percent growth in owner earnings for 10 years, then 5 percent growth thereafter, and assuming a discount rate of 10 percent—which is conservative—the intrinsic value of American Express at the end of 1994 was about $50 billion, or $100 per share.  Thus Buffett’s purchase of 27 million shares at $25 had a significant margin of safety, and therefore significant potential upside.

International Business Machines

Buffett had always avoided investing in technology companies because constant disruption and innovation make for very short company life spans.  But by the end of 2011, Berkshire Hathaway had purchased 63.9 million shares of IBM, or 5.4 percent of the company.  At $10.8 billion, it was the largest purchase of individual stock Buffett has ever made.

(Photo by Paul Rand, via Wikimedia Commons)

Favorable Long-Term Prospects

After 50 years of reading the financial statements of IBM, Buffett suddenly realized the competitive advantages IBM has in finding and keeping clients.  IBM dominates information technology (IT) services, which includes consulting, systems integration, IT outsourcing, and business process outsourcing.  IBM is number-one globally in the consulting and systems integration space, and number-one globally in IT outsourcing.

Revenues from IT services are relatively stable.  Consulting, systems integration, and IT outsourcing are even thought to possess ‘moat-like’ qualities, writes Hagstrom.  In consulting and systems integration, intangible assets like reputation, track record, and client relationships are sources of a moat.  In IT outsourcing, switching costs and scale advantages create a moat.

J. Heinz Company

On February 14, 2013, Berkshire Hathaway and 3G Capital purchased H. J. Heinz Company for $23 billion.  The purchase price was $72.50 a share, a 20 percent premium to the stock price the day before.

(Wikimedia Commons)

Favorable Long-Term Prospects;  Rationality

Heinz is number one in ketchup globally and second in sauces.  The company is poised to do well in rapidly growing emerging markets.

Buffett has partnered with 3G Capital in the purchase of Heinz.  3G has a track record of relentlessly lowering costs.

Holding Period:  Forever

Buffett is “quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.”



If you do not have the time or inclination to study companies in depth, then a low-cost index fund is best.  But if you can understand some businesses, then a concentrated portfolio makes sense.

There is a mathematical formula, the Kelly criterion, that you can use to get an idea of how large a position to take on your best ideas.  The formula was invented by the physicist John L. Kelly.

(John L. Kelly, Wikimedia Commons)

Buffett talked about index funds vs. focused portfolios in the 1993 Berkshire Hathaway Letter to Shareholders:

By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals.  Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.

On the other hand, if you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you.  It is apt simply to hurt your results and increase your risk.  I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding that money to his top choices—the businesses he understands best and that present the least risk, along with the greatest profit potential.

Here is Buffett in a 1998 lecture at the University of Florida:

If you can identify six wonderful businesses, that is all the diversification you need.  And you will make a lot of money.  And I can guarantee that going into the seventh one instead of putting more money into your first one is [going to] be a terrible mistake.  Very few people have gotten rich on their seventh best idea.  So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty, and I [would] probably have half of [it in] what I like best.


Even in a highly focused portfolio of 5 to 10 stocks, often your best idea should be by far the largest position in your portfolio.

Recall that Buffett invested two-thirds of his net worth in GEICO before he launched the Buffett partnership.  He had over a 50 percent profit after a year.  Later, Buffett invested 40 percent of the Buffett partnership in American Express.  The shares nearly tripled over the next two years.  A couple of decades later, Buffett invested $1.02 billion—about a third of Berkshire Hathaway’s portfolio—in Coca-Cola.  This turned out to be a 10-bagger for Berkshire, netting $10 billion in profit over the ensuing decade.

It can be tempting for an investor to listen to forecasters predict the stock market, the economy, or elections.  But owning a few good businesses over time is a far more reliable and safer way to compound your capital—at higher rates—than speculating on the stock market or the economy.

Here are a few good quotes from Buffett on forecasting:

  • I don’t invest a dime based on macro forecasts.
  • Market forecasters will fill your ear but never fill your wallet.
  • We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.
  • Charlie and I never have an opinion on the market because it wouldn’t be any good and it might interfere with the opinions we have that are good.

Hagstrom puts it as follows:

In shorter periods, we realize that changes in interest rates, inflation, or near-term expectations for a company’s earnings can affect share prices.  But as the time horizon lengthens, the trendline economics of the underlying business will increasingly dominate its share price.

… Focus investors tolerate the [short-term] bumpiness because they know that, in the long run, the underlying economics of the companies will more than compensate for any short-term price fluctuations.

Investing is Probabilistic

(Photo by Michele Lombardo)

Nearly all investments are probabilistic decisions, or decisions under uncertainty.  Hagstrom quotes Buffett:

Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain.  That is what we’re trying to do.  It’s imperfect but that’s what it is all about.

Hagstrom also quotes Charlie Munger:

The model I like—to sort of simplify the notion of what goes on in a market for common stocks—is the pari-mutuel system at the racetrack.  If you stop and think about it, a pari-mutuel system is a market.  Everybody goes there and bets and the odds are changed based on what’s bet.  That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and good position et cetera is way more likely to win than a horse with a terrible record and extra weight and so on and so on.  But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2.  Then it’s not clear which is statistically the best bet.  The prices have changed in such a way that it’s very hard to beat the system.

When you find a high-probability bet with substantial upside—which will only happen rarely—then you should take a big position.  How big?  You have to know yourself in terms of how much portfolio volatility you can tolerate.  As long as you can hold for the longer term—for at least 5 or 10 years—without reacting to shorter term volatility, then it makes sense to take large positions on the best ideas you find.

If you apply the Kelly criterion to a focused portfolio of value stocks, then you typically need to normalize positions sizes.  Mohnish Pabrai has explained this:

John Maynard Keynes was very successful as a focused value investor:

Hagstrom has a quote from Keynes:

It is a mistake to think one limits one’s risk by spreading too much between enterprises which one knows little and has no reason for special confidence… One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.

Keynes was against market timing, and in favor of a very concentrated portfolio.

Hagstrom also mentions Ruane, Cuniff & Company, started by Bill Ruane and Rick Cuniff.  They would have 90 percent of the fund in 6 to 10 positions.

Lou Simpson used a very concentrated approach when he managed GEICO’s equity portfolio.  Between 1980 and 2004, GEICO’s portfolio returned 20.3 percent per year compared to 13.5 percent for the market.

Active share is the percentage of a portfolio that differs from the benchmark index holdings.  The only way to do better than the index is to invest differently.  Yet most professional investors have portfolios not much different than the index.  They are more worried about not underperforming the index than they are focused on doing better than the index.  Hagstrom reports that just 25 percent of mutual funds today are considered truly active.

Moreover, many professional investors are focused on short-term results.  The problem is that the performance of a portfolio of stocks is largely random for time horizons less than 5 years.  That is why Buffett focuses on 5-year periods to measure Berkshire Hathaway’s performance.  After 5 years—and even more after 10 years—a stock will track the performance of the underlying business.

(Illustration by Marek)

Many professional investors fixate on quarterly or annual results because many of their clients (or potential clients) decide to invest in the fund based on these short-term results.

Many of the best long-term investors have had periods of significant underperformance over shorter periods of time.  When Keynes managed the Chest Fund, it underperformed the market one-third of the time.  This includes underperforming the market by 18 percentage points in the first three years Keynes managed the fund.  But Keynes’ record over a couple of decades was outstanding.

The Sequoia Fund, managed by Bill Ruane, underperformed the market 37 percent of the time.  In fact, Sequoia underperformed for the first 4 years of its existence.  By the end of 1974, the fund was 36 percentage points behind the market.  Yet three years later—seven years since inception—Sequoia was up 220 percent, versus 60 percent for the S&P 500 Index.

Over 14 years, Charlie Munger underperformed 36 percent of the time.  But Munger’s overall record was far better than the market.  (Lou Simpson underperformed the market 24 percent of the time, but also had a remarkable long-term record of beating the market.)

If you’re a long-term investor in businesses—whether public or private—what matters over time is the economic performance of those businesses, not the prices at which the businesses can be bought or sold.  Hagstrom:

If you owned a business and there were no daily quotes to measure its performance, how would you determine your progress?  Likely you would measure the growth in earnings, the increase in return on capital, or the improvement in operating margins.  You simply would let the economics of the business dictate whether you were increasing or decreasing the value of your investment.

Hagstrom quotes Buffett:

While market values track business values quite well over long periods, in any given year the relationship can gyrate capriciously.

Buffett again:

The speed at which a business’s success is recognized… is not that important as long as the company’s intrinsic value is increasing at a satisfactory rate.  In fact, delayed recognition can be an advantage:  It may give you a chance to buy more of a good thing at a bargain price.

When you consider a new investment idea, you should always compare it to the best ideas already in your portfolio.  Since good ideas are rare, this should set a high threshold and screen out 99 percent of what you consider.  Hagstrom observes:

You already have at your disposal, with what you now own, an economic benchmark—a measuring stick.  You can define your own personal benchmark in several different ways:  look-through earnings, return on equity, or margin of safety, for example.  When you buy or sell stock of a company in your portfolio, you have either raised or lowered your economic benchmark.  The job of a portfolio manager who is a long-term owner of securities, and who believes future stock prices eventually will match with underlying economics, is to find ways to raise your benchmark.

If you step back and think for a moment, the Standard & Poor’s 500 index is a measuring stick.  It is made up of 500 companies and each has its own economic return.  To outperform the S&P 500 index over time—to raise that benchmark—we have to assemble and manage a portfolio of companies with economics that are superior to the average weighted economics of the index.


If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long-term economic characteristics of each business.  Second, assess the quality of the people in charge of running it;  and third, try to buy into a few of the best operations at a sensible price.  I certainly would not wish to own an equal part of every business in town.  Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies?  And since finding great businesses and outstanding managers is so difficult, why should we discard proven products?  Our motto is:  If at first you succeed, quit trying.

Buffett again:

Inactivity strikes us as an intelligent behavior.  Neither we nor most business managers would dream of feverishly trading highly profitable subsidiaries because a small move in the Federal Reserve’s discount rate was predicted or because some Wall Street pundit has reversed his views on the market.  Why, then, should we behave differently with our minority positions in wonderful businesses?

Buying and holding wonderful businesses has two important benefits in addition to growing capital at an above-average rate.  Transaction costs are kept to an absolute minimum, and after-tax returns are maximized.

Buffett gives an example of $1 doubling every year for 20 years.  First assume that you sell and pay tax at the end of each year.  So after the first year, you would have a total of $1.66.  By the end of 20 years, you would have a net gain of $25,200, after paying taxes of $13,000.  By contrast, if you held the $1 dollar as it repeatedly doubled, and didn’t sell until the end of the 20-year period, you would have $692,000 after paying taxes of about $356,000.

To achieve high after-tax returns, turnover should be between 0 and 20 percent.  20 percent turnover implies a 5-year holding period.  As long as you are very patient and can stay focused on the long term without reacting emotionally to shorter term volatility, you should be able to construct and stick with a focused portfolio of businesses that you understand.  Always being rational and not reacting out of emotion is more important than IQ.  Buffett:

You don’t need to be a rocket scientist.  Investing is not a game where the 160 IQ guy beats the guy with the 130 IQ.  The size of an investor’s brain is less important than his ability to detach the brain from the emotions.



Although it’s not widely recognized, Ben Graham was keenly aware of the importance of psychology for investors.  Graham held that your worst enemy as an investor is usually yourself.

Warren Buffett, Graham’s most famous student, says there are three important principles in Graham’s approach to investing:

  • Stock is a fractional ownership in a business. What matters for the investor is how the business performs over time.
  • Margin of safety:  Given a reasonable estimate of intrinsic value—based on net asset value or earnings power—you should only buy when the price is well below that estimate.  The lower the price is compared to intrinsic value, the safer the investment and simultaneously the higher the potential reward.
  • Short-term price fluctuations have no meaning for the true investor because on the whole they do not reflect changes in business value. Fluctuations do occasionally create opportunities, however, for the investor to buy if the price becomes cheap enough.

When the stock price drops, a rational investor’s reaction should be the same as a businessperson who gets a lowball offer on his or her privately owned business:  Ignore it.  Graham:

The true investor scarcely ever is forced to sell his shares and at all other times is free to disregard the current price quotation.

Behavioral Finance

(Daniel Kahneman, via Wikimedia Commons)

Behavioral finance is based on discoveries (in the past few decades) in psychology by Daniel Kahneman, Amos Tversky, and many others.  Kahneman was awarded the Nobel Prize in economics in 2002 for discoveries that he and Tversky made from decades of experiments of people making decisions under uncertainty.

Before Kahneman and Tversky, economists always assumed—based on utility theory as described by John von Neumann and Oskar Morgenstern—that people make rational decisions under uncertainty.  (Investment decisions are decisions under uncertainty.)

We now know that nearly all investors make systematic errors.  Behavioral finance allows us to understand these errors.

Overconfidence, Confirmation Bias, Availability Bias

People by nature are overconfident.  Typically if you ask people in a random group how good a driver they are, at least 80-90 percent will say ‘above average.’  But of course no more than 50% can be above average.

In many areas of life, overconfidence is not bad and often even is helpful.  When we were hunter-gatherers, it was a net benefit for the tribe if hunters were individually overconfident.  Similarly today, although many entrepreneurs fail, it is a net benefit for the economy that nearly all entrepreneurs believe they will succeed.

When you are investing, however, overconfidence will penalize your results over time.  Hagstrom points out:

Investors, as a rule, are highly confident they are smarter than everyone else.  They have a tendency to overestimate their skills and their knowledge.  They typically rely on information that confirms what they believe, and disregard contrary information.  In addition, the mind works to assess whatever information is readily available rather than to seek out information that is little known….

Overconfidence explains why so many money managers make wrong calls.  They take too much confidence from the information they gather, and think they are more right than they actually are.

Confirmation bias means only seeing information that confirms what you already believe, rather than seeking and being aware of potentially disconfirming information.  Availability bias means only noticing information that is readily available.

Overreaction Bias

Overreaction Bias means investors overreact to bad news and react slowly to good news.  If there is bad news and the stock price drops, an investor is likely to overreact and to sell, even though the long-term, underlying economics of the business are often unchanged.

Richard Thaler researched overreaction.  He constructed a portfolio of ‘Loser’ stocks—stocks that had been the worst performers over the preceding 5 years.   He compared the ‘Loser’ portfolio to a portfolio of ‘Winner’ stocks—stocks that had performed best over the preceding 5 years.  Thaler found that over the subsequent 5 years, the ‘Loser’ portfolio far outperformed both the market and the ‘Winner’ portfolio.

Loss Aversion

People are risk averse when considering potential gains, but risk seeking when facing the possibility of a certain loss.  This is the essence of prospect theory—invented by Kahneman and Tversky—which is captured in the following graph:

(Value function in Prospect Theory, drawing by Marc Rieger, via Wikimedia Commons)

Loss aversion means that, in general, people feel a loss 2 to 2.5 times more than an equivalent gain.  (That’s why the value function in the graph is steeper for losses.)  Therefore, when people are presented with a 50/50 bet, on average they will only bet if the potential gain is at least twice as large as the potential loss.

Loss aversion causes people to hold on to their losing investments for too long.  By not selling an investment that hasn’t worked, the investor can postpone the feeling of a loss.  Yet the sooner the investor can recognize a mistake and close the position, the sooner the investor can reinvest that capital in a potentially more profitable way.

Mistakes in investing are inevitable.  Even for the best value investors, on average they tend to be right about two-thirds of the time and wrong one-third of the time.  The best investors can recognize quickly when either they have made a mistake or when unforeseeable events have invalidated the investment thesis.

Long-Term Investment Time Horizon

Warren Buffett focuses on the performance of the business over a 5-year or 10-year period.  He invests in a stock when it is a bargain relative to the probable long-term earnings power of the business.

Many investors are way too focused on the short term.  The problem is that if you check a stock price each day, there is 50 percent chance it will be lower.  And due to loss aversion, you will feel the pain of a lower price at least twice as much as the pleasure of an equivalent gain.  Therefore, after carefully constructing your portfolio, it’s essential to stay focused on the performance of the businesses over rolling 5-year periods.  It’s also essential to check stock prices as infrequently as you can.

Very often the individual investors who have gotten the best results over the course of 20-30 years are those investors who effectively forgot about their investments.  These investors often didn’t check stock prices for years at a time.  As Ben Graham said, for many investors it would be better if they couldn’t get any stock quote at all.

Warren Buffett has often said you should only invest in a business where you wouldn’t worry at all if the stock market closed for 5 or 10 years.  All that matters for the long-term value investor is how the underlying business performs over time.  If it’s a good business that increases earnings and maintains a high return on capital over time, then your fractional ownership of the business will track the increase in intrinsic value.



Too many investors have the mistaken belief that the stock market can be predicted.  But it can’t.  Ben Graham:

[If] I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.

Hagstrom did some research about long-term investing, and here is what he found:

We calculated the one-year return, trailing three-year return, and trailing five-year return (price only) between 1970 and 2012.  During this 43-year period, the average number of stocks in the S&P 500 index that doubled in any one year averaged 1.8 percent, or about nine stocks out of 500.  Over three-year rolling periods, 15.3 percent of stocks doubled, about 77 stocks out of 500.  In rolling five-year blocks, 29.9 percent doubled, about 150 out of 500.

So, back to the original question:  Over the long term, do large returns from buying and holding stocks actually exist?  The answer is indisputably yes.  And unless you think a double over five years is trivial, this equates to a 14.9 percent average annual compounded return.

Then Hagstrom notes that the greatest number of opportunities to get high excess returns is after three years.  So, as an investor, you should patiently find cheap and good stocks that you can hold for at least 3 to 5 years.  There continue to be many opportunities over this time frame because many investors only look at the very short term.  The average holding period is only a few months, which is hardly different from a coin flip.


Keith Stanovich holds that rationality is not the same thing as intelligence.  He says IQ tests or SAT/ACT exams do a poor job of measuring rational thought:

It is a mild predictor at best, and some rational thinking skills are totally dissociated from intelligence.

There appear to be two main reasons why even many high IQ people are not able to think rationally:  a processing problem and a content problem.

To understand the processing problem, we must first note that we have essentially two different brains:  System 1 and System 2.

System 1 operates automatically and quickly.  It makes instinctual decisions based on heuristics.

System 2 allocates attention (which has a limited budget) to the effortful mental activities that demand it, including complex computations involving logic, math, or statistics.

Usually System 1 and System 2 work well together, but not always.  Daniel Kahneman explains in his great book, Thinking, Fast and Slow:

The division of labor between System 1 and System 2 is highly efficient:  it minimizes effort and optimizes performance.  The arrangement works well most of the time because System 1 is generally very good at what it does: its models of familiar situations are accurate, its short-term predictions are usually accurate as well, and its initial reactions to challenges are swift and generally appropriate.  System 1 has biases, however, systematic errors that it is prone to make in specified circumstances…  it sometimes answers easier questions than the one it was asked, and it has little understanding of logic and statistics.  One further limitation of System 1 is that it cannot be turned off.

If the situation requires a complex computation in order to arrive at a good decision, then System 1 makes predictable errors.  In order to avoid these mistakes, a person must train his or her System 2 to activate and to think carefully.

So the processing problem requires training System 2.  But there is a second problem the investor also must solve:  the content problem.  The ability to think rationally using System 2 can only lead to good decisions if System 2 has access to enough mindware.  Mindware—as defined by Harvard cognitive scientist David Perkins—is all the rules, strategies, procedures, and knowledge people have at their disposal to help solve a problem.

In investing, the most important thing is reading a great deal, especially the financial statements of various companies.  Over time, an investor can slowly develop useful mindware.



To determine how good Warren Buffett is, there are two basic variables:  relative outperformance and duration.  Hagstrom argues that both are needed.  Over shorter periods of time, luck plays a large role.  But as you extend out in time—several decades and then some—luck plays less and less of a role.

Buffett has crushed the market over a period of almost 60 years.  Buffett is  unmatched over this time frame.

Buffett also remains very bullish on the United States.  He says the luckiest new babies in history are those being born today:

…Warren Buffett is unabashedly bullish on the United States of America.  He has never been shy to express his belief that the United States offers tremendous opportunity to anyone who is willing to work hard.  He is upbeat, cheerful, and optimistic about life in general.  Conventional wisdom holds that it is the young who are the eternal optimists and as you get older pessimism begins to tilt the scale.  But Buffett appears to be the exception.  And I think part of the reason is that for almost six decades he has managed money through a long list of dramatic and traumatic events, only to see the market, the economy, and the country recover and thrive.

It is a worthwhile exercise to Google the noteworthy events of the 1950s, 1960s, 1970s, 1980s, 1990s, and the first decade of the twenty-first century.  Although too numerous to list here, the front-page headlines would include nuclear war brinksmanship;  presidential assassination and resignation;  civil unrest and riots;  regional wars;  oil crisis, hyperinflation, and double-digit interest rates;  and terrorist attacks—not to mention the occasional recession and periodic stock market crash.

Hagstrom proceeds to argue that Buffett has three advantages:  behavioral, analytical, and organizational.

Behavioral Advantage

Those who know Buffett agree that it is rationality that sets him apart.  Buffett is extremely rational.  As Roger Lowenstein writes in Buffett: The Making of an American Capitalist, “Buffett’s genius [is] largely a genius of character—of patience, discipline, and rationality.”  The maximization of shareholder value depends largely on the rational allocation of capital.  This is a key trait Buffett looks for in good managers, and it’s a trait he himself has to a remarkable degree.

Analytical Advantage

For Buffett, both the investor and the businessperson should look at a company in terms of how much cash it can produce over time.  By recognizing, furthermore, that short-term stock prices are largely random, you can learn to value a business—based on discounted FCF or net asset value—and wait patiently until its stock price is well below intrinsic value.

Don’t waste time trying to predict the stock market, the economy, or elections.  No one has been able to predict these things.  Instead, stay focused on understanding individual businesses.  Over a long period of time—at least 5-10 years—what really matters, as long as you paid reasonable prices, is the performance of the businesses you own.

Organizational Advantage

Buffett has set up Berkshire Hathaway so that he can focus on long-term capital allocation, while the managers of the businesses Berkshire owns can focus on maximizing long-term business value.

If you’re an individual investor, you don’t have to worry about short-term performance or consensus opinions.  You can find a simple business that you understand, and then wait patiently for it to go on sale.  Find a few such businesses.  Then buy and hold, paying attention only to how the businesses perform over the years.

I would add that, for the individual investor, most often you can find the best investment opportunities among microcap companies—companies with market caps up to $300 million.  Because very few professional investors ever look at micro caps, the greatest pricing inefficiencies usually occur here.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Quantitative Deep Value Investing

(Image:  Zen Buddha Silence by Marilyn Barbone.)

May 20, 2018

Virtually all of the historical evidence shows that quantitative deep value investing—systematically buying stocks at low multiples (low P/B, P/E, P/S, P/CF, and EV/EBITDA)—does better than the market over time.

Deep value investing means investing in ugly stocks that are doing terribly—with low- or no-growth—and that are trading at low multiples.  Quantitative deep value investing means that the portfolio of deep value stocks is systematically constructed based solely on quantitative factors including cheapness.  (It’s a process that can easily be automated.)

One of the best papers on quantitative deep value investing is by Josef Lakonishok, Andrei Shleifer, and Robert Vishny (1994), “Contrarian Investment, Extrapolation, and Risk.”  Link:

Buffett has called deep value investing the cigar butt approach:

…You walk down the street and you look around for a cigar butt someplace.  Finally you see one and it is soggy and kind of repulsive, but there is one puff left in it.  So you pick it up and the puff is free—it is a cigar butt stock.  You get one free puff on it and then you throw it away and try another one.  It is not elegant.  But it works.  Those are low return businesses.

(Photo by Sensay)

Outline for this blog post:

  • Rare Temperament
  • Early Buffett: Deep Value Investor
  • Investors Much Prefer Income Over Assets
  • Companies at Cyclical Lows



Many value investors prefer to invest in higher-quality companies rather than deep value stocks.  A high-quality company has a sustainable competitive advantage that allows it to earn a high ROIC (return on invested capital) for a long time.  When you invest in such a company, you can simply hold the position for years as it compounds intrinsic value.  Assuming you’ve done your homework and gotten the initial buy decision right, you typically don’t have to worry much.

Investing in cigar butts (deep value stocks), however, means that you’re investing in many mediocre or bad businesses.  These are companies that have terrible recent performance.  Some of these businesses won’t survive over the longer term, although even the non-survivors often survive many years longer than is commonly supposed.

Deep value investing can work quite well, but it takes a certain temperament not to care about various forms of suffering—such as being isolated and looking foolish.  As Bryan Jacoboski puts it:

The very reason price and value diverge in predictable and exploitable ways is because people are emotional beings.  That’s why the distinguishing attribute among successful investors is temperament rather than brainpower, experience, or classroom training.  They have the ability to be rational when others are not.

(Photo by Nikki Zalewski)

In The Manual of Ideas (Wiley, 2013), John Mihaljevic explains the difficulty of deep value investing:

It turns out that Graham-style investing may be appropriate for a relatively small subset of the investment community, as it requires an unusual willingness to stand alone, persevere, and look foolish.

On more than one occasion, we have heard investors respond as follows to a deep value investment thesis: ‘The stock does look deeply undervalued, but I just can’t get comfortable with it.’  When pressed on the reasons for passing, many investors point to the uncertainty of the situation, the likelihood of negative news flow, or simply a bad gut feeling.  Most investors also find it less rewarding to communicate to their clients that they own a company that has been in the news for the wrong reasons.

Comfort can be expensive in investing.  Put differently, acceptance of discomfort can be rewarding, as equities that cause their owners discomfort frequently trade at exceptionally low valuations.

Many investors will look at a list of statistically cheap stocks and conclude that most of them would be awful investments.  But in practice, a basket of deep value stocks tends to outperform, given enough time.  And typically some of the big winners include stocks that looked the worst prior to being included in the portfolio.



Warren Buffett started out as a cigar-butt investor.  That was the method he learned from his teacher and mentor, Ben Graham, the father of value investing.  When Buffett ran his partnership, he generated exceptional performance using a deep value strategy focused on microcap stocks:

(Early Buffett: Teaching)

One reason Buffett transitioned from deep value to buying high-quality companies (and holding them forever) was simply that the assets he was managing at Berkshire Hathaway became much too large for deep value.  But in his personal account, Buffett recently bought a basket of South Korean cigar butts and ended up doing very well.

Buffett has made it clear that if your assets under management are relatively small, then deep value investing—especially when focused on microcap stocks—can do better than investing in high-quality companies.  Buffett has said he could make 50% a year by investing in deep value microcap stocks:

In the microcap world, since most professional investors don’t look there, if you turn over enough rocks you can find some exceptionally cheap companies.  If you don’t have sufficient time and interest to find the most attractive individual microcap stocks, using a quantitative approach is an excellent alternative.  A good quantitative value fund focused on microcaps is likely to do much better than the S&P 500 over time.  That’s the mission of the Boole Fund.



Outside of markets, people naturally assess the value of possessions or private businesses in terms of net asset value—which typically corresponds with what a buyer would pay.  But in markets, when the current income of an asset-rich company is abnormally low, most investors fixate on the low income even when the best estimate of the company’s value is net asset value.  (Mihaljevic makes this point.)

If an investor is considering a franchise (high-quality) business like Coca-Cola or Johnson & Johnson, then it makes sense to focus on income, since most of the asset value involves intangible assets (brand value, etc).

But for many potential investments, net asset value is more important than current income.  Most investors ignore this fact and stay fixated on current income.  This is a major reason why stock prices occasionally fall far below net asset value, which creates opportunities for deep value investors.

(Illustration by Teguh Jati Prasetyo)

Over a long period of time, the income of most businesses does relate to net asset value.  Bruce Greenwald, in his book Value Investing (Wiley, 2004), explains the connection.  For most businesses, the best way to estimate intrinsic value is to estimate the reproduction cost of the assets.  And for most businesses—because of competition—earnings power over time will not be more than what is justified by the reproduction cost of the assets.

Only franchise businesses like Coca-Cola—with a sustainable competitive advantage that allows it to earn more than its cost of capital—are going to have normalized earnings that are higher than is justified by the reproduction cost of the assets.

Because most investors view cigar butts as unattractive investments—despite the overwhelming statistical evidence—there are always opportunities for deep value investors.  For instance, when cyclical businesses are at the bottom of the cycle, and current earnings are far below earnings power, investors’ fixation on current earnings can create very cheap stocks.

A key issue is whether the current low income reflects a permanently damaged business or a temporary—or cyclical—decline in profitability.



Although you can make money by buying cheap businesses that are permanently declining, you can usually make more money by buying stocks at cyclical lows.

(Illustration by Prairat Fhunta)


Assuming a low enough entry price, money can be made in both cheap businesses condemned to permanent fundamental decline and businesses that may benefit from mean reversion as their industry moves through the cycle.  We much prefer companies that find themselves at a cyclical low, as they may restore much, if not all, of their earning power, providing multi-bagger upside potential.  Meanwhile, businesses likely to keep declining for a long time have to be extremely cheap and keep returning cash to shareholders to generate a positive investment outcome.

The question of whether a company has entered permanent decline is anything but easy to answer, as virtually all companies appear to be in permanent decline when they hit a rock-bottom market quotation.  Even if a business has been cyclical in the past, analysts generally adopt a ‘this time is different’ attitude.  As a pessimistic stock price inevitably influences the appraisal objectivity of most investors, it becomes exceedingly difficult to form a view strongly opposed to the prevailing consensus.

If you can stay calm and rational while being isolated and looking foolish, then you can buy deeply out of favor cyclical stocks, which often have multi-bagger upside potential.

Example: Ensco plc. (ESV)

A good example of a cyclical stock with multi-bagger potential is Ensco plc., an offshore oil driller.  The Boole Microcap Fund had an investment in Atwood Oceanics, which was acquired by Ensco in 2017.  The Boole Fund continues to hold Ensco because it’s quite cheap—not only compared to book value, but also compared to normalized earnings in the next 3 to 5 years.

Oil companies prefer offshore drillers that are well-capitalized and reliable.  Ensco has one of the best safety records in the industry.  Also, it was rated #1 in customer satisfaction for the eighth consecutive year in the leading independent industry survey.  Moreover, Ensco is one of the best capitalized drillers in the industry, with $2.9 billion in liquidity and only $236 million in debt due before 2024.

Ensco is cheap.  The current price is $7.11, while book value per share is $20.

  • Low case: If oil prices languish below $60 for the next 3 to 5 years, then Ensco will be a survivor due to its large fleet, globally diverse customer base, industry leading customer satisfaction ratings, and well-capitalized position.  Ensco is likely worth at least half of book value ($20 a share), which would be $10 a share, over 40% higher than today’s $7.11.
  • Mid case: If oil prices are in a range of $65 to $85 over the next 3 to 5 years—which is likely based on long-term supply and demand—then Ensco is probably worth at least book value ($20 a share), over 180% higher than today’s $7.11.
  • High case: If oil prices are in a range of $65 to $85 over the next 3 to 5 years—and if global rig utilization normalizes—then Ensco could easily be worth at least 150% of book value, which is $30+ a share, over 320% higher than today’s $7.11.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Walter Schloss: Cigar-Butt Specialist

May 6, 2018

Walter Schloss generated one of the best investment track records of all time—close to 21% (gross) annually over 47 years—by investing exclusively in cigar butts (deep value stocks).  Cigar butt investing usually means buying stock at a discount to book value, i.e., a P/B < 1 (price-to-book ratio below 1).

The highest returning cigar butt strategy comes from Ben Graham, the father of value investing.  It’s called the net-net strategy whereby you take current assets minus all liabilities, and then invest at 2/3 of that level or less.

  • The main trouble with net nets today is that many of them are tiny microcap stocks—below $50 million in market cap—that are too small even for most microcap funds.
  • Also, many net nets exist in markets outside the United States.  Some of these markets have had problems periodically related to the rule of law.

Schloss used net nets in the early part of his career (1955 to 1960).  When net nets became too scarce (1960), Schloss started buying stocks at half of book value.  When those became too scarce, he went to buying stocks at two-thirds of book value.  Eventually he had to adjust again and buy stocks at book value.  Though his cigar-butt method evolved, Schloss was always using a low P/B to find cheap stocks.

(Photo by Sky Sirasitwattana)

One extraordinary aspect to Schloss’s track record is that he invested in roughly 1,000 stocks over the course of his career.  (At any given time, his portfolio had about 100 stocks.)  Warren Buffett commented:

Following a strategy that involved no real risk—defined as permanent loss of capital—Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500.  It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type.  A few big winners did not account for his success.  It’s safe to say that had millions of investment managers made trades by a) drawing stock names from a hat; b) purchasing these stocks in comparable amounts when Walter made a purchase; and then c) selling when Walter sold his pick, the luckiest of them would not have come close to equaling his record. There is simply no possibility that what Walter achieved over 47 years was due to chance.

Schloss was aware that a concentrated portfolio—e.g., 10 to 20 stocks—could generate better long-term returns.  However, this requires unusual insight on a repeated basis, which Schloss humbly admitted he didn’t have.

Most investors are best off investing in low-cost index funds or in quantitative value funds.  For investors who truly enjoy looking for undervalued stocks, Schloss offered this advice:

It is important to know what you like and what you are good at and not worry that someone else can do it better.  If you are honest, hardworking, reasonably intelligent and have good common sense, you can do well in the investment field as long as you are not too greedy and don’t get too emotional when things go against you.

I found a few articles I hadn’t seen before on The Walter Schloss Archive, a great resource page created by Elevation Capital:

Here’s the outline for this blog post:

  • Stock is Part Ownership;  Keep It Simple
  • Have Patience;  Don’t Sell on Bad News
  • Have Courage
  • Buy Assets Not Earnings
  • Buy Based on Cheapness Now, Not Cheapness Later
  • Boeing:  Asset Play
  • Less Downside Means More Upside
  • Multiple Ways to Win
  • History;  Honesty;  Insider Ownership
  • You Must Be Willing to Make Mistakes
  • Don’t Try to Time the Market
  • When to Sell
  • The First 10 Years Are Probably the Worst
  • Stay Informed About Current Events
  • Control Your Emotions;  Be Careful of Leverage
  • Ride Coattails;  Diversify



A share of stock represents part ownership of a business and is not just a piece of paper.

Try to establish the value of the company.  Use book value as a starting point.  There are many businesses, both public and private, for which book value is a reasonable estimate of intrinsic value.  Intrinsic value is what a company is worth—i.e., what a private buyer would pay for it.  Book value—assets minus liabilities—is also called “net worth.”

Follow Buffett’s advice: keep it simple and don’t use higher mathematics.

(Illustration by Ileezhun)

Some kinds of stocks are easier to analyze than others.  As Buffett has said, usually you don’t get paid for degree of difficulty in investing.  Therefore, stay focused on businesses that you can fully understand.

  • There are thousands of microcap companies that are completed neglected by most professional investors.  Many of these small businesses are simple and easy to understand.



Hold for 3 to 5 years.  Schloss:

Have patience.  Stocks don’t go up immediately.

Schloss again:

Things usually take longer to work out but they work out better than you expect.

(Illustration by Marek)

Don’t sell on bad news unless intrinsic value has dropped materially.  When the stock drops significantly, buy more as long as the investment thesis is intact.

Schloss’s average holding period was 4 years.  It was less than 4 years in good markets when stocks went up more than usual.  It was greater than 4 years in bad markets when stocks stayed flat or went down more than usual.



Have the courage of your convictions once you have made a decision.

(Courage concept by Travelling-light)

Investors shun companies with depressed earnings and cash flows.  It’s painful to own stocks that are widely hated.  It can also be frightening.  As John Mihaljevic explains in The Manual of Ideas (Wiley, 2013):

Playing into the psychological discomfort of Graham-style equities is the tendency of such investments to exhibit strong asset value but inferior earnings or cash flows.  In a stressed situation, investors may doubt their investment theses to such an extent that they disregard the objectively appraised asset values.  After all—the reasoning of a scared investor might go—what is an asset really worth if it produces no cash flow?

A related worry is that if a company is burning through its cash, it will gradually destroy net asset value.  Ben Graham:

If the profits had been increasing steadily it is obvious that the shares would not sell at so low a price.  The objection to buying these issues lies in the probability, or at least the possibility, that earnings will decline or losses continue, and that the resources will be dissipated and the intrinsic value ultimately become less than the price paid.

It’s true that an individual cigar butt (deep value stock) is more likely to underperform than an average stock.  But because the potential upside for a typical cigar butt is greater than the potential downside, a basket of cigar butts (portfolio of at least 30) does better than the market over time and also has less downside during bad states of the world—such as bear markets and recessions.

Schloss discussed an example: Cleveland Cliffs, an iron ore producer.  Buffett owned the stock at $18 but then sold at about that level.  The steel industry went into decline.  The largest shareholder sold out because he thought the industry wouldn’t recover.

Schloss bought a lot of stock at $6.  Nobody wanted it.  There was talk of bankruptcy.  Schloss noted that if he had lived in Cleveland, he probably wouldn’t have been able to buy the stock because all the bad news would have been too close.

Soon thereafter, the company sold some assets and bought back some stock.  After the stock increased a great deal from the lows, then it started getting attention from analysts.

In sum, often when an industry is doing terribly, that’s the best time to find cheap stocks.  Investors avoid stocks when they’re having problems, which is why they get so cheap.  Investors overreact to negative news.



(Illustration by Teguh Jati Prasetyo)


Try to buy assets at a discount [rather] than to buy earnings.  Earnings can change dramatically in a short time.  Usually assets change slowly.  One has to know much more about a company if one buys earnings.

Not only can earnings change dramatically; earnings can easily be manipulated—often legally.  Schloss:

Ben made the point in one of his articles that if U.S. Steel wrote down their plants to a dollar, they would show very large earnings because they would not have to depreciate them anymore.



Buy things based on cheapness now.  Don’t buy based on cheapness relative to future earnings, which are hard to predict.

Graham developed two ways of estimating intrinsic value that don’t depend on predicting the future:

  • Net asset value
  • Current and past earnings

Professor Bruce Greenwald, in Value Investing (Wiley, 2004), has expanded on these two approaches.

  • As Greenwald explains, book value is a good estimate of intrinsic value if book value is close to the replacement cost of the assets.  The true economic value of the assets is the cost of reproducing them at current prices.
  • Another way to determine intrinsic value is to figure out earnings power—also called normalized earnings—or how much the company should earn on average over the business cycle.  Earnings power typically corresponds to a market level return on the reproduction value of the assets.  In this case, your intrinsic value estimate based on normalized earnings should equal your intrinsic value estimate based on the reproduction value of the assets.

In some cases, earnings power may exceed a market level return on the reproduction value of the assets.  This means that the ROIC (return on invested capital) exceeds the cost of capital.  It can be exceedingly difficult, however, to determine by how much and for how long earnings power will exceed a market level return.  Often it’s a question of how long some competitive advantage can be maintained.  How long can a high ROIC be sustained?

As Buffett remarked:

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.  The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

A moat is a sustainable competitive advantage.  Schloss readily admits he can’t determine which competitive advantages are sustainable.  That requires unusual insight.  Buffett can do it, but very few investors can.

As far as franchises or good businesses—companies worth more than adjusted book value—Schloss says he likes these companies, but rarely considers buying them unless the stock is close to book value.  As a result, Schloss usually buys mediocre and bad businesses at book value or below.  Schloss buys “difficult businesses” at clearly cheap prices.

Buying a high-growing company on the expectation that growth will continue can be quite dangerous.  First, growth only creates value if the ROIC exceeds the cost of capital.  Second, expectations for the typical growth stock are so high that even a small slowdown can cause the stock to drop noticeably.  Schloss:

If observers are expecting the earnings to grow from $1.00 to $1.50 to $2.00 and then $2.50, an earnings disappointment can knock a $40 stock down to $20.  You can lose half your money just because the earnings fell out of bed.

If you buy a debt-free stock with a $15 book selling at $10, it can go down to $8.  It’s not great, but it’s not terrible either.  On the other hand, if things turn around, that stock can sell at $25 if it develops its earnings.

Basically, we like protection on the downside.  A $10 stock with a $15 book can offer pretty good protection.  By using book value as a parameter, we can protect ourselves on the downside and not get hurt too badly.

Also, I think the person who buys earnings has got to follow it all the darn time.  They’re constantly driven by earnings, they’re driven by timing.  I’m amazed.



(Boeing 377 Stratocruiser, San Diego Air & Space Museum Archives, via Wikimedia Commons)

Cigar butts—deep value stocks—are characterized by two things:

  • Poor past performance;
  • Low expectations for future performance, i.e., low multiples (low P/B, low P/E, etc.)

Schloss has pointed out that Graham would often compare two companies.  Here’s an example:

One was a very popular company with a book value of $10 selling at $45.  The second was exactly the reverse—it had a book value of $40 and was selling for $25.

In fact, it was exactly the same company, Boeing, in two very different periods of time.  In 1939, Boeing was selling at $45 with a book of $10 and earning very little.  But the outlook was great.  In 1947, after World War II, investors saw no future for Boeing, thinking no one was going to buy all these airplanes.

If you’d bought Boeing in 1939 at $45, you would have done rather badly.  But if you’d bought Boeing in 1947 when the outlook was bad, you would have done very well.

Because a cigar butt is defined by poor recent performance and low expectations, there can be a great deal of upside if performance improves.  For instance, if a stock is at a P/E (price-to-earnings ratio) of 5 and if earnings are 33% of normal, then if earnings return to normal and if the P/E moves to 15, you’ll make 900% on your investment.  If the initial purchase is below true book value—based on the replacement cost of the assets—then you have downside protection in case earnings don’t recover.



If you buy stocks that are protected on the downside, the upside takes care of itself.

The main way to get protection on the downside is by paying a low price relative to book value.  If in addition to quantitative cheapness you focus on companies with low debt, that adds additional downside protection.

If the stock is well below probable intrinsic value, then you should buy more on the way down.  The lower the price relative to intrinsic value, the less downside and the more upside.  As risk decreases, potential return increases.  This is the opposite of what modern finance theory teaches.  According to theory, your expected return only increases if your risk also increases.

In The Superinvestors of Graham-and-Doddsville, Warren Buffett discusses the relationship between risk and reward.  Sometimes risk and reward are positively correlated.  Buffett gives the example of Russian roulette.  Suppose a gun contains one cartridge and someone offers to pay you $1 million if you pull the trigger once and survive.  Say you decline the bet as too risky, but then the person offers to pay you $5 million if you pull the trigger twice and survive.  Clearly that would be a positive correlation between risk and reward.  Buffett continues:

The exact opposite is true with value investing.  If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case.  The greater the potential for reward in the value portfolio, the less risk there is.

One quick example:  The Washington Post Company in 1973 was selling for $80 million in the market.  At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more.  The company owned the Post, Newsweek, plus several television stations in major markets.  Those same properties are worth $2 billion now, so the person who would have paid $400 million would not have been crazy.

Now, if the stock had declined even further to a price that made the valuation $40 million instead of $80 million, its beta would have been greater.  And to people that think beta measures risk, the cheaper price would have made it look riskier.  This is truly Alice in Wonderland.  I have never been able to figure out why it’s riskier to buy $400 million worth of properties for $40 million than $80 million.


Most brokers don’t recommend buying more on the way down because most people (including brokers’ clients) don’t like to buy when the price keeps falling.  In other words, most investors focus on price instead of intrinsic value.



A stock trading at a low price relative to book value—a low P/B stock—is usually distressed and is experiencing problems.  But there are several ways for a cigar-butt investor to win, as Schloss explains:

The thing about buying depressed stocks is that you really have three strings to your bow:  1) Earnings will improve and the stocks will go up;  2) somebody will come in and buy control of the company;  or 3) the company will start buying its own stock and ask for tenders.

Schloss again:

But lots of times when you buy a cheap stock for one reason, that reason doesn’t pan out but another reason does—because it’s cheap.



Look at the history of the company.  Value line is helpful for looking at history 10-15 years back.  Also, read the annual reports.  Learn about the ownership, what the company has done, when business they’re in, and what’s happened with dividends, sales, earnings, etc.

It’s usually better not to talk with management because it’s easy to be blinded by their charisma or sales skill:

When we buy into a company that has problems, we find it difficult talking to management as they tend to be optimistic.

That said, try to ensure that management is honest.  Honesty is more important than brilliance, says Schloss:

…we try to get in with people we feel are honest.  That doesn’t mean they’re necessarily smart—they may be dumb.

But in a choice between a smart guy with a bad reputation or a dumb guy, I think I’d go with the dumb guy who’s honest.

Finally, insider ownership is important.  Management should own a fair amount of stock, which helps to align their incentives with the interests of the stockholders.

Speaking of insider ownership, Walter and Edwin Schloss had a good chunk of their own money invested in the fund they managed.  You should prefer investment managers who, like the Schlosses, eat their own cooking.



(Illustration by Lkeskinen0)

You have to be willing to make mistakes if you want to succeed as an investor.  Even the best value investors tend to be right about 60% of the time and wrong 40% of the time.  That’s the nature of the game.

You can’t do well unless you accept that you’ll make plenty of mistakes.  The key, again, is to try to limit your downside by buying well below probable intrinsic value.  The lower the price you pay (relative to estimated intrinsic value), the less you can lose when you’re wrong and the more you can make when you’re right.



No one can predict the stock market.  Ben Graham observed:

If I have noticed anything over these sixty years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.

(Illustration by Maxim Popov)

Or as value investor Seth Klarman has put it:

In reality, no one knows what the market will do; trying to predict it is a waste of time, and investing based upon that prediction is a speculative undertaking.

Perhaps the best quote comes from Henry Singleton, a business genius (100 points from being a chess grandmaster) who was easily one of the best capital allocators in American business history:

I don’t believe all this nonsense about market timing.  Just buy very good value and when the market is ready that value will be recognized.

Singleton built Teledyne using extraordinary capital allocation skills over the course of more than three decades, from 1960 to the early 1990’s.  Fourteen of these years—1968 to 1982—were a secular bear market during which stocks were relatively flat and also experienced a few large downward moves (especially 1973-1974).  But this long flat period punctuated by bear markets didn’t slow down or change Singleton’s approach.  Because he consistently bought very good value, on the whole his acquisitions grew significantly in worth over time regardless of whether the broader market was down, flat, or up.

Of course, it’s true that if you buy an undervalued stock and then there’s a bear market, it may take longer for your investment to work.  However, bear markets create many bargains.  As long as you maintain a focus on the next 3 to 5 years, bear markets are wonderful times to buy cheap stocks (including more of what you already own).

In 1955, Buffett was advised by his two heroes, his father and Ben Graham, not to start a career in investing because the market was too high.  Similarly, Graham told Schloss in 1955 that it wasn’t a good time to start.

Both Buffett and Schloss ignored the advice.  In hindsight, both Buffett and Schloss made great decisions.  Of course, Singleton would have made the same decision as Buffett and Schloss.  Even if the market is high, there are invariably individual stocks hidden somewhere that are cheap.

Schloss always remained fully invested because he knew that virtually no one can time the market except by luck.



Don’t be in too much of a hurry to sell… Before selling try to reevaluate the company again and see where the stock sells in relation to its book value.

Selling is hard.  Schloss readily admits that many stocks he sold later increased a great deal.  But he doesn’t dwell on that.

The basic criterion for selling is whether the stock price is close to estimated intrinsic value.  For a cigar butt investor like Schloss, if he paid a price that was half book, then if the stock price approaches book value, it’s probably time to start selling.  (Unless it’s a rare stock that is clearly worth more than book value, assuming the investor was able to buy it low in the first place.)

If stock A is cheaper than stock B, some value investors will sell A and buy B.  Schloss doesn’t do that.  It often takes four years for one of Schloss’s investments to work.  If he already has been waiting for 1-3 years with stock A, he is not inclined to switch out of it because he might have to wait another 1-3 years before stock B starts to move.  Also, it’s very difficult to compare the relative cheapness of stocks in different industries.

Instead, Schloss makes an independent buy or sell decision for every stock.  If B is cheap, Schloss simply buys B without selling anything else.  If A is no longer cheap, Schloss sells A without buying anything else.



John Templeton’s worst ten years as an investor were his first ten years.  The same was true for Schloss, who commented that it takes about ten years to get the hang of value investing.



(Photo by Juan Moyano)

Walter Schloss and his son Edwin sometimes would spend a whole day discussing current events, social trends, etc.  Edwin Schloss said:

If you’re not in touch with what’s going on or you don’t see what’s going on around you, you can miss out on a lot of investment opportunities. So we try to be aware of everything around us—like John Templeton says in his book about being open to new ideas and new experiences.



Try not to let your emotions affect your judgment.  Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.

Quantitative investing is a good way to control emotion.  This is what Graham suggested and practiced.  Graham just looked at the numbers to make sure they were below some threshold—like 2/3 of current assets minus all liabilities (the net-net method).  Graham typically was not interested in what the business did.

On the topic of discipline and controlling your emotions, Schloss told a great story about when Warren Buffett was playing golf with some buddies:

One of them proposed, “Warren, if you shoot a hole-in-one on this 18-hole course, we’ll give you $10,000 bucks.  If you don’t shoot a hole-in-one, you owe us $10.”

Warren thought about it and said, “I’m not taking the bet.”

The others said, “Why don’t you?  The most you can lose is $10. You can make $10,000.”

Warren replied, If you’re not disciplined in the little things, you won’t be disciplined in the big things.”

Be careful of leverage.  It can go against you.  Schloss acknowledges that sometimes he has gotten too greedy by buying highly leveraged stocks because they seemed really cheap.  Companies with high leverage can occasionally become especially cheap compared to book value.  But often the risk of bankruptcy is too high.

Still, as conservative value investor Seth Klarman has remarked, there’s room in the portfolio occasionally for a super cheap, highly indebted company.  If the probability of success is high enough, it may not be a difficult decision.  If you pick the right one, you can make 10 times your money.



Sometimes you can get good ideas from other investors you know or respect.  Even Buffett did this.  Buffett called it “coattail riding.”

Schloss, like Graham and Buffett, recommends a diversified approach if you’re doing cigar butt (deep value) investing.  Have at least 15-20 stocks in your portfolio.  A few investors can do better by being more concentrated.  But most investors will do better over time by using a quantitative, diversified approach.

Schloss tended to have about 100 stocks in his portfolio:

…And my argument was, and I made it to Warren, we can’t project the earnings of these companies, they’re secondary companies, but somewhere along the line some of them will work out.  Now I can’t tell you which ones, so I buy a hundred of them.  Of course, it doesn’t mean you own the same amount of each stock.  If we like a stock we put more money in it.  Positions we are less sure about we put less in… We then buy the stock on the way down and try to sell it on the way up.

Even though Schloss was quite diversified, he still took larger positions in the stocks he liked best and smaller positions in the stocks about which he was less sure.

Schloss emphasized that it’s important to know what you know and what you don’t know.  Warren Buffett and Charlie Munger call this a circle of competence.  Even if a value investor is far from being the smartest, there are hundreds of microcap companies that are easy to understand with enough work.

(Image by Wilma64)

The main trouble in investing is overconfidence: having more confidence than is warranted by the evidence.  Overconfidence is arguably the most widespread cognitive bias suffered by humans, as Nobel Laureate Daniel Kahneman details in Thinking, Fast and Slow.  By humbly defining your circle of competence, you can limit the impact of overconfidence.  Part of this humility comes from making mistakes.

The best choice for most investors is either an index fund or a quantitative value fund.  It’s the best bet for getting solid long-term returns, while minimizing or removing entirely the negative influence of overconfidence.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:


Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

University of Berkshire Hathaway

(Image:  Zen Buddha Silence by Marilyn Barbone.)

April 22, 2018

Daniel Pecaut and Corey Wrenn recently published a wonderful book, University of Berkshire Hathaway.  The book is a summary of 30 years’ worth of teachings delivered by Warren Buffett and Charlie Munger at the annual meetings of Berkshire Hathaway (1986 through 2015).

Pecaut and Wrenn had the same idea that many value investors have had:  To figure out how to succeed as a value investor, it makes sense to study the best.  Warren Buffett and Charlie Munger are at the top of the list.

(Photo by USA International Trade Administration, via Wikimedia Commons)

Through 2017, after 52 years under Buffett and Munger’s management, the value of Berkshire Hathaway has grown 2,404,748% versus 15,508% for the S&P 500 Index.  Compounded annually, that’s 20.9% per year for Berkshire stock versus 9.9% per year for the S&P 500.

(Photo by Nick Webb)

Pecaut and Wrenn point out a key fact about how Buffett and Munger have achieved this stunning success:

More than two-thirds of Berkshire’s performance over the S&P was earned during down years.  This is the fruit of Buffett and Munger’s “Don’t lose” philosophy.  It’s the losing ideas avoided, as much as the money made in bull markets that has built Berkshire’s superior wealth over the long run.

Buffett himself has made the same point, including at the 2007 meeting.  His best ideas have not outperformed the best ideas of other great value investors.  However, his worst ideas have not been as bad, and have lost less over time, as compared with the worst ideas of other top value investors.

Pecaut then states:

Though Corey and I have been aware of the results for a number of years, we still marvel at Buffett and Munger’s marvelous achievement.  They have presided over one of the greatest records of wealth-building in history.  For five decades, money under Buffett’s control has grown at a phenomenal rate.

In the 1970s, the annual meeting of Berkshire Hathaway was attended by a half-dozen people or so.  In recent years, there have been roughly 40,000 attendees.  The event has been dubbed “Woodstock for Capitalists.”

(2011 Berkshire Hathaway Annual Meeting, Photo by timbu, licensed under CC BY 2.0)

Pecaut and Wrenn write that studying the teachings of Professors Buffett and Munger can be as good as an MBA if you’re a value investor.  They declare:

It is, without a shadow of a doubt, the best investment either of us has ever made.

That’s not to say there are any easy answers if you want to become a good value investor.  It takes many years to master the art.  And even after you’ve found an investment strategy that fits you personally, you must keep learning and improving forever.

There are two important points to make immediately.  First, it’s a statistical fact that most of us will do better over time by adopting a fully automated investment strategy — whether indexed or quantitative.

Second, whether you use an automated strategy or not, if you’re investing relatively small sums, you are likely to do best by focusing on micro caps (companies with market caps under $300 million).  Most great value investors, including Buffett and Munger, started their careers investing in micro caps.  In general, you can get the best returns by investing in micro caps because they are largely neglected by investors.  Also, most microcap businesses are tiny and thus easier to understand.

Although Pecaut and Wrenn’s book is organized by year, I’ve re-arranged the teachings of Buffett and Munger based on topic.  Here’s the outline:

Value Investing

  • Value Investing
  • What vs. When
  • Temperament and Discipline
  • Modern Portfolio Theory
  • Growth, Book Value
  • Business Risk
  • Good Managers
  • Sustainable Competitive Advantage
  • Know the Big Cost
  • Basic “Macro Thesis”
  • Macro Forecasting
  • Capital-Intensive Businesses
  • Cyclical Industries

Thinking for Yourself

  • Logic, Not Emotion
  • Intellectual Independence
  • In/Out/Too Hard
  • Information:  Good, Not Quick

Lifetime Learning

  • Lifetime Learning and Constructive Criticism
  • Invest in Yourself
  • Making It In Business
  • Multidisciplinary Models, Opportunity Cost
  • Biographies:  Improve Your Friends

What is Berkshire Hathaway?

  • Berkshire Hathaway
  • Berkshire:  Good Home for Good Businesses
  • No Master Plan
  • Culture
  • Munger’s Optimism
  • Legacy


  • Buying National Indemnity
  • Insurance and Hurricanes
  • Building the Insurance Business
  • The Unexpected

Comments on Specific Investments

  • BYD
  • 3G Capital Partners

Other Topics

  • The Game of Bridge
  • The Ovarian Lottery
  • Predicting Changes in Technology
  • Inflation:  Gold vs. Wonderful Business
  • Luck and an Open Mind
  • The Luckiest Crop in History


Value Investing


Here’s a summary of the basic concepts of value investing.  The intrinsic value of any business is the total cash that will be generated by the business in the future, discounted back to the present.  Another way to think of intrinsic value is “what a company would bring if sold to a knowledgeable buyer.”

Typically, if a value investor thinks a business is worth X, they will try to buy it at 1/2 X.  This creates a margin of safety in case the investor has made a mistake or experiences bad luck.  If the investor is roughly correct, they can double their money or better.

(Ben Graham, the father of value investing and Warren Buffett’s teacher and mentor, Equim43 via Wikimedia Commons)

Many good value investors are right 60% of the time and wrong 40% of the time.  Mistakes and surprises (both good and bad) are inevitable for every investor.  That’s why a margin of safety is essential.

Another wrinkle is business quality.  When Buffett and Munger started their careers, they followed the teachings of Ben Graham.  In Graham’s approach, business quality doesn’t matter as long as you buy a basket of cheap stocks.  However, Buffett and Munger slowly learned from experience the following lesson:

It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

If you buy a mediocre or bad business at half price, the problem is that the intrinsic value of the business can decline.  On the other hand, if you buy a great business, it’s often hard to overpay because the value compounds over time.

A great business is one that has a high return on invested capital (ROIC) — and high return on equity (ROE) — that can be sustained, ideally for decades.  If you pay a fair or even high price, but hold the business for decades, then your annual return eventually will approximate the ROE of the business.

  • Say a business has an ROE of 40% and can sustain it over time.  Then your annual return as investor, if you hold the stock over decades, eventually will approximate 40%.  That’s the power of investing in a high-quality business.
  • But such a great business is exceedingly rare and hard to find.  Tread very carefully.  The vast majority of investors are unable to invest successfully using this method.

Also bear in mind that Buffett and Munger have never paid any attention to forecasts, whether of the economy, interest rates, the stock market, or elections.  When they’ve been able to find a good or great business at a reasonable price, they’ve always bought, regardless of forecasts and regardless of the current economic or political situation.

  • Most investors who’ve paid attention to forecasts have done worse than they would have done had they simply ignored forecasts.
  • Buffett and Munger focus exclusively on the future cash flow of the individual business as compared to its current price.  Typically they assume the future cash flow will occur over decades.  Thus, shorter term forecasts of the stock market or the economy are irrelevant, in addition to being fundamentally unreliable (see Macro Forecasting below).

Central to this approach is circle of competence, or a clear awareness of which businesses you can understand.  It doesn’t matter if most businesses are beyond your ability to analyze as long as you stick with those businesses than you can analyze.

  • Even if you were only able to understand 100-200 simple businesses, eventually a few of them will become cheap for temporary reasons.  That’s all you need.  Getting to that point may take a few years, though, so it’s essential that you enjoy the process.  Otherwise, just stick with index funds or quantitative value funds.

For a value investor, there are no called strikes.  As Buffett has explained, you can stand at the plate all day and watch hundreds of “pitches” — businesses at specific prices — without taking a swing.  You wait for the “fat pitch” — a business you can really understand that’s available at a good price.

What’s the ideal business?  One that has a high and sustainable ROIC (and ROE).  Or, as Buffett put it at the 1987 Berkshire meeting:

Something that costs a penny, sells for a dollar and is habit forming.

Moreover, a company with a sustainably high ROIC is the best hedge against inflation over time, according to Buffett and Munger.  But it’s very difficult to find businesses like this.  There just aren’t that many.  And since Buffett and Munger have to invest tens of billions of dollars a year — unlike earlier in their careers — they’re forced to focus mostly on larger businesses.

At the 1996 meeting, Buffett observed that they invested in high-quality businesses that were easy to understand and not likely to change much.  Specifically, they had investments in soft drinks, candy, shaving, and chewing gum.  Buffett:

There’s not a whole lot of technology going into the art of the chew.



Buffett and Munger have observed that having the right temperament and extraordinary discipline is far more important than IQ for long-term success in investing.  (Of course, if you’ve got the right temperament plus a great deal of discipline, high IQ certainly helps.)

High IQ alone won’t bring success in investing.  Buffett said at the 2004 meeting that Sir Isaac Newton, one of the smartest people in history, wasted much time trying to turn lead into gold and also lost a bundle in the South Sea Bubble.



Buffett and Munger have been critical of modern portfolio theory for a long time.  Munger often notes that to a man with a hammer, every problem looks pretty much like a nail.  Buffett has observed that academics have been able to gather huge amounts of data on past stock prices.  When there’s so much data, it’s often easy to find patterns.  Also, those who have been trained in higher mathematics sometimes feel the need to apply that skill even to areas that are better understood in very simple terms.  Buffett:

The business schools reward difficult, complex behavior more than simple behavior, but simple behavior is more effective.

A key part of modern portfolio theory is EMH — the Efficient Market Hypothesis.  EMH takes different forms.  But essentially it says that all available information is already reflected in stock prices.  Therefore, it’s not possible for any investor to beat the market except by luck.

Buffett and Munger have maintained that markets are usually efficient, but not always.  If an investor has enough patience and diligence, occasionally she will discover certain stock prices that are far away from intrinsic value.

Moreover, a stock is not just a price that wiggles around.  A stock represents fractional ownership in the underlying business.  Some businesses are simple enough to be understandable.  The dedicated investor can gain enough understanding of certain businesses so that she can know if the stock price is obviously too high or too low.  Modern portfolio theorists have overlooked the fact that a stock represents fractional ownership of a business.

Buffett advises thinking about buying part ownership of a business like you would think about buying a farm.  You’d want to look at how much it produces on average and how much you’d be willing to pay for that.  Only then would you look at the current price.

(Farmland at Moss Landing, California, Photo by Fastily via Wikimedia Commons)

Furthermore, if you owned a farm, you wouldn’t consider selling just because a farm nearby was sold for a lower-than-expected price.  In Chapter 12 of The General Theory of Employment, Interest, and Money, John Maynard Keynes uses a similar example:

But the Stock Exchange revalues many investments every day and the revaluations give a frequent opportunity to the individual (though not to the community as a whole) to revise his commitments.  It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and reconsider whether he should return to it later in the week.



Growth only creates value if the company has a return on invested capital (ROIC) that is higher than the cost of capital.

Also, if a company has a sustainably high ROIC and ROE, then book value is not an important factor in the investment decision.  Book value, Buffett said, is what was put into the business in the past.  What matters is how much cash you can take out of the business in the future.  If the company is high quality — with a sustainably high ROIC and ROE — then it’s hard to pay too high a price if you’re going to hold it for decades.  (In the 1990’s, Buffett and Munger noted that the average ROE for American businesses was about 12-13%.)

However, it’s exceptionally difficult to identify a business that will maintain a high ROIC and ROE for a couple of decades or more.  Buffett and Munger have been able to do it because they are seriously smart and they are learning machines who’ve constantly evolved.  Most investors simply cannot beat the market, regardless of their method.  Most investors would be better off investing in a low-cost index fund or in a quantitative value fund.



(Photo by Alain Lacroix)

At the 1997 meeting, Buffett identified three key business risks.  First, in general, a company with high debt is at risk of bankruptcy.  A good recent example of this is Seadrill Ltd. (NYSE: SDRL).  This company was an industry leader that was started by billionaire John Fredriksen (who started out in shipping, which he continues to do).  Seadrill is an excellent company, but it’s now in serious trouble because of its high debt levels.  Fredriksen has been forced to launch a new offshore drilling company.

The second business risk Buffett mentioned is capital intensity.  The ideal business has a sustainably high ROE and low capital requirements.  That doesn’t necessarily mean that a capital-intensive business can’t be a good investment.  For instance, Berkshire recently acquired the railroad BNSF.  The ROE obviously isn’t nearly as high as that of a company like See’s Candies.  But it’s a solid investment for Berkshire.

  • As Buffett and Munger have explained, if the ROE on a regulated business is 11-12%, but part of Berkshire’s capital is insurance float that costs 3% or less, that’s obviously a good situation because the return on capital exceeds the cost by at least 8-9% per year.  In some years, Berkshire’s insurance float has even had a negative cost, meaning that Berkshire has been paid to hold it.

A third business risk is being in a commodity business.  Because a true commodity business — like an oil producer — has no control over price, it must be a low-cost producer to be a good investment.



Buffett and Munger have explained that they look for .400 hitters in the business world.  Buffett says when he finds one, and can buy the business at a reasonable price while keeping the manager in place, he is thrilled.  He doesn’t then try to tell the .400 hitter how to swing.  Instead, he lets the star continue to run the business as before.

Buffett has also commented that it’s quite difficult to pay a .400 hitter too much.  A great manager can make a world of difference for a business.  For instance, when Robert Goizueta took over Coca-Cola in 1981, its market value was $4 billion.  As of 1997, Buffett remarked, the market value exceeded $150 billion.

Using another analogy, Buffett has said that he loves painting his own canvas and getting applause for it.  So he looks for managers who are wired the same way.  He gives them the freedom to continue to paint their own paintings.  Also, they don’t have to talk with shareholders, lawyers, reporters, etc.



Buffett and Munger look for companies that have a sustainably high ROIC (and ROE).  To maintain a high ROIC (and ROE) requires a sustainable competitive advantage.  Buffett:

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.

Buffett and Munger have also used the term moat.  In 1995, Munger said the ideal business is a terrific castle with an honest lord.  The moat is a barrier to competition and can take many forms including low costs, patents, trademarks, technology, or advantages of scale.

(Bodiam Castle in England, Photo by Allen Watkin, via Wikimedia Commons)

A sustainable competitive advantage — a moat — is very rare.  The essence of capitalism is that high returns get competed away.  Generally if a company is experiencing a high ROIC, competitors will enter the market and drive the ROIC down toward the cost of capital.

  • ROIC (return on invested capital) is a more accurate measure of how the business is doing than ROE (return on equity).  Buffett uses return on net tangible assets, which is ROIC.
  • But ROE is close to ROIC for companies with low or no debt, which are the types of companies Berkshire usually prefers.
  • Also, ROE is a bit more intuitive when you’re thinking about the advantages of holding a high-quality business for decades.  In this situation, your returns as an investor will approximate the ROE over time.

When you buy a great business with a sustainably high ROIC, you typically only have to be smart once, says Buffett.  But if it’s a mediocre business, you have to stay smart.

Buffett has also observed that paying a high price for a great business is rarely a mistake.



A superior cost structure is often central to a company’s competitive advantage.  Buffett said in 2001 that he doesn’t care whether the business is raw-material-intensive, people-intensive, or capital-intensive.  What matters is that the business must have a sustainable competitive advantage whereby a relatively high ROIC and ROE can be maintained.

ROIC must stay above the cost of capital.  A superior cost structure is a common way to help achieve this.



The only long-term macro thesis Buffett has is that America will continue to do well and grow over time.  Buffett often points out that in the 20th century, there were wars, a depression, epidemics, recessions, etc., but the Dow went from 66 to 11,000 and GDP per capita increased sixfold.

As long as you believe GDP per capita will continue to increase, even if a bit more slowly, then you want to buy (and hold) good businesses.  For most investors, you should simply buy (and hold) either a quantitative value fund or a low-cost broad market index fund.

Another way Buffett has put it: In 1790, there were four million people in America, 290 million in China, and 100 million in Europe.  But 215 years later — as of 2005 — America has 30% of the world’s GDP.  It’s an unbelievable success story.



Looking historically, there are virtually no top investors or business people who have done well from macro forecasting — which includes trying to predict the stock market, the economy, interest rates, or elections.  As for those investors who have done well from macro forecasting, luck played a key role in most cases.

Warren Buffett puts it best:

  • Charlie and I never have an opinion on the market because it wouldn’t be any good and it might interfere with the opinions we have that are good.
  • We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.
  • Market forecasters will fill your ear but never fill your wallet.
  • Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.
  • Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.
  • [On economic forecasts:] Why spend time talking about something you don’t know anything about?  People do it all the time, but why do it?
  • I don’t invest a dime based on macro forecasts.

Consider efforts to forecast what the stock market will do in any given year.  There have always been pundits making such predictions, but no one has been able to do it correctly with any sort of consistency.

(Illustration by Maxim Popov)

Furthermore, if you simply focus on individual businesses, as Buffett and Munger advise and have always done, then what happens to the overall stock market doesn’t matter.  Bear markets occur periodically, but their timing is unpredictable.  Also, even in a bear market, some stocks decline less than the market and some stocks even go up.  If you’re focused on individual businesses, then the only “macro” thesis you need is that the U.S. and global economy will continue to grow over time.

Virtually every top investor and business person has done well by being heavily invested in businesses (often only a few).  As Buffett and Munger have repeatedly observed, understanding a business is achievable, while forecasting the stock market is not.

Indeed, when Buffett started his career as an investor, both Graham and his father told him the Dow was too high.  Buffett had about $10,000.  Buffett has commented since then that if he had listened to Graham and his father, he would still probably have about $10,000.

Now, every year there are “pundits” who make predictions about the stock market.  Therefore, as a matter of pure chance, there will always be people in any given year who are “right.”  But there’s zero evidence that any of those who were “right” at some point in the past have been correct with any sort of reliability.  In other words, the fact that certain pundits turned out to be right during one period tells you virtually nothing about which pundits will turn out to be right in some future period.

There are always naysayers making bearish predictions.  But anyone who owned an S&P 500 index fund from 2007 to present (early 2018) would have done dramatically better than most of those who listened to naysayers.  Buffett:

Ever-present naysayers may prosper by marketing their gloomy forecasts.  But heaven help them if they act on the nonsense they peddle.

Consider Buffett’s recent 10-year bet on index funds versus hedge funds.

Buffett chose a very low-cost Vanguard 500 index fund.  Protégé Partners, Buffett’s counterparty to the bet, selected the five best “funds-of-hedge funds” that it could.  As a group, those funds-of-hedge funds invested in over 200 hedge funds.  Buffett writes in the 2017 annual letter:

Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund.  This assemblage was an elite crew, loaded with brains, adrenaline, and confidence.

Here are the results of the 10-year bet:

Net return after 10 years
Fund of Funds A 21.7%
Fund of Funds B 42.3%
Fund of Funds C 87.7%
Fund of Funds D 2.8%
Fund of Funds E 27.0%
S&P 500 Index Fund 125.8%


Compound Annual Return
Fund of Funds A 2.0%
Fund of Funds B 3.6%
Fund of Funds C 6.5%
Fund of Funds D 0.3%
Fund of Funds E 2.4%
S&P 500 Index Fund 8.5%

To see a more detailed table of the results, go to page 12 of the Berkshire 2017 Letter:

Many forecasters (including many investors) have predicted, starting in 2012 or 2013 and continuing up until today (April 2018), that the S&P 500 Index was going to be far lower.  One reason the hedge funds involved in Buffett’s bet didn’t do well at all, as a group, is because many of them were hedged against a possible market decline.

  • The timing of bear markets is unpredictable.  Also, the stock market has recovered from every decline and has eventually gone on to new highs.  (As long as humans keep making progress in technology and in other areas, the stock market will keep increasing over the long term.)  For these reasons, it virtually never pays to hedge against market declines.
  • Most of those who successfully hedged against the bear market in 2008 missed the recovery starting in 2009.  Said differently, most of those who “successfully” (mostly by luck) hedged against the bear market in 2008 would have been at least as well off if they’d stayed fully invested without hedging.

Virtually no one predicted 2800+ on the S&P 500, which again shows that forecasting the stock market is just not doable on a repeated basis.

  • Even at 2800+, the S&P 500 Index may not be significantly overvalued because interest rates are low and profit margins are structurally higher, as Professor Bruce Greenwald of Columbia University suggested in this Barron’s interview:
  • The largest companies include Apple, Alphabet (Google), Microsoft, Amazon, and Facebook, most of which have far higher normalized profit margins and ROE than the vast majority of large companies in history.  Software and related technologies are becoming much more important in the world economy.
  • Moreover, progress in computer science or in other technologies could accelerate.  For instance, a big breakthrough in artificial intelligence could conceivably boost GDP by 5-10% or more.  Historically, it’s never paid to bet against progress, especially technological progress.



In 1994, Munger commented that figuring out the future of an individual business is much more doable — and repeatable — than trying to make a macro forecast — which can’t be done repeatedly.  Munger:

To think about what will happen versus when is a far more efficient way to behave.



In 2010, Buffett discussed Berkshire’s recent investment in capital-intensive businesses.  He noted that for most of its history under current management, Berkshire tried to invest in high ROIC (and ROE) businesses that don’t require much capital, with See’s Candies being the best example.  However, due to its many successful investments, Buffett has had torrents of cash coming to headquarters for many years now.

There simply are not many businesses like See’s, and besides, as Berkshire gets larger, Buffett would need to find hundreds of companies like See’s in order to move the needle.

Buffett started investing in MidAmerican Energy in 1999.  Buffett learned that a regulated, capital-intensive business like this could earn decent returns of 11-12%.  Not brilliant and nothing like See’s.  But still decent, with ROIC above the cost of capital.

Based on his experience with MidAmerican Energy, Buffett reached the decision to acquire Burlington Northern Santa Fe (BNSF) for Berkshire.  Again, a capital-intensive, regulated business, but with a strong competitive position and with decent returns on capital.

(BNSF, Photo by Winnie Chao)

Also remember that Berkshire’s insurance float continues to have low cost — often 3% or less, and sometimes even negative.  Investing such low-cost float at 11-12% returns is quite good.



Most investors don’t invest in cyclical companies because they don’t like earnings that are highly variable and unpredictable.  As a result, many cyclical companies can get very cheap indeed.

Buffett and Munger focus on normalized earnings instead of current earnings.  The volatility and unpredictability of current earnings creates some wonderful opportunities for long-term value investors.

The Boole Microcap Fund had an investment in Atwood Oceanics, which was acquired by Ensco plc. (NYSE: ESV) last year.  The Boole Fund continues to hold Ensco because it’s very cheap.  The current price is $5.43, while book value per share is $26.86.

Just how cheap is Ensco?

  • Low case: If oil prices languish below $60 for the next 3 to 5 years, then Ensco will be a survivor, due to its large fleet, globally diverse customer base, industry leading customer satisfaction ratings, and well-capitalized position.  Ensco is likely worth at least half of book value ($26.86 a share), which would be $13.43 a share, nearly 150% higher than today’s $5.43.
  • Mid case: If oil prices are in a range of $65 to $85 over the next 3 to 5 years – which is likely based on long-term supply and demand – then Ensco is probably worth at least book value ($26.86 a share), nearly 400% higher than today’s $5.43.
  • High case: If oil prices are in a range of $65 to $85 over the next 3 to 5 years – and if global rig utilization normalizes – then Ensco could easily be worth at least 150% of book value, which is $40+ a share, over 640% higher than today’s $5.43.

Note that oil-related companies in general are often excellent long-term investments.  They outperform the broader market over time, especially when they are cheap, as they are today.  And oil-related companies offer notable diversification, inflation protection, and exposure to global growth.

See this paper by Jeremy Grantham and Lucas White (you may have to register, but it’s free):

Buffett has pointed out that See’s Candies loses money eight months out of the year.  But the company has been phenomenally profitable over the decades.

(Photo by Cihcvlss, via Wikimedia Commons)


Thinking for Yourself


(Photo by Djama86)

Buffett first learned this lesson from Ben Graham:

You’re neither right nor wrong because the crowd disagrees with you.  You’re right because your data and reasoning are right.

Focus on what is knowable and important.  Ignore the crowd.  The market is there to serve you, not to instruct you.  Graham:

Basically, price fluctuations have only one significant meaning for the true investor.  They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.  At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

Buffett has often suggested, including in 2010, that most investors would be better off if there were no stock market quotations.  Buy a good business and then totally ignore prices.  Just follow the progress of the business over time.  If you don’t want to follow individual businesses, then simply buy a low-cost index fund or a quantitative value fund.



Buffett and Munger have pointed out that you’re better off as an investor not knowing popular opinion.  You’re better off learning as much as you can about businesses that you can understand.  You’re better off insulating yourself from the crowd.

Along these lines, Buffett has also commented that he’s never read an analyst report.  All the information you need can be found in the company’s financial statements.  If you need more information, you can conduct scuttlebutt research by talking with employees, customers, suppliers, competitors, etc.

Munger has said that you should focus only on the intrinsic value of the business.  If it’s a business you can understand, then only after you have a rough estimate of intrinsic value do you look at the current price.  In other words, you figure out the value of the business based on what it does and its financials.  You don’t look to the current price for information (other than as a market consensus).



Buffett and Munger have remarked that they have three boxes for potential investment ideas: in, out, and too hard.

It’s a big advantage if you classify most ideas as “too hard” because that means you can focus only on those businesses that you can understand.  As Buffett said at the 2006 meeting, if you’re fast, you can run the 100 meters for the gold medal.  You don’t have to throw the shot put.

Buffett has also often observed that generally you don’t get paid for degree of difficulty in investing.  Many of the best investment ideas have been rather simple.

At the 2008 meeting, Buffett mentioned that if it’s a worthwhile investment idea, he can usually make a good decision in five minutes.  Buffett said spending five months wouldn’t improve the quality of the decision past the five minute point.  Similarly, if it’s a “no go,” Buffett typically cuts off the proposal mid-sentence.



In 1994, Buffett said good information is far more important than quick information.  His primary source for information is annual reports.  Buffett said if the mail and quotes were delayed three weeks, he would still do just fine.


Lifetime Learning


Buffett and Munger are learning machines.  Buffett always says to read everything you can get your hands on.

Munger observed in 2003 that “Berkshire has been built on criticism.”  The ability to take constructive criticism is a central part of being a rational learning machine.

(Illustration by Hafakot)

Buffett and Munger also indicated in 2003 that their biggest errors have been errors of omission rather than commission.  Buffett said that Berkshire would have made roughly $10 billion if he had finished buying Wal-Mart.  The stock went up a bit when Buffett started buying.  Buffett waited for it to come back down, but it never did.



Buffett and Munger contend that the very best investment you can make is in yourself.  Become a learning machine, and never stop learning about your passions and areas of interest.  You’ve got one brain and one life, so maximize them and have fun along the way.

(Photo by Marek Uliasz)

Do what you love.  Work for people you admire.  You can become, to a large extent, the person you want to be, notes Buffett.  And if you hang around people better than you, you’ll become better.



In 2010, Buffett said the common factor for all of Berkshire’s excellent managers is that they love what they do.  Buffett noted that there’s nothing like following your passion.

Munger again recommended being a learning machine.  If you resolve to go to bed each night wiser than when you got up, you may rise slowly, but you’re sure to rise.

Buffett and Munger also reminded investors: stay in your circle of competence.  The size of the circle isn’t important, but knowing its boundaries is crucial.

For most investors, a quantitative value fund or an index fund is the best option.  (Buffett advises his own friends of modest means to stick with index funds.)

  • The Boole Microcap Fund is a quantitative value fund.



Munger has long argued that in order to be as rational a thinker and decision-maker as you can be, you need to master the primary models in the major disciplines.  Munger noted at the meeting in 2000 that these models include probability in math and break-points and back-up systems in engineering.

Here’s a discussion of big ideas in the major subject areas:

If you’ve only mastered one area, that can create many problems.

To a man with a hammer, every problem looks pretty much like a nail.

Moreover, Munger has pointed out that when you’re making a decision — investment or otherwise — your best decision is automatically a function of your next-best decision, which is your “opportunity cost.”



In 1988, Munger recommended reading biographies and “making friends with the eminent dead.”  This is a good way to improve your experience while also improving the quality of your friends.

Biographies are often a good way to learn about a specific subject when the person written about is an expert in that subject.


What is Berkshire Hathaway?

People often think Berkshire Hathaway is like a mutual fund that owns many positions in equities.  But that’s not correct.  See Buffett’s 2016 letter to shareholders:

(I focus here on the 2016 letter because it’s the most recent letter that still contains some discussion of the major business areas.  Going forward —including 2017 — you have to go to the annual report to see the discussion.  Here’s the 2017 annual report:


(Berkshire Hathaway logo via Wikimedia Commons)

First, Berkshire Hathaway is one of the largest and most successful insurance companies in the world.  Berkshire owns excellent property/casualty (P/C) insurance companies, including reinsurance and also GEICO.  Berkshire has operated at an underwriting profit for 14 consecutive years — up to but not including 2017 — generating a total pre-tax gain of $28 billion.

Second, Berkshire owns outright many great (and many good) individual businesses.  This includes 44 businesses in manufacturing, services, and retailing.  Buffett refers to this group as a “motley crew,” with a couple earning an unlevered return on net tangible assets in excess of 100%.  Most earn returns in the 12% to 20% range.  As well, some of these businesses have many individual business lines.  For instance, notes Buffett, Marmon has 175 separate business units.

  • Many of these businesses can operate far better being owned by Berkshire than they would if they were independent.  These companies can focus entirely on building long-term intrinsic value, without worrying about shorter term results or capital.  They can make the capital investments that make sense.  If they generate excess capital, it is sent to the parent company level, where Warren Buffett can invest it in the best available opportunities.
  • Viewed as a single business, says Buffett, in 2016 this entity employed $24 billion in net tangible assets and earned 24% after-tax on that capital.
  • Recent additions include Duracell and Precision Castparts.

Third, Berkshire owns regulated businesses such as Berkshire Hathaway Energy — a multi-state, multi-country utility business, including renewable energy projects and gas pipelines.  Buffett:

When it comes to wind energy, Iowa is the Saudi Arabia of America.

The other major regulated business is Burlington Northern Santa Fe.  For BNSF, it takes a single gallon of diesel fuel to move a ton of freight almost 500 miles.  This makes railroads four times as fuel-efficient as trucks, writes Buffett.

Fourth, Berkshire owns businesses Buffett classifies as finance and financial products.  This includes CORT (furniture), XTRA (semi-trailers), and Marmon (primarily tank cars but also freight cars, intermodal tank containers and cranes).  And there’s Clayton Homes.  Most of its revenue comes from the sale of manufactured homes, but most of its earnings result from a large mortgage portfolio.

  • Clayton’s customers are usually lower-income families who would not otherwise be able to own a home.  Monthly payments average only $587, including the cost of insurance and property taxes.  Clayton has programs — such as loan extensions and payment forgiveness — to help borrowers through difficulties.  Clayton foreclosed on only 2.5% of its mortgage portfolio in 2016.

Finally, Berkshire has well over $100 billion in public equities, such as American Express, Apple, Coca-Cola, IBM, Phillips 66, U.S. Bancorp, and Wells Fargo.  Note that Todd Combs and Ted Weschler each manage more than $12 billion of Berkshire’s public equity portfolio.

Buffett and Munger have always been highly ethical leaders, seeking to follow all laws and rules, and also working to treat their partners and employees as they would wish to be treated were their positions reversed.



In 2013, Munger remarked that Buffett was highly successful early in his career, when he managed an investment partnership, because he had very little competition.  This occurred primarily because Buffett focused on microcap companies, where few other investors ever look.

  • Even today, micro caps are overlooked and neglected by the vast majority of investors.  There’s far less competition in microcap investing, especially as compared with mid caps and large caps.  You can usually find a far greater number of undervalued stocks among micro caps.  That’s why I launched the Boole Microcap Fund, to help folks profit in a systematic way from inexpensive micro caps:
  • Because Buffett is one of the best investors ever, his returns today, were he starting again, would still be phenomenal.  In fact, Buffett has said on many occasions that if he were starting again today, he could get 50% annual returns by investing in micro caps.

So the key to Buffett’s early success was no real competition.

Similarly, one reason Berkshire Hathaway has become remarkably successful today is lack of competition.  Berkshire is one of the only companies that buys great or good businesses on the condition that those businesses continue to be run as before (ideally by the same manager).  Moreover, Buffett can usually decide in five minutes whether to buy the business in question.  And no seller ever worries about Berkshire’s check clearing.

Berkshire gets many calls no one else gets.  Berkshire has the money, the willingness to act immediately, and the policy that the business be run as before.  Perhaps even more importantly, Munger has noted, Berkshire uses the golden rule in its treatment of subsidiaries:  Berkshire seeks to treat subsidiaries as it would itself like to be treated were the positions reversed.

To illustrate the point, Buffett told the story of a business owner thinking about selling.  He worried that if he sold to competitors, they would fire the people who built the business.  The new owners would behave like Attila the Hun.

If the owner sold the business to a private equity firm, they would load it up with debt with the goal of reselling it.  And when they resold it, the Attila the Hun scenario would occur again.

The owner concluded that selling to Berkshire was not necessarily wonderful, but it was the only real choice.  Buffett then commented that this particular business turned out to be an outstanding acquisition for Berkshire.  The people stayed, and the previous owner is still doing what he loves.  Buffett:

Our competitive advantage is that we have no competitors.

A similar situation happened with Nebraska Furniture Mart (NFM).  Rose Blumkin, known as “Mrs. B”, borrowed $500 from her brother and launched NFM in 1937.  Mrs. B sold products at cheaper prices than her competitors in the furniture business.

(Nebraska Furniture Mart logo, via Wikimedia Commons)

In 1983, at the age of 89, Mrs. B was interested in selling.  Many were interested in buying, but Mrs. B only wanted to sell to “Mr. Buffett”.  She sold him 80% of Nebraska Furniture Mart based on a one-page deal and a handshake.  (Buffett later commented that Mrs. B was the best entrepreneur he’d ever met and could run rings around chief executives of the Fortune 500.)

Finally, Buffett mentioned that Berkshire has a different shareholder base.  Virtually everyone — including owner/managers — thinks like a long-term owner.



In 2001, say Pecaut and Wrenn, Buffett observed that he and Charlie did not have any master plan.  They just were continuing to focus on allocating capital as rationally as they could.

Henry Singleton, CEO of Teledyne, who has been described by Buffett and Munger as the greatest CEO/capital allocator in American business history, also never had a plan.

Furthermore, Buffett and Munger have often remarked that, as a value investor, you only need one good idea a year to do well over time.



In 2015, Buffett talked about developing the right culture.  It takes a long time.  Culture comes from the top.  The leader must consistently set a good example and communicate well.  Good behavior must be rewarded and bad behavior punished.

The Golden Rule

Buffett asserted that always striving to treat people the way you would like to be treated has always been a core value at Berkshire.



People love Munger for his brilliance, wit, and honesty.  He tells it like it is in as few words as possible.  Munger sometimes comes across as a curmudgeon next to Buffett, who’s typically very upbeat and optimistic.

But the truth is that Munger loves science and technology, and is extremely optimistic about the future.  He has said that most problems are technical problems that will be solved.  The future is very bright.

At the same time, Munger recommends low expectations and gratitude — in addition to hard work and honesty — as a recipe for personal happiness.  Be grateful for all the good things and good people in life.  Keep your expectations low, and you’ll often be pleasantly surprised.  Be stoic through the inevitable challenges.

Munger also commented at a Daily Journal meeting in 2016 that what you want to be is stressed and challenged.  Your full potential can only come out if you challenge yourself and if you embrace all the challenges that life throws at you.



In 2011, Munger joked that Warren wanted people to say at his funeral, “That’s the oldest looking corpse I ever saw.”

More seriously, write Pecaut and Wrenn, Munger wanted his own tombstone to read, “Fairly won, wisely used.”

Buffett, for his part, wanted to be remembered as “Teacher.”  Buffett loves teaching.  At every annual meeting, Buffett and Munger spend virtually six hours teaching.  In addition to that, Buffett writes the annual letter as a form of teaching.  Buffett appears in the media frequently.  And Buffett generously hosts many hundreds of business students, who come in groups every year to Omaha for hours of great teaching.

As a young man, Buffett taught at the University of Nebraska:


The best thing a human being can do is to help another human being know more.




In 2003, Buffett told the story of how he bought National Indemnity from Jack Ringwalt in 1967.  Buffett had noticed that Ringwalt would get worked up once a year for 15 minutes, threatening to sell the company.  Buffett asked a mutual friend, Charlie Heider, to let Buffett know the next time Ringwalt had an episode.

Heider called Buffett one day to let him know Jack was ready.  Buffett immediately called Ringwalt and was able to buy the company from him.  National Indemnity was the foundation for Berkshire Hathaway, which today is one of the largest and most successful insurance companies in the world.



In 2006, Buffett remarked that Hurricane Katrina was a $60 billion event and Berkshire paid out $3.4 billion.  This brought up the question of whether the preceding two years, or the previous 100 years, was the best way to think about the future.  Buffett announced:

We’re in.  If the last two years hold, we’re not getting enough.  If the last 100 years hold, we’re getting paid plenty.

Buffett imagined that there could be a $250 billion event, and that Berkshire’s exposure would be 4%, or $10 billion.  Pecaut and Wrenn pose the following question.  Berkshire has had about 8-10% of the property/casualty (P/C) insurance market based on their float.  But their exposure is around 4-5%.  How?  Shrewd, it seems.

Berkshire doesn’t care at all about smoothness of earnings, especially in P/C insurance.  Berkshire always has at least $20 billion in cash.  And it’s approaching the point where more cash than that will come in every year from its wide variety of businesses.  Thus, Berkshire is easily able to cover occasional large payments in P/C.

In brief, Berkshire gets larger, though lumpier earnings because it’s designed that way, whereas Berkshire’s competitors need some smoothness in their earnings.  Buffett says this is close to a permanent advantage for Berkshire that increases every year.



In 2011, Buffett said that Ajit Jain built Berkshire’s reinsurance business from scratch.  Buffett pointed out that Ajit is as rational as anyone he’s met and loves what he does.  There’s not a single decision Ajit has made that Buffett thinks he could have done better.

Furthermore, before Ajit came along, Berkshire spent 15 years in reinsurance not making any money.  Ajit turned Berkshire’s reinsurance business into a real profit center.

Buffett also remarked that it’s difficult to differentiate between a long-term trend and a series of random events.  This makes it very challenging to price reinsurance of catastrophes.  Buffett’s tactic is to assume the worst and price from there.

(Photo by Wittayayut Seethong)

Munger observed that P/C is not such a good business in itself.  You must be in the top 10% to do well.  Of course, to the extent that Berkshire maintains its huge float at a very low cost, it gains additional long-term benefits by investing a portion of the float in undervalued or high-quality businesses.

In 2013, Buffett commented that it’s much better to build the reinsurance business — rather than buy — once you’ve got the right people and plenty of capital.

  • As Pecaut and Wrenn record, Buffett has often emphasized that Berkshire is “an unusually rational place.”  Buffett has said that it’s been good that he and Charlie have not had outside influences pushing them in unwanted directions.
  • Specifically in insurance, Berkshire has chosen to write no policies at all (for long stretches of time) if the prices are not right.  This has added to their long-term profitability, even though their earnings are lumpier than most.  (One time National Indemnity shrunk its business by 80% until prices recovered.)
  • Most insurers are pressured by Wall Street to increase premiums every year.  But some years insurance prices don’t make sense and virtually guarantee losses.  As well, many managers do not have much vested interest in the insurer they manage.  This makes them even more likely to give in because they don’t want criticism or pressure.
  • To make matters worse, if other insurers are writing policies and collecting premiums when prices don’t make sense, then there is “social proof” or a “bandwagon effect”:  it appears that many others are doing well at the moment, even if it’s long-term unprofitable.
  • It’s not greed, but envy that drives much human behavior, says Buffett.  Envy is particularly stupid because there’s no upside, adds Munger.  Buffett agrees, joking: “Gluttony is a lot of fun.  Lust has its place, too, but we won’t get into that.”
  • Recently some hedge funds have gotten into reinsurance.  Buffett commented that anything Wall Street can sell, it will.  Munger chimed in, saying Wall Street would “throw in a lot of big words, too.”
  • Buffett concluded that if you own a gas station, and the guy across the street sells below cost, you’ve got a problem.  But insurance works differently.  It pays over time not to write policies when prices don’t make sense.
  • Munger: “With our cranky methods, we probably have the best insurance operation in the world.  So why change?”



Having spent decades in insurance, Buffett and Munger know how to think about risks and probabilities.  In 2004, Buffett said people tend to underestimate risks that haven’t happened for awhile, while overestimating risks when they’ve happened recently.

Buffett also has repeatedly stated that the person who runs Berkshire after Buffett must be able to consider scenarios that have never occurred before.

Here’s something else to keep in mind.  Assume there’s only a 2% chance of some event happening in any given year.  Assume the probability stays unchanged from year to year.  Then after 50 years, there’s a 63.6% chance the event will have occurred.  After 100 years, there’s an 86.7% chance the event will have ocurred.

(Photo by Michele Lombardo)

Berkshire is extremely rigorous in its consideration of various risks.  Buffett quipped at the 2005 meeting:

It’s Armageddon around here every day.

Buffett and Munger say they’ll never lose sleep because they are very careful and conservative in how they’ve structured Berkshire.  As Buffett asks, why have even a tiny risk of failure just to get an extra percentage point of return?  Ironically, write Pecaut and Wrenn, Buffett and Munger’s conservative approach has led to one of the highest multi-decade records of compounding anywhere.


Comments on Specific Investments


In 2010, Munger recounted how he had lost money in a venture capital investment when he was young.  Finally, decades later, Munger came across BYD, a Chinese maker of rechargeable batteries and electric cars, employing over 17,000 top engineers.  Berkshire made an investment in BYD that has worked well.

(BYD logo via Wikimedia Commons)

Munger suggested that BYD is an illustration of Berkshire’s commitment to keep learning.



When Berkshire acquired control of GEICO in 1995, the auto insurer had 2.5% market share.  At the end of 2016, GEICO had reached 12% of industry volume.  GEICO’s low costs — they sell direct without agents — gives it a very sustainable competitive advantage.

(GEICO logo by Dream out loud, via Wikimedia Commons)

Buffett recognized GEICO’s advantage long ago when writing his Columbia grad school thesis on the company.  Since 1995, Berkshire, under Buffett’s direction, has spent annually more on advertising for GEICO than the rest of the auto insurance industry combined.  The net result is that GEICO continues to gobble up market share every year.

  • Pecaut and Wrenn record that in 2013, two-thirds of all new auto policies went to GEICO.

Additionally, GEICO has enjoyed excellent management.  Buffett on Tony Nicely:

Tony became CEO of GEICO in 1993, and since then the company has been flying.  There is no better manager than Tony, who brings his combination of brilliance, dedication and soundness to the job.  (The latter quality is essential to sustained success. As Charlie says, it’s great to have a manager with a 160 IQ – unless he thinks it’s 180.)  Like Ajit, Tony has created tens of billions of value for Berkshire.

See page 10 of Buffett’s 2016 letter:



Berkshire recently joined with 3G Capital Partners on some deals, including the $23 billion acquisition of Heinz in 2013.  3G’s Jorge Paulo Lemann and Warren Buffett have known each other since they were both on the board of Gillette.

At the 2015 meeting, a question was asked about 3G’s method of significantly reducing the workforce of recently acquired companies.  Buffett replied that Burger King was now outperforming its competitors by a wide margin, thanks to the cost-cutting methods of 3G.

Buffett then noted that the railroad business had 1.6 million people employed after World War II.  Now the railroad industry has under 200,000 employees, but it is much larger, more efficient, and safer.  In short, Buffett applauds 3G’s achievements.  Ongoing progress and improvement is the nature of capitalism.



In 2013, Buffett announced that Berkshire was buying the final 20% of ISCAR that it didn’t own from the Wertheimer family for roughly $2 billion.

Buffett compared ISCAR to Sandvik, a Swedish company that owns Sandvik Tooling and Seco Tools — competitors of ISCAR.  Buffett stated that Sandvik is very good, but ISCAR — an Israeli company — is much better.

How did ISCAR become so good?  Buffett said the combination of brains and a huge amount of passion is what created ISCAR’s success.  ISCAR has long had talented and extremely hard-working people who constantly improve the product and work to delight customers.  Buffett praised ISCAR as one of the best companies in the world.


Other Topics


In the 1990’s, Buffett and Munger commented that their main job is capital allocation.  Buffett: “Aside from that, we play bridge.”  Bridge is a great game for value investors because you constantly have to make decisions based on probabilities. is a great site for learning and playing bridge.  Like most games, bridge gets increasingly fun the more you learn how to play.  (I enjoy bridge and chess, though I’m still a novice at both.)

(Image by Otm, via Wikimedia Commons)



In order to create a fair economic and political system, Buffett suggests using a thought experiment called The Ovarian Lottery.  The idea is that you get to write the rules for society.  The catch is that it’s 24 hours before you will be born and you don’t know if you’ll be bright or retarded, female or male, able or disabled, etc.

No one chooses the advantages or disadvantages of one’s birth.  If you go through this thought experiment carefully, you’re likely to set up a fair society.  American political philosopher John Rawls used a similar thought experiment:

Warren Buffett’s hero is his father, Howard Buffett.  Warren has called him the best human being he ever knew.  But Howard Buffett was a Republican.  Warren Buffett became a Democrat over time, partly through the influence of his wife, Susie, and partly due to thinking along the lines of The Ovarian Lottery.



Buffett and Munger have generally avoided investing in technology companies because it’s extremely difficult to predict how technology will change.  As Munger commented at the 1999 meeting:

The development of the streetcar led to the rise of the department store.  Since streetcar lines are immovable, it was thought that the department store had an unbeatable position.  Offering revolving credit and a remarkable breadth of merchandise, the department store was king.  Yet in time, while the rails remained, the streetcars disappeared.  People moved to the suburbs, which led to the rise of the shopping center and ended the dominance of department stores.

Now the Internet poses a threat to both.



What’s a better inflation hedge, gold or owning a wonderful business?

When Buffett took over Berkshire, the stock was trading at three-quarters of an ounce of gold.  Now gold is just north of $1,280, while Berkshire is around $250,000.  Berkshire has returned 20x more than gold.  It’s no contest.



In 2015, Buffett remarked that he’d experienced many pieces of good luck, three in particular:  meeting Lorimer Davidson, buying National Indemnity, and hiring Ajit Jain.

  • When Buffett was a young man, he stopped by a GEICO office on a Saturday.  Buffett told the guard he was a student of Ben Graham.  The guard let him in.  Buffett met Lorimer Davidson, a GEICO executive.  Davidson thought he would spend 5 minutes helping a student of Graham.  But when Davidson started talking with Buffett, he recognized how unusually smart and knowledgeable Buffett was.  So Davidson answered Buffett’s questions and educated him on the insurance business for four hours.  Buffett claims that he learned more in those four hours than he could have at any university course.
  • As described earlier, Buffett bought National Indemnity from Jack Ringwalt.  Buffett had noticed that Ringwalt would want to sell for about 15 minutes each year.  Buffett was very patient, and then persuasive and decisive.
  • In the mid 1980’s, Ajit Jain walked in on a Saturday offering to work for Berkshire even though he didn’t have any experience in insurance.

Buffett has marveled at his good luck.  He also observes that maintaining an open mind has been essential.



Buffett has frequently repeated that babies born in America today are the luckiest crop in history.  GDP per capita is higher than ever.  The standard of living is higher than ever.  The average person today lives far better than John D. Rockefeller, for instance.  Innovation and economic growth continue to move forward.

Buffett still says that, if he were given the choice of being born anywhere today, he would choose the U.S. over any other place.




An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Made in America

(Image:  Zen Buddha Silence by Marilyn Barbone.)

April 8, 2018

Made in America is the autobiography of Sam Walton, founder of Wal-Mart.  It’s a terrific book.  H. Ross Perot commented:

Every person who dreams of building a great business must read this book.  Sam Walton set the standard for listening to his customers and listening to the people who do the work.  In addition to being a great entrepreneur and business leader, Sam Walton was, above all, a fine, decent, kind, generous man.


  • Learning to Value a Dollar
  • Starting on a Dime
  • Bouncing Back
  • Swimming Upstream
  • Raising a Family
  • Recruiting the Team
  • Taking the Company Public
  • Rolling Out the Formula
  • Building the Partnership
  • Stepping Back
  • Creating a Culture
  • Making the Customer Number One
  • Meeting the Competition
  • Expanding the Circles
  • Thinking Small
  • Giving Something Back
  • Running a Successful Company: Ten Rules That Worked For Me

Sam Walton:

…ours is a story about the kinds of traditional principles that made America great in the first place.  It is a story about entrepreneurship, and risk, and hard work, and knowing where you want to go and being willing to do what it takes to get there.  It’s a story about believing in your idea even when maybe some other folks don’t, and about sticking to your guns.  But I think more than anything it proves there’s absolutely no limit to what plain, ordinary working people can accomplish if they’re given the opportunity and the encouragement and the incentive to do their best.  Because that’s how Wal-Mart became Wal-Mart: ordinary people joined together to accomplish extraordinary things.

(Photo by Sven, via Wikimedia Commons)



Walton says growing up during the Great Depression impacted his views on money.  Walton’s dad – who was a very hard worker – had a number of jobs, including banker, farmer, farm-loan appraiser, insurance agent, and real estate agent.  When he was out of work in the Great Depression, Walton’s dad eventually went to work for his brother’s Walton Mortgage Company.

In twenty-nine, thirty, and thirty-one, he had to repossess hundreds of farms from wonderful people whose families had owned the land forever… All of this must have made an impression on me as a kid…

Walton’s mother started a little milk business.  Young Walton helped his mom.  Walton also started selling magazine subscriptions.  And he had a paper route from the seventh grade through college.

I learned from a very early age that it was important for us kids to help provide for the home, to be contributors rather than just takers.  In the process, of course, we learned how much hard work it took to get your hands on a dollar, and that when you did it was worth something.  One thing my mother and dad shared completely was their approach to money: they just didn’t spend it.

(Image by Hohum, via Wikimedia Commons)

Walton remarks that he didn’t know much about business, even after earning a college degree in the subject.  When he got to know his wife Helen’s family, he learned a great deal from Helen’s father L. S. Robson.  Walton writes:

He influenced me a great deal.  He was a great salesman, one of the most persuasive individuals I have ever met.  And I am sure his success as a trader and a businessman, his knowledge of finance and the law, and his philosophy had a big effect on me.  My competitive nature was such that I saw his success and admired it.  I didn’t envy it.  I admired it.  I said to myself: maybe I will be as successful as he is someday.

Helen’s father organized the family businesses as a partnership.  Walton later adopted this approach, creating what would later be called Walton Enterprises.

How does Walton view money?

Here’s the thing: Money has never meant that much to me, not even in the sense of keeping score.  If we had enough groceries, and a nice place to live, plenty of room to keep and feed my bird dogs, a place to hunt, a place to play tennis, and the means to get the kids good educations – that’s rich.  No question about it.  And we have it.  We’re not crazy.  We don’t live like paupers the way some people depict us.  We all love to fly, and we have nice airplanes, but I’ve owned about eighteen airplanes over the years, and I never bought one of them new.

When it comes to Wal-Mart, Walton has always been very cheap.  Wal-Mart didn’t buy a jet until the company approached $40 billion in sales “and even then they had to practically tie me up and hold me down to do it.”  In the early days of Wal-Mart, when they went on buying trips, they’d pack as many as eight people into one room.

Why did Wal-Mart continue to be cheap even after it had become a behemoth?  Walton:

We exist to provide value to our customers, which means that in addition to quality and service, we have to save them money.  Every time Wal-Mart spends one dollar foolishly, it comes right out of our customers’ pockets.  Every time we save them a dollar, that puts us one more step ahead of the competition – which is where we always plan to be.



Walton was always ambitious:

Mother must have been a pretty special motivator, because I took her seriously when she told me I should always try to be the best I could at whatever I took on.  So, I have always pursued everything I was interested in with a true passion – some would say obsession – to win.  I’ve always held the bar pretty high for myself: I’ve set extremely high personal goals.

(Photo by Travelling-light)

As a kid, Walton was a class officer several years.  He was also a Boy Scout.  And he played football, baseball, and basketball.   In both high school and college (at the intramural level), he continued to play sports.

In high school, Walton was student body president and he was active in many clubs.  He enjoyed basketball and was a “gym rat,” always at the gym playing hoops.  When Walton was a senior, his basketball team went undefeated and won the state championship.  This was one of his “biggest thrills.”

Walton continues:

My high school athletic experience was really unbelievable, because I was also the quarterback on the football team, which went undefeated too – and won the state championship as well… I guess I was just totally competitive as an athlete, and my main talent was probably the same as my best talent as a retailer – I was a good motivator.

Walton comments that his ambition and competitive spirit led him to consider as a distant goal running for President of the United States.  In the meantime, he became president of the student body while at the University of Missouri.  Walton:

I learned early that one of the secrets to campus leadership was the simplest thing of all: speak to people coming down the sidewalk before they speak to you.  I did that in college.  I did it when I carried my papers.  I would always look ahead and speak to the person coming toward me.  If I knew them, I would call them by name, but even if I didn’t I would still speak to them… I ran for every office that came along.

(Illustration by Madmirror)

While in college, Walton continued delivering papers.  He had hired a few helpers by this point, and was making $4,000 to $5,000 a year.  [That’s the equivalent of at least $60,000 to $75,000 in 2018 dollars.]  Walton also waited tables and was a lifeguard.  He graduated from the University of Missouri in June 1940.

Walton thought he was going to be an insurance salesman because his high school girlfriend’s father sold insurance for General American Life Insurance Company.  It seemed like a lucrative career and Walton knew he could sell.

Walton wanted to attend Wharton business school, but he realized that even with his paper route and other jobs, he wouldn’t have enough money to pay for it.  Walton met with two company recruiters who came to the Missouri campus.  One was from J. C. Penney and the other from Sears Roebuck.

Walton says he got into retail – starting at J. C. Penney – simply because he was tired and wanted “a real job.”  Although he was only making $75 a month, Walton loved retail.  That’s where he stayed for the next fifty-two years.

Walton almost lost his job because he had never learned handwriting very well.  Fortunately, the store manager, Duncan Majors, was a great motivator and believed in Walton.  Duncan Majors was proud of having trained more Penney managers than anyone else in the country at that time.  He spent time training and developing all his boys.

By early 1942, as an ROTC graduate, Walton prepared to join the war effort.  But he flunked the physical due to a minor heart irregularity.  Walton wandered south, toward Tulsa, thinking he might like to work in the oil business.  Instead, he got a job at a big Du Pont gunpowder plant in the town of Pryor, outside Tulsa.  That’s where he met his wife Helen Robson at a bowling alley.  She was smart, educated, ambitious, opinionated, strong-willed, and energetic, and she was an athlete who enjoyed the outdoors.

Walton served in the military:

I wish I could recount a valiant military career – like my brother Bud, who was a Navy bomber pilot on a carrier in the Pacific – but my service stint was really fairly ordinary time spent as a lieutenant and then as a captain doing things like supervising security at aircraft plants and POW camps in California and around the country.

By 1945, Walton knew he wanted to go into a retailing and to own his own store.  He read every book he could on retailing.

People today, looking back, know that Wal-Mart initially had a small-town strategy.  This was just luck.  Helen, Sam Walton’s wife, said she wouldn’t live in any town with more than 10,000 people.

Walton discovered that there was a Ben Franklin variety store that he could run in Newport, Arkansas – a cotton and railroad town of 7,000 people.  The current owner was losing money and wanted to sell the store.  Walton bought it for $25,000 – $5,000 of his own money and $20,000 from Helen’s father.  Walton made a mistake, however, by not examining the lease agreement carefully.

(Photo by PenelopeIsMe, via Wikimedia Commons)

Walton set an ambitious goal:

I wanted my little Newport store to be the best, most profitable variety store in Arkansas within five years… Set that as a goal and see if you can’t achieve it.  If it doesn’t work, you’ve had fun trying.

One important lesson Walton grasped early on was that you can learn from everybody.  Walton would spend the rest of his career implementing this principle.  He would visit as many stores as possible and speak with as many people as possible.

At the beginning, Walton’s main competition was across the street: Sterling Store, managed by John Dunham.  Walton spent huge amounts of time visiting Sterling Store in order to absorb as much as he could.

Walton also learned a great deal from the Ben Franklin franchise program.  It was a complete course in how to run a store.  The only trouble was that franchisees weren’t given much discretion.  Walton was told what merchandise to sell and how much to sell it for.  Walton also had to buy the merchandise at set prices.  Soon Walton started buying merchandise directly from manufacturers.  He was always looking for “offbeat suppliers” from whom he could get a good deal.  Walton did a lot of driving.

Walton says he learned a simple lesson that would later change the way retailers sell and customers buy:

…say I bought an item for 80 cents.  I found that by pricing it at $1.00 I could sell three times more of it than by pricing it at $1.20.  I might make only half the profit per item, but because I was selling three times as many, the overall profit was much greater.  Simple enough.  But this is really the essence of discounting… In retailer language, you can lower your markup but earn more because of the increased volume.

Walton tried many different promotional things.  For instance, they put a popcorn machine and then an ice cream machine out in front of the store.  Both turned out to be profitable.

No matter how well things were going, Walton was a tinkerer:

…I never could leave well enough alone, and, in fact, I think my constant fiddling and meddling with the status quo may have been one of my biggest contributions to the later success of Wal-Mart.

(Illustration by lkonstudio)

When Walton took over the Ben Franklin store, it had done $72,000 in annual sales.  The first year Walton managed the store, it did $105,000 in sales.  The second year was $142,000 and the third year was $175,000.

After five years, Walton ended up reaching his goal:

That Little Ben Franklin store was doing $250,000 in sales a year, and turning $30,000 to $40,000 a year in profit.  It was the number-one Ben Franklin store – for sales and profit – not only in Arkansas, but in the whole six-state region.

Unfortunately, Walton was unable to keep the store because he forgot to include a clause in the lease that gave him an option to renew after the first five years.  Walton notes that it was the low point of his business career.  But he remained determined:

I’ve never been one to dwell on reverses, and I didn’t do so then.  It’s not just a corny saying that you can make a positive out of most any negative if you work at it hard enough.  I’ve always thought of problems as challenges, and this one wasn’t any different… I didn’t dwell on my disappointment.  The challenge at hand was simple enough to figure out: I had to pick myself up and get on with it, do it all over again, only even better this time.



Helen’s father and Walton drove to Bentonville, Arkansas.  They found an old variety store whose owners were looking to sell.  But the two parties couldn’t reach an agreement.  Later, on his own, Helen’s father was able to reach an agreement with the sellers.

Although the store had done only $32,000 in sales before Walton bought it, he had big plans.  Walton had heard about two Ben Franklin stores that were using a new concept: self-service.  All the merchandise was sitting on shelves for the customers to pick out.  The check-out registers were at the front of the store.

(Illustration by Alexmillos)

Walton adopted the self-service concept for his Bentonville store.  He called it Walton’s Five and Dime.  The store did well right away.  Part of the reason was Walton’s friendliness and his habit of yelling at people from a block away.

Walton then started looking for other stores that he could manage in other towns.  He found one in Fayetteville and used the same name: Walton’s Five and Dime.  It, too, was set up using self-service.  Walton comments:

This was the beginning of our way of operating for a long while to come.  We were innovating, experimenting, and expanding.  Somehow over the years, folks have gotten the impression that Wal-Mart was something I dreamed up out of the blue as a middle-aged man, and that it was just this great idea that turned into an overnight success.  It’s true that I was forty-four when we opened our first Wal-Mart in 1962, but the store was totally an outgrowth of everything we’d been doing since Newport – another case of me being unable to leave well enough alone, another experiment.  And like most other overnight successes, it was twenty years in the making.

Walton made his first real hire at the manager level: Willard Walker.  Walton found Willard by looking in competitors’ stores.  He would continue using this approach to finding talent going forward.  Also, Walton offered Willard equity in the business.

Meanwhile, Walton’s brother Bud had bought his own Ben Franklin store in Versailles, Missouri.  So Walton asked his brother if he wanted to go fifty-fifty on a new Ben Franklin store that was going to be part of a shopping center in Kansas City.  Bud agreed.

Based on what he saw in Kansas City, Walton got the notion of going into shopping center development.  He persisted with the idea for two years.  But it didn’t work.

I probably lost $25,000, and that was at a time when Helen and I were counting every dollar.  It was probably the biggest mistake of my business career.  I did learn a heck of a lot about the real estate business from the experience, and maybe it paid off somewhere down the line – though I would rather have learned it some cheaper way.

Wal-Mart executive David Glass:

Two things about Sam Walton distinguish him from almost everyone else I know.  First, he gets up every day bound and determined to improve something.  Second, he is less afraid of being wrong than anyone I’ve ever known.  And once he sees he’s wrong, he just shakes it off and heads in another direction.

Walton developed a love of flying.  His first plane, a two-seater, only went 100 miles an hour, but it allowed him to get places in a straight line.  One time, the motor cut off for about a minute.  Walton thought he was done.  But he was able to circle around and land with a dead engine.

(Photo by TSRL, via Wikimedia Commons)

As Walton proceeded to open up new stores, he created business partnerships that included – along with other partners – himself, Bud, Sam’s dad, Helen’s two brothers, and even Sam and Helen’s kids, who invested their paper route money.

John Walton (one of Sam and Helen’s four kids):

This is hard to believe, but between my paper route money and the money I made in the Army – both of which I invested in those stores – that investment is worth about $40 million today.

In less than fifteen years, they had become the largest independent variety store operator.  But in 1960, they were still only doing $1.4 million a year.  Walton continued to look for ways to improve.

Soon he learned that if they built a huge store, they could sell as much as $2 million a year from one location.  Walton traveled the country to look at the “early discounters.”  For example, in California, Sol Price had started Fed-Mart.  Closer to Arkansas, there was Herb Gibson, who sold cheaper than anyone else, but also sold higher volume than anyone else.

Soon Walton built his first discount store – what would become the first Wal-Mart.  Because they couldn’t use Ben Franklin at all, Walton had to make arrangements with a distributor in Springfield, Missouri.  Since nobody wanted to take a chance on the first Wal-Mart, Sam and Helen had to borrow even more than they already had:

We pledged houses and property, everything we had.  But in those days, we were always borrowed to the hilt.

By the time they had three Wal-Marts up and running, Walton knew that it would work.



Wal-Mart’s challenges strengthened it:

Many of our best opportunities were created out of necessity.  The things that we were forced to learn and do, because we started out underfinanced and undercapitalized in these remote, small communities, contributed mightily to the way we’ve grown as a company.  Had we been capitalized, or had we been the offshoot of a large corporation the way I wanted to be, we might not ever have tried the Harrisons or the Rogers or the Springdales and all those other little towns we went into in the early days.

(Illustration by Miaoumiaou)

Early on, Wal-Mart didn’t have systems or computers.  Walton recalls that much of what they did was poorly done.  But they stayed focused on low prices:

The idea was simple: when customers thought of Wal-Mart, they should think of low prices and satisfaction guaranteed.  They could be pretty sure they wouldn’t find it cheaper anywhere else, and if they didn’t like it, they could bring it back.

Wal-Mart lacked established distributors.  Salesmen would randomly show up.  It was difficult to get the bigger companies like Proctor & Gamble to show any interest.

The basic discounter’s strategy was to sell health products – toothpaste, mouthwash, headache remedies, soap, shampoo – at cost.  This brought people into the store.  The discounter would price everything else also at low prices, but with a 30 percent markup.

Gradually, Walton phased out his variety stores until all the stores were Wal-Marts.

Headquarters would give a profit and loss statement to each individual Wal-Mart store.  Problems could be handled immediately.  Most store managers owned a piece of their stores, so they were incentivized to maximize profit over time.  Walton:

For several years the company was just me and the managers in the stores.  Most of them came to us from variety stores, and they turned into the greatest bunch of discount merchants anybody ever saw.  We all worked together, but each of them had lots of freedom to try all kinds of crazy things themselves.

Walton mentions Don Whitaker as being like an operations manager.  Claude Harris was the first buyer.

Walton talks about the importance of merchandising:

…there hasn’t been a day in my adult life when I haven’t spent time thinking about merchandising.  I suspect I have emphasized item merchandising and the importance of promoting items to a greater degree than most any other retail management person in this country.  It has been an absolute passion of mine.  It is what I enjoy doing as much as anything in the business.  I really love to pick an item – maybe the most basic merchandise – and then call attention to it.  We used to say you could sell anything if you hung it from the ceiling.  So we would buy huge quantities of some thing and dramatize it.  We would blow it out of there when everybody knew we would have only sold a few had we just left it in the normal store position.  It is one of the things that has set our company apart from the very beginning and really made us difficult to compete with.  And, man, in the early days of Wal-Mart it really got crazy sometimes.

(Illustration by Beststock Images)

For instance, one of Wal-mart’s managers, Phil Green, created the world’s largest display of Tide.  It was eighteen cases high, 75 or 100 feet long, and 12 feet wide.  Everyone thought Phil was crazy, but he sold all of it at deeply discounted prices.

Wal-Mart executive David Glass comments:

The philosophy it teaches, which rubs off on all the associates and the store managers and the department heads, is that your stores are full of items that can explode into big volume and big profits if you are just smart enough to identify them and take the trouble to promote them.

Glass explains that in retail, you’re either operations driven or merchandise driven.  If a retailer is merchandise driven, they can always improve operations.  But retailers that are operations driven often don’t learn merchandising.  Early every Saturday morning, Wal-Mart managers would meet and critique their own and others’ merchandising.  Walton:

We wanted everybody to know what was going on and everybody to be aware of the mistakes we made.  When somebody made a bad mistake – whether it was myself or anybody else – we talked about it, admitted it, tried to figure out how to correct it, and then moved on to the next day’s work.

Wal-Mart associates also continued Walton’s practice of constantly checking out the competition in order to find ways to improve.



On family vacations, it was a given that Walton would visit as many stores as possible.

Walton never pressured his kids at all to go into retailing.  But they got involved anyway.  Rob became the first company lawyer for Wal-Mart.  Jim got involved with locating and buying store sites.  John became the second company pilot.  (John was a Green Beret medic who later created a business that builds boats.)  Alice was a buyer for Wal-Mart and then developed her own investment company.

Walton worries that his grandchildren might join the “idle rich.”

Maybe it’s time for a Walton to start thinking about going into medical research and working on cures for cancer, or figuring out new ways to bring culture and education to the underprivileged…



Walton notes that he has the personality of a promoter but the soul of an operator.  He never stops trying to improve things.  When the idea of discounting began to catch on, Walton visited every store and every headquarters he could.  He gleaned something from each visit.  He may have gotten the most from his study of Sol Price, an excellent operator who had started Fed-Mart in southern California in 1955.  Walton:

I guess I’ve stolen – I actually prefer the word “borrowed” – as many ideas from Sol Price as from anybody else in the business.

Most discounters failed.  Walton explains:

It all boils down to not taking care of their customers, not minding their stores, not having folks in their stores with good attitudes, and that was because they never even really tried to take care of their own people.  If you want the people in the stores to take care of the customers, you have to make sure you’re taking care of the people in the stores.  That’s the most important single ingredient of Wal-Mart’s success.

As Wal-Mart continued to expand, it had to hire more executives.  Ferold Arend was the company’s first vice president of operations (and later president).

Logistics also became increasingly important.  Walton got the idea of using computers long before they were very useful.  But computers kept improving.  Abe Marks comments on Walton:

He was really ten years away from the computer world coming.  But he was preparing himself.  And this is a very important point: without the computer, Sam Walton could not have done what he’s done.  He could not have built a retailing empire the size of what he’s built, the way he built it.  He’s done a lot of other things right, too, but he could not have done it without the computer.  It would have been impossible.

A warehouse was long overdue.  But Walton had already borrowed heavily and the company also had borrowed heavily.  Walton:

…We were generating as much financing for growth as we could from the profits of the stores, but we were also borrowing everything we could.  I was taking on a lot of personal debt to grow the company – it approached $2 million [over $14 million in 2018 dollars]… The debt was beginning to weigh on me.

(Photo by Adonis1969)

Wal-Mart needed someone to run operations.  Walton hired a fellow named Ron Mayer.  Walton says 1968 to 1976 – the time Ron was in charge of operations – was the most important period in Wal-Mart’s history.  Walton:

We were forced to be ahead of our time in distribution and in communication because our stores were sitting out there in tiny little towns and we had to stay in touch and keep them supplied.  Ron started the programs that eventually improved our in-store communications system.  Building on the groundwork already laid by Ferold Arend, Ron also took over distribution and began to design and build a system that would enable us to grow as fast as we could come up with the money.  He was the main force that moved us away from the old drop shipment method, in which a store ordered directly from the manufacturer and had the merchandise delivered directly to the store by common carrier.  He pushed us in some new directions, such as merchandise assembly, in which we would order centrally for every store and then assemble their orders at the distribution center, and also cross-docking, in which preassembled orders for individual stores would be received on one side of our warehouse and leave out the other.



The company’s cash shortage forced it to give up five sites where they were going to build new stores.  Going public could solve the cash problem.  Thus far, there were a number of different partnership agreements for the various stores.

So Rob started to work on the plan, which was to consolidate all these partnerships into one company and then sell about 20 percent of it to the public.  At the time, our family owned probably 75 percent of the company, Bud owned 15 percent or so, some other relatives owned a percentage…

(Photo by Designer491)

Anybody who bought stock in Wal-Mart’s first public offering in late 1970 – at a price of $16.50 per share – and who held it, did extraordinarily well.  Walton:

…let’s say you bought 100 shares back in that original public offering, for $1,650.  Since then, we’ve had nine two-for-one stock splits, so you would have 51,200 shares today.  Within the last year, it’s traded at right under $60 a share.  So your investment would have been worth right around $3 million…

An investment of $1,650 in late 1970 would have turned into $3 million over the ensuing two decades.  An investment of $16,500 would have become $30 million.  Since then, Wal-Mart has continued to grow, albeit more slowly.

Going public allowed Walton to pay off all his debts.

Walton never worried about market expectations, especially over the short term:

If we fail to live up to somebody’s hypothetical projection for what we should be doing, I don’t care.  It may knock our stock back a little, but we’re in it for the long run.  We couldn’t care less about what is forecast or what the market says we ought to do.  If we listened very seriously to that sort of stuff, we never would have gone into small-town discounting in the first place.



Jack Shewmaker, later president and COO, made this remark about working at Wal-Mart in 1970:

It would be safe to say that in those days we all worked a minimum of sixteen hours  day.

(Illustration by Roman Doroshenko)

Kmart was expanding rapidly, but wouldn’t go into towns with below 50,000 population.  Gibson’s, another prominent discounter, wouldn’t go into towns much below 10,000.  But Wal-Mart knew it could be profitable even in towns with under 5,000.  As for big cities:

We never planned on actually going into the cities.  What we did instead was build our stores in a ring around a city – pretty far out – and wait for the growth to come to us.  That strategy worked practically everywhere.

The airplane became a useful tool for looking at real estate.  When Walton was flying, he would get low and turn the plane on its side when he passed over real estate of interest.

Walton would visit individual stores as often as possible, and he expected his executives to do the same.  But much of the day-to-day operations Walton left to folks like Ferold Arend and Ron Mayer, then later Jack Shewmaker, and after that David Glass and Don Soderquist.  Walton sees his role as picking good people and then giving them maximum authority and responsibility.  Many have pointed out that Walton is extremely good at picking the right people.

Every Saturday morning, Walton would go to work at 2 or 3 a.m.  He would spend several hours examining data for many of the stores.  This allowed him to be prepared for the Saturday morning meeting at 7:30 a.m.  Walton:

But if you asked me am I an organized person, I would have to say flat no, not at all.  Being organized would really slow me down.  In fact, it would probably render me helpless.  I try to keep track of what I’m supposed to do, and where I’m supposed to be, but it’s true I don’t keep much of a schedule.

Walton fondly recalls this initial period:

Managing that whole period of growth was the most exciting time of all for me personally.  Really, there has never been anything quite like it in the history of retailing.  It was the retail equivalent of a real gusher: the whole thing, as they say in Oklahoma and Texas, just sort of blowed.  We were bringing great folks on board to help make it happen, but at that time, I was involved in every phase of the business: merchandising, real estate, construction, studying the competition, arranging the financing, keeping the books – everything.  We were all working untold hours, and we were tremendously excited about what was going on.

(Photo by Bjørn Hovdal)

Wal-Mart’s phenomenal growth:

Year Stores Sales
1970 32 $31 million
1972 51 $78 million
1974 78 $168 million
1976 125 $340 million
1978 195 $678 million
1980 276 $1.2 billion

Walton observes:

On paper, we really had no right to do what we did.  We were all pounding sand, and stretching our people and our talents to the absolute maximum.

Walton would hire people who lacked experience but showed potential.  He believed that a lack of knowledge and experience could be overcome with passion and a willingness to work extremely hard.

Distribution continued to be challenging:

…I don’t think our distribution system ever really got under complete control until David Glass finally relented and came on board in 1976.  More than anybody else, he’s responsible for building the sophisticated and efficient system we use today.



Giving associates a stake in the business, and giving them the chance to participate in decisions that would impact profitability, was an essential part of Wal-Mart’s growth and success.

(Photo by Adonis1969)

Walton realized that the more you share profits with associates, the more profitable the company can become.  Walton explains:

…the way management treats the associates is exactly how the associates will then treat the customers.  And if the associates treat the customers well, the customers will return again and again, and that is where the real profit in this business lies, not in trying to drag strangers into your stores for one-time purchases based on splashy sales or expensive advertising.  Satisfied, loyal, repeat customers are at the heart of Wal-Mart’s spectacular profit margins, and those customers are loyal to us because our associates treat them better than salespeople in other stores do.

Walton says this biggest regret is not including associates in the initial profit-sharing plan when the company went public in 1970.  But in 1971, Walton started giving associates part ownership of the business.  Many associates realized they were better off working at Wal-Mart – which is non-unionized – than they would be working somewhere that is unionized.  Why?  Both because associates can become part owners and because Wal-Mart executives have a policy of always listening to any associate with an issue or idea.



One of Walton’s hobbies was tennis, which he preferred to golf since golf takes too long.  Walton’s tennis partner George Billingsley says about Walton:

He loved the game.  He never gave you a point, and he never quit.  But he is a fair man.  To him, the rules of tennis, the rules of business, and the rules of life are all the same, and he follows them.  As competitive as he is, he was a wonderful tennis opponent – always gracious in losing and in winning.  If he lost, he would say, ‘I just didn’t have it today, but you played marvelously.’

Walton also enjoyed training his dogs:

I pride myself on being able to train my own dogs, and I’ve never had a dog handler, like some of these country gentlemen friends of mine.  I enjoy picking out ordinary setter or pointer pups and working with them…

Walton nearly always had his dogs with him when he drove around.  He loved the outdoors and was a believer in conservation.  Also, he liked to hunt birds.  Some of his best friends were bird hunters.

(Photo by Cynoclub)

Walton stepped back somewhat from Wal-Mart in 1976.  Unfortunately, two factions in the company developed and they began to compete fiercely.  The old guard, including many store managers, were loyal to Ferol.  The new guard lined up behind Ron.  (Many in the new guard had been hired by Ron.)  Soon everybody began taking sides.  It was very unhealthy.

Walton made the problem much worse by appointing Ron CEO.  Walton thought things might run OK this way.  But Walton couldn’t stay out of things.  He continued doing everything he was doing before.

The truth is, I failed at retirement worse than just about anything else I’ve ever tried.

Walton didn’t think the company was going in the right direction, so he decided to step back in as CEO.  He asked Ron to stay as vice chairman and CFO.  But Ron had wanted to run the company, so he decided to leave.

Before he left, Ron told Walton that Wal-Mart had such a strong organization that it would continue to do well.  But Ron’s faith in Wal-Mart didn’t prevent roughly one third of senior managers from leaving after Ron left.

Walton believes most setbacks can be turned into opportunities.  He promoted Jack Shewmaker to executive vice president of operations, personnel, and merchandise.  And Walton hired David Glass as executive vice president in charge of finance and distribution.

These two guys are completely different in personality, but they are both whip smart.  And with us up against it like we were, everybody had to head in the same direction.  Once again, Wal-Mart proved everybody wrong, and we just blew the doors off our previous performances.  David made us a stronger company almost immediately.  Ron Mayer may have been the architect of our original distribution systems, but David Glass, frankly, was much better than Ron at distribution, and that was one of the big areas of expertise I had been afraid of losing.  David also was much better at fine-tuning and honing our accounting systems.  He, along with Jack, was a powerful advocate for much of the high technology that keeps us operating and growing today.  And not only did he turn out to be a great chief financial officer, he also proved to be a fine talent with people.  This new team was even more talented, more suited for the job at hand than the previous one.



(Photo by Maurizio Distefano)

Saturday morning meetings often began with a cheer.  Walton:

It’s sort of a “whistle while you work” philosophy, and we not only have a heck of a good time with it, we were better because of it.  We build spirit and excitement.  We capture the attention of our folks and keep them interested, simply because they never know what’s coming next.  We break down barriers, which helps us communicate better with one another.  And we make our people feel part of a family in which no one is too important or too puffed up to lead a cheer or be the butt of a joke…

In 1984, Walton lost a bet to David Glass and “had to pay up by wearing a grass skirt and doing the hula on Wall Street.”  (Glass bet that the company would achieve a pretax profit of more than 8 percent; Walton bet against it.)  While outsiders might have viewed it as a publicity stunt, Walton observes that it’s a part of Wal-Mart’s culture to make things interesting, unpredictable, and fun.

…we thrive on a lot of the traditions of small-town America, especially parades with marching bands, cheerleaders, drill teams, and floats.  Most of us grew up with it, and we’ve found that it can be even more fun when you’re an adult who usually spends all your time working.  We love all kinds of contests, and we hold them all the time for everything from poetry to singing to beautiful babies.  We like theme days, where everyone in the store dresses up in costume.

Wal-Mart turned its annual meeting for shareholders into a fun, two-day event.

One potential problem for nearly all large companies is resistance to change.  Walton writes:

So I’ve made it my own personal mission to ensure that constant change is a vital part of the Wal-Mart culture itself… In fact, I think one of the greatest strengths of Wal-Mart’s ingrained culture is its ability to drop everything and turn on a dime.

Ongoing education is also important.  Associates can go to the Wal-Mart Institute at the University of Arkansas.  Or they can, with the company’s help, earn college degrees.



(Photo by Feelfree777)

For my whole career in retailing, I have stuck with one guiding principle… the secret of successful retailing is to give your customers what they want.  And really, if you think about it from your point of view as a customer, you want everything: a wide assortment of good quality merchandise; the lowest possible prices; guaranteed satisfaction with what you buy; friendly, knowledgeable service; convenient hours; free parking; a pleasant shopping experience.

Walton defends Wal-Mart:

Of all the notions I’ve heard about Wal-Mart, none has ever baffled me more than this idea that we are somehow the enemy of small-town America.  Nothing could be further from the truth: Wal-Mart has actually kept quite a number of small towns from becoming practically extinct by offering low prices and saving literally billions of dollars for the people who live there, as well as by creating hundreds of thousands of jobs in our stores.

Beyond its direct economic impact – customers vote with their feet and have saved huge amounts of money – Wal-Mart is committed to creating a sense of community in its managers and associates.  Community involvement is important.

In the early days of Wal-Mart, department stores put pressure on Wal-Mart.  The department stores didn’t like the fact that many of their customers were switching to Wal-Mart simply because Wal-Mart’s prices were much lower.  The department stores even tried to use “fair trade” laws to block discounters from doing business.

Furthermore, Wal-Mart’s vendors weren’t all happy about Wal-Mart’s determination to get the lowest possible prices from them.  Walton spells out his company’s reasoning:

…we are the agents for our customers.  And to do the best job possible, we’ve got to become the most efficient deliverer of merchandise that we can.  Sometimes that can best be accomplished by purchasing goods directly form the manufacturer.  And other times, direct purchase simply doesn’t work.  In those cases, we need to use middlemen to deal with smaller manufacturers and make the process more efficient.  What we believe in strongly is our right to make that decision – whether to buy directly or from a rep – based on what it takes to best serve our customers.




…We decided that instead of avoiding our competitors, or waiting for them to come to us, we would meet them head-on.  It was one of the smartest strategic decisions we ever made… Our competitors have honed and sharpened us to an edge we wouldn’t have without them.

(Photo by Nataliia Shcherbyna)

Bud Walton:

Competition is very definitely what made Wal-Mart – from the very beginning.  There’s not an individual in these whole United States who has been in more retail stores – all types of retail stores, too, not just discount stores – than Sam Walton.  Make that all over the world.  He’s been in stores in Australia and South America, Europe and Asia and South Africa.  His mind is just so inquisitive when it comes to this business.  And there may not be anything he enjoys more than going into a competitor’s store trying to learn something from it.

At a regional meeting of discounters, competitors went through Wal-Mart’s stores and offered their critiques.  Wal-Mart executives were surprised at how many things they weren’t doing well.  But they listened carefully and made adjustments accordingly.  Those adjustments were crucial in preparing Wal-Mart to begin competing more broadly with Kmart.  (Kmart had 1,000 stores while Wal-Mart only had 150 at that time.)

Many discounters were driven out of business in the mid-1970s when the economy weakened.  Wal-Mart began to buy struggling retailers.  In 1981, Wal-Mart had almost no stores east of the Mississippi.  But Kuhn’s Big K stores – with 112 locations – was faltering.  Wal-Mart had a difficult time deciding what to do, but they finally acquired Kuhn’s.  After working through some problems related to the acquisition, Wal-Mart was now in a position to keep growing amazingly fast.  Walton:

We exploded from that point on, almost always opening 100 new stores a year, and more than 150 in some years…

I don’t know how the folks around executive offices see me, and I know they get frustrated with the way I make everybody go back and forth on so many issues that come up.  But I see myself as being a little more inclined than most of them are to take chances.  On something like the Kuhn’s decision, I try to play a “what-if” game with the numbers – but it’s generally my gut that makes the final decision.



…one of the main reasons we’ve been able to roll this company out nationally was all the pressure put on me by guys like David Glass and, earlier, Jack Shewmaker and Ron Mayer, to invest so heavily in technology.  Yes, I argued and resisted, but I eventually signed the checks.  And we have been able to move way out front of the industry in both communications and distribution… I would go so far as to say, in fact, that the efficiencies and economies of scale we realize from our distribution system give us one of our greatest competitive advantages.

Many people have contributed over the years, but David Glass has to get the lion’s share of the credit for where we are today in distribution.  David had a vision for automated distribution centers – linked by computer both to our stores and to our suppliers – and he set about building such a system, beginning in 1978 at Searcy, Arkansas.

Wal-Mart’s warehouses reached a point where they could directly replenish nearly 85 percent of inventory compared to 50 to 65 percent for competitors.  When in-store merchants place computer orders, the orders arrive at the store in about two days.  Most competitors had to wait five or more days for their orders to arrive.

Wal-Mart has a private fleet of trucks.  Walton would regularly meet in the drivers’ break room at 4 a.m. with a bunch of doughnuts.  He would ask them all sorts of questions about the stores.  Most truck drivers were very candid, which gave Walton another way to gain store-level intelligence.

(Wal-Mart distribution center, Photo by Redwood8)

Walton describes a distribution center:

Start with a building of around 1.1 million square feet, which is about as much floor space as twenty-three football fields, sitting out somewhere on some 150 acres.  Fill it high to the roof with every kind of merchandise you can imagine, from toothpaste to TV’s, toilet paper to toys, bicycles to barbecue grills.  Everything in it is bar-coded, and a computer tracks the location and movement of every case of merchandise, while it’s stored and when it’s shipped out.  Some six hundred to eight hundred associates staff the place, which runs around the clock, twenty-four hours a day.  On one side of the building is a shipping dock with loading doors for around thirty trucks at a time – usually full.  On the other side is the receiving dock, which may have as many as 135 doors for unloading merchandise.

These goods move in and out of the warehouse on some 8 1/2 miles of laser-guided conveyor belts, which means that the lasers read the bar codes on the cases and then direct them to whatever truck is filling the order placed by one of the stores it’s servicing that night… When the thing is running full speed, it’s just a blur of boxes and crates flying down those belts, red lasers flashing everywhere, directing this box to that truck, or that box to this truck.  Out in the parking lot, whole packs of Wal-Mart trucks rumble in and out all day.



Walton on thinking small:

…the bigger Wal-Mart gets, the more essential it is that we think small.  Because that’s exactly how we have become a huge corporation – by not acting like one… If we ever forget that looking a customer in the eye, and greeting him or her, and asking politely if we can be of help is just as important in every Wal-Mart today as it was in that little Ben Franklin in Newport, then we just ought to go into a different business because we’ll never survive in this one.

In a giant, centrally driven company, there’s no place for creativity, no room for the maverick merchant, no need for the entrepreneur or the promoter.

Walton shares six principles for how to think small:

  • Think One Store at a Time
  • Communicate, Communicate, Communicate
  • Keep Your Ear to the Ground
  • Push Responsibility – and Authority – Down
  • Force Ideas to Bubble Up
  • Stay Lean, Fight Bureaucracy

Think One Store at a Time

The focus always has to be on lowering prices, improving service, and making things better for customers who shop in the stores.  Similarly, getting the right merchandising mix requires merchandisers at the store level, who deal with customers face to face, day in and day out.

When managers meet at the end of the week, the discussion of sales is at the individual store level.  No other large retailer does that.

Communicate, Communicate, Communicate

Walton says:

If you had to boil down the Wal-Mart system to one single idea, it would probably be communication, because it is one of the real keys to our success.


That’s why we’ve spent hundreds of millions of dollars on computers and satellites – to spread all the little details around the company as fast as possible.

Sometimes Walton would get a message to everyone by doing a TV recording.  One time, he had all the associates pledge to follow “the ten-foot rule.”  If you come within 10 feet of a customer, look her in the eye, greet her, and ask her if you can help her.  Walton told all the associates that, if they did this, not only would it be better for customers, but the associates themselves would become better leaders in the process.

Keep Your Ear to the Ground

Both district managers and regional managers are expected to travel around to individual stores, just as Walton himself used to do all the time.  Valuable intelligence is always available using this approach.

As with any retailer, there’s always a head-to-head confrontation between operations and merchandising.  At Wal-Mart, there are some enormous arguments.  But they have a rule never to leave an item hanging in the weekly meeting.  They always make a decision.  Sometimes it’s wrong and gets corrected ASAP.  But once the decision is made, everyone is on board as long as the decision stands.

Push Responsibility – and Authority – Down

As much as possible, every level of manager is given responsibility and authority – and is rewarded with equity.  Many Wal-Mart managers who never went to college end up performing very well.

Force Ideas to Bubble Up

This goes with pushing responsibility down.  Any associate can have a good idea about how to improve something.  It’s happened countless times at Wal-Mart.

Stay Lean, Fight Bureaucracy

Bureaucracy builds up naturally unless the culture is to eliminate or limit bureaucracy as much as possible.  Walton is committed to not letting egos get out of control because, in his view, much bureaucracy is the result of some empire builder’s ego.



  • RULE 1: COMMIT to your business.  Believe in it more than anybody else.  I think I overcame every single one of my personal shortcomings by the sheer passion I brought to my work.
  • RULE 2: SHARE your profits with all your associates, and treat them as partners.  In turn, they will treat you as a partner, and together you will all perform beyond your wildest expectations.
  • RULE 3: MOTIVATE your partners.  Money and ownership alone aren’t enough.  Constantly, day by day, think of new and more interesting ways to motivate and challenge your partners.  Set high goals, encourage competition, and then keep score.  If things get stale, cross-polinate; have managers switch jobs with one another to stay challenged… Don’t become too predictable.
  • RULE 4: COMMUNICATE everything you possibly can to your partners.  The more they know, the more they’ll understand.  The more they understand, the more they’ll care.
  • RULE 5: APPRECIATE everything your associates do for the business… all of us like to be told how much somebody appreciates what we do for them.
  • RULE 6: CELEBRATE your successes.  Find some humor in your failures.  Don’t take yourself so seriously.  Loosen up, and everybody around you will loosen up.  Have fun.  Show enthusiasm – always.
  • RULE 7: LISTEN to everyone in your company.  And figure out ways to get them talking.  The folks on the front lines – the ones who actually talk to the customer – are the only ones who really know what’s going on out there.
  • RULE 8: EXCEED your customers’ expectations.  If you do, they’ll come back over and over.  Give them what they want – and a little more.  Let them know you appreciate them.  Make good on all your mistakes, and don’t make excuses – apologize.  Stand behind everything you do.
  • RULE 9: CONTROL your expenses better than your competition.  This is where you can always find the competitive advantage.
  • RULE 10: SWIM upstream.  Go the other way.  Ignore the conventional wisdom.  If everybody else is doing it one way, there’s a good chance you can find your niche by going in exactly the opposite direction.  But be prepared for a lot of folks to wave you down and tell you you’re headed the wrong way.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Grinding It Out

(Image:  Zen Buddha Silence by Marilyn Barbone.)

April 1, 2018

I was an overnight success all right, but thirty years is a long, long night.

In Grinding It Out, Ray Kroc tells the story of how he created McDonald’s.  Kroc launched the company in 1954 when he was 52 years old.  Twenty-two years later McDonald’s topped one billion in total revenue.

(Photo by Ruslan Gilmanshin)



Kroc spent seventeen years selling paper cups before he discovered a five-spindled milk-shake machine called the Multimixer.  Kroc:

It wasn’t easy to give up security and a well-paying job to strike out on my own… I plunged gleefully into my campaign to sell a Multimixer to every drug store soda fountain and dairy bar in the nation.  It was a rewarding struggle.  I loved it.  Yet I was alert to other opportunities.

(Multimixer, Photo by Visitor7, via Wikimedia Commons)

Kroc began to hear about the McDonald brothers.  They had not just one Multimixer.  Nor just two or three.  They had eight Multimixers.  This peaked Kroc’s curiosity, so he went to look at the McDonald brothers’ operation in San Bernardino, California.

At first, Kroc wasn’t impressed.  But then he saw all the helpers arriving and setting up.  Soon they were moving really fast.  And flocks of people were in line getting hamburgers.  Each hamburger was only 15 cents, and there was almost no wait between the customer placing an order and the order being filled.

Kroc spoke with several customers and learned that they just loved the food.  Kroc was captivated by the system.  He asked the McDonald brothers to join him for dinner, which they did:

I was fascinated by the simplicity and effectiveness of the system they described that night.  Each step in producing the limited menu was stripped down to its essence and accomplished with a minimum of effort.  They sold hamburgers and cheeseburgers only.  The burgers were a tenth of a pound of meat, all fried the same way, for fifteen cents.  You got a slice of cheese on it for four cents more.  Soft drinks were ten cents, sixteen-ounce milk shakes were twenty cents, and coffee was a nickel.

The McDonald brothers showed Kroc the design of a new drive-in building.  It was red and white with touches of yellow.  There was a set of arches that went through the roof.  There was also a tall sign out front with arches illuminated by neon tubes.

Kroc’s excitement grew:

That night in my motel room I did a lot of heavy thinking about what I’d seen during the day.  Visions of McDonald’s restaurants dotting crossroads all over the country paraded through my brain.  In each store, of course, were eight Multimixers whirring away and paddling a steady flow of cash into my pockets.

The next day, Kroc returned to see the operation in action again.  He paid particular attention to how the french fries were made.  McDonald’s french fries were outstanding and a key to the store’s success.  Kroc observed carefully and thought that he had memorized the process for making terrific french fries.  Kroc admits this was a mistake because he missed a few things.

Kroc met with Mac and Dick McDonald again.  This time, Kroc asked them why they didn’t expand into a chain.  The brothers demurred.  When pressed, they pointed to their house on a hill.  They said they were leading a peaceful existence and didn’t want any more problems.  Eventually, Kroc said that he himself could open up the new locations.




When I flew back to Chicago that fateful day in 1954, I had a freshly signed contract with the McDonald brothers in my briefcase.  I was a battle-scared veteran of the business wars, but I was still eager to go into action.  I was 52 years old.  I had diabetes and incipient arthritis.  I had lost my gall bladder and most of my thyroid gland in earlier campaigns.  But I was convinced the best was ahead of me.  I was still green and growing, and I was flying along at an altitude slightly higher than a plane.

Kroc recounts that he was born in Oak Park, just west of Chicago, in 1902.  Kroc’s parents were of Czech origin Bohemians, as Ray says.  His father, Louis Kroc, had gone to work for Western Union at age twelve and had worked his way up.  Ray Kroc’s mother, Rose, was “a loving soul.”  She gave piano lessons to make extra money.

(Czech Republic on map with flag pin, Photo by Sjankauskas)

Ray Kroc’s brother, Bob, became a professor and medical researcher, but Ray wasn’t much interested in school.  Ray wasn’t even interested in reading books:

I was never much of a reader when I was a boy.  Books bored me.  I liked action.  But I spent a lot of time thinking about things.  I’d imagine all kinds of situations and how I would handle them.

They called me Danny Dreamer a lot, even later when I was in high school and would come home all excited about some scheme I’d thought up.  I never considered my dreams wasted energy; they were invariably linked to some form of action.  When I dreamed about having a lemonade stand, for example, it wasn’t long before I set up a lemonade stand.  I worked hard at it, and I sold a lot of lemonade.  I worked at a grocery store one summer when I was still in grammar school.  I worked at my uncle’s drug store.  I worked in a tiny music store I’d started with two friends.  I worked at something whenever possible.  Work is the meat in the hamburger of life.  There is an old saying that all work and no play makes Jack a dull boy.  I never believed it because, for me, work was play.  I got as much pleasure out of it as I did from playing baseball.

Kroc went with his father to see many Chicago Cubs games.  The Cubs were contenders then.

Kroc enjoyed working for his uncle Earl Edmund Sweet’s drug store soda fountain in Oak Park.

That was where I learned that you could influence people with a smile and enthusiasm and sell them a sundae when what they’d come for was a cup of coffee.

Kroc learned to play the piano well.  He thought he could make money as a piano man.  He ended up going into the music store business with two friends.  But it didn’t really work.

Though Kroc didn’t like school — one reason being that the progress felt much too slow — there was one school activity he did like: debating.

When World War I came, Kroc got a job selling coffee beans and novelties door-to-door.  He thought he wouldn’t need to go back to school.  Soon Kroc felt he should be a part of the war effort.  Kroc:

My parents objected strenuously, but I finally talked them into letting me join up as a Red Cross ambulance driver.  I had to lie about my age, of course, but even my grandmother could accept that.  In my company, which assembled in Connecticut for training, was another fellow who had lied about his age to get in.  He was regarded as a strange duck, because whenever we had time off and went out on the town to chase girls, he stayed in camp drawing pictures.  His name was Walt Disney.

Kroc writes that he wanted to be a salesman, and also to play the piano.  For a time, he sold novelty ribbons.  Kroc was doing well:

In 1919 anyone making twenty-five or thirty dollars a week was doing well, and it wasn’t long before — on good weeks with a lot of musical jobs — I was making more money than my father.

Kroc had several jobs as a piano man, including playing in a band at Paw-Paw Lake, Michigan.  That’s where he met his first wife, Ethel Flemming, of Scottish background.

Kroc continues:

My next job was in Chicago’s financial district as a board marker on the New York Curb, as the market that became the American Stock Exchange used to be called.  My employer was a firm named Wooster-Thomas.  A substantial sound to that, I thought.  My job was to read the ticker tape and translate the symbols from it into prices that I posted on the blackboard for the scrutiny of the gentlemen who frequented our office.  I later learned that the impressive-sounding name fronted a bucket-shop operation that was selling watered stock all over the place.

A bit later, Kroc got a job selling Lily brand paper cups.



Kroc was selling Lily paper cups from early in the morning until 5:00 or 5:30pm.  He says he would have worked longer, but he had a job playing piano at radio station WGES in Oak Park.  Kroc worked at WGES 6pm to 8pm, and then 10pm to 2am.  Kroc:

I was driven by ambition.  I hated to be idle for a minute.

(Photo of paper cups by Fedoseeva Galina)

Kroc again:

My cup sales kept growing as I learned how to plan my work and work my plan.  My confidence grew at the same rate.  I found that my customers appreciated a straightforward approach.  They would buy if I made my pitch and asked for their order without a lot of beating around the bush.  Too many salesmen, I found, would make a good presentation and convince the client, but they couldn’t recognize that critical moment when they should have stopped talking.  If I ever notice my prospect starting to fidget, glancing at his watch or looking out the window or shuffling the papers on his desk, I would stop talking right then and ask for his order.

Winter of 1924 was tough for the paper cup business.  Kroc notes that one reason he didn’t do well was because he put the customer first:

My philosophy was one of helping my customer, and if I couldn’t sell him by helping him improve his own sales, I felt I wasn’t doing my job.

Kroc started doing well in the paper cup business.  But knowing how things slowed down in the winter, Kroc took a 5-month leave of absence.  He got a job in Fort Lauderdale, Florida, selling real estate for W. F. Morang & Son.  Kroc quickly became a top salesman.

The property was underwater, but there was a solid bed of coral rock beneath, and the dredging for the intercoastal raised all the lots high and dry, with permanent abutments.  People who purchased those lots really got a bargain, even though the prices were astronomical for those times, because the area is now one of the most beautiful in all of Florida, and lots there are worth many times what they sold for then.

Of course, there were many lots sold at that time that didn’t turn out to be good investments at all.  There was a great deal of chicanery.  After a crackdown, Kroc got a job playing piano before returning to Chicago.



From 1927 to 1937, Kroc focused entirely on selling paper cups.  The paper container industry was undergoing several changes.  But then the stock market crashed in 1929, which ushered in the Great Depression.  Kroc’s father, who had been successfully speculating in real estate, was hit hard.

In 1930, Kroc saw an opportunity at the soda fountains in Walgreen’s Drug Company.

(Soda fountain, Photo by Bigapplestock)

At Walgreen’s, customers could buy sodas “to go.”  Kroc tried to convince the food service man for Walgreen’s, a man named McNamarra.  No go.  But then Kroc got McNamarra to try it for one month using free cups.

Finally he agreed.  I brought him the cups, and we set the thing up at one end of the soda fountain.  It was a big success from the first day.  It wasn’t long before McNamarra was more excited about the idea of takeouts than I was.  We went in to see Fred Stoll, the Walgreen purchasing agent, and set up what was to be a highly satisfactory arrangement for both of us.  The best part of it for me personally was that every time I saw a new Walgreen’s store going up it meant new business.  This sort of multiplication was clearly the way to go.  I spent less and less time chasing pushcart vendors around the West Side and more time cultivating large accounts where big turnover would automatically winch in sales in the thousands and hundreds of thousands.  I went after Beatrice Creamery, Swift, Armour, and big plants with in-factory food service systems such as U.S. Steel.

Soon Kroc had roughly fifteen salesmen working for him.

I loved to see one of these young fellows catch hold and grow in his job.  It was the most rewarding thing I’d ever experienced.

Kroc counselled his salesmen to sell themselves first, which would make it easier to sell paper cups.

Kroc mentions one of his customers, Ralph Sullivan in Battle Creek, Michican, who invented a new way to make milk shakes:

Ralph had come up with the idea of reducing butterfat content in a milk shake by making it with frozen milk.  The traditional method of making a shake was to put eight ounces of milk into a metal container, drop in two small scoops of ice cream, add flavoring, and put the concoction onto a spindle mixer.  Ralph’s formula was to take regular milk, add a stabilizer, sugar, corn starch, and a bit of vanilla flavoring and freeze it.  The result was ice milk.  He would put four ounces of milk into a metal container, drop in four scoops of this ice milk, and finish it off in the traditional way.  The result was a much colder, much more viscous drink, and people loved it.  The lines around his store in the summertime were nothing less than amazing.  This ice milk shake had a lot of advantages over regular milk shakes.  Instead of being a thin, semicool drink, it was thick and very cold.

The Multimixer was a piece of equipment that could make five milk shakes at once.  It was a game changer.  Kroc ended up leaving the paper cup business in order to sell Multimixers.  Kroc formed a partnership with the inventor of the Multimixer, Earl Prince.



Kroc encountered a great deal of adversity in his life, especially when he was trying to sell Multimixers.

For me, this was the first phase of grinding it out   building my personal monument to capitalism.  I paid tribute… for many years before I was able to rise with McDonald’s on the foundation I had laid.  Perhaps without that adversity I might not have been able to persevere later on when my financial burdens were redoubled.

(Illustration by Chris Dorney)

Kroc successfully marketed Multimixers at restaurant and dairy association conventions.  Soon Kroc was so busy that he had to hire a bookkeeper.  Partly by luck, he found Mrs. June Martino.  She was warm and compassionate, but also focused and able.  June studied electronics at Northwestern University.  Because higher mathematics was difficult for her, she had a tutor.  She was determined and “no challenge was too big for her,” notes Kroc.



In Southern California in the early 1930s, the drive-in restaurant came into existence.  Mac and Dick McDonald were New Englanders who moved to Southern California to work on movies.  At one point, they ran their own movie theatre.  Sometimes they only ate on meal a day in order to save money.  They would have a hot dog from a nearby stand.

Dick McDonald later recalled that he and his brother noticed that the hot dog stand was the only business doing well then.  That probably gave the brothers the idea of launching a drive-in restaurant.

The McDonald brothers’ first restaurant in San Bernardino was doing a great deal of business, but it still wasn’t very profitable.  Kroc:

So they did a courageous thing.  They closed that successful restaurant in 1948 and reopened it a short time later with a radically different kind of operation.  It was a restaurant stripped down to the minimum in service and menu, the prototype for legions of fast-food units that later would spread across the land.  Hamburgers, fries, and beverages were prepared on an assembly line basis, and, to the amazement of everyone, Mac and Dick included, the thing worked!  Of course, the simplicity of the procedure allowed the McDonalds to concentrate on quality in every step, and that was the trick.

(Original McDonald’s fast food restaurant, Photo by Cogart Strangehill, via Wikimedia Commons)

Kroc reached an agreement with the McDonald brothers.  Kroc would be able to franchise copies of McDonald’s everywhere in the United States.  He admits he made a mistake in the contract with the McDonalds: any changes to Kroc’s units would have to be put in writing, signed by both brothers, and sent by registered mail.  The McDonalds had an affable openness and Kroc trusted them.  But there would be problems later.

The agreement stipulated that Kroc would receive 1.9 percent of gross sales from franchisees.  Of that, 0.5 percent would go to the McDonald brothers.  Kroc also could charge an initial franchise fee of $950 for each license.

Making great french fries was essential:

…I had explained to Ed MacLuckie with great pride the McDonald’s secret for making french fries.  I showed him how to peel the potatoes, leaving just a bit of the skin to add flavor.  Then I cut them into shoestring strips and dumped them into a sink of cold water.  The ritual captivated me.  I rolled my sleeves to the elbows and, after scrubbing down in proper hospital fashion, I immersed my arms and gently stirred the potatoes until the water went white with starch.  Then I rinsed them thoroughly and put them into a basket for deep frying in fresh oil.

The only trouble was that, after following this process, the french fries tasted like mush.  Something had gone wrong or there was a missing step.  Eventually Kroc learned that potatoes taste better if they’re allowed to dry out.  (Without knowing it, the McDonald brothers had been letting their potatoes dry in the desert breeze.)  It took Kroc and associates three months before they perfected the process of making french fries.

Kroc’s first store was in a mediocre location, but it did well.  Many of Kroc’s golfing friends from Rolling Green became successful McDonald’s operators.

Kroc frequently helped prepare a McDonald’s for opening.  He didn’t mind mopping or cleaning the restrooms, even if he was in his suit.



Harry Sonneborn resigned as vice-president of Tastee-Freeze and sold all his stock because he wanted to work in Ray Kroc’s organization.  Sonneborn had noticed how exceptionally well a McDonald’s restaurant nearby was doing.  Kroc told him that McDonald’s couldn’t afford to hire him.  However, the company needed the help and Harry was persistent.  McDonald’s ended up hiring him.

Kroc envisioned Sonneborn dealing with finance, June Martino running the office, and he himself managing operations and new development.  Kroc, Sonneborn, and Martino worked extremely hard, but it was also fun:

We were breaking new ground, and we had to make a lot of fundamental decisions that we live with for years to come.  This is the most joyous kind of executive experience.  It’s thrilling to see your creation grow.

(Old style McDonald’s, Photo by Wahkeenah, via Wikimedia Commons)

Kroc writes that one fundamental decision he made was that the corporation would not be a supplier for its operators.  Kroc explains:

My belief was that I had to help the individual operator succeed in every way I could.  His success would ensure my success.  But I couldn’t do that and, at the same time, treat him as a customer.  There is a basic conflict in trying to treat a man as a partner on the one hand while selling him something at a profit on the other.  Once you get into the supply business, you become more concerned about what you are making on sales to your franchisee than with how his sales are doing… Our method enabled us to build a sophisticated system of purchasing that allows the operator to get his supplies at rock-bottom prices.

Opening new locations was slow and painful work.  Kroc describes what they were trying to build:

We wanted to build a restaurant system that would be known for food of consistently high quality and uniform methods of preparation.

(Photo by Ben Garney, via Wikimedia Commons)

Kroc and associates also realized that McDonald’s should go into the restaurant development business.  The idea came from Harry Sonneborn.  They started Franchise Realty Corporation with $1,000 paid-in capital.  Harry turned that into $170 million worth of real estate.  The idea was to get a property owner to lease his land on a subordinated basis.  Kroc observes:

This was the beginning of real income for McDonald’s.  Harry devised a formula for the monthly payments being made by our operators that paid our own mortgage and other expenses plus a profit.  We received this monthly minimum or a percentage of the volume the operator did, whichever was greater.

Harry succeeded in getting life insurance companies to invest, which gave McDonald’s the capital they needed to keep growing rapidly.

Kroc notes the gratitude he felt toward Harry Sonneborn and June Martino:

…June later told me that all the while her two boys were growing up, she never made it to one of their birthday parties or graduation ceremonies, and there were several times that she had to be in the office on Christmas.  I knew what she and Harry were doing, because I was in the same boat… I couldn’t give them raises to compensate them for their past efforts, but I could make sure that they would be rewarded when McDonald’s became one of the country’s major companies, which I never doubted it would.  I gave them stock ten percent to June and twenty percent to Harry and ultimately it would make them rich.



Fred Turner was a terrific worker and natural leader, says Kroc.  At first, Turner was going to be a franchisee.  To get experience, he started out as a worker in an already established McDonald’s.  But Kroc realized that Turner should be in charge of corporate operations.  Turner started at headquarters in January 1957.  The company opened twenty-five new locations that year, and Turner was involved in every one.

Also involved in each opening in 1957 was Jim Schindler, a stainless-steel supplier from Leitner Equipment Company.  At June’s suggestion, Kroc hired Schindler.  Kroc had to pay him $12,000 a year, more than Harry, June, or Ray himself was getting.  Kroc remarks that Schindler might not have come on board for that salary had he not had a Bohemian background like Kroc.

Kroc comments on a difference between Sonneborn and himself:

Harry was the scholarly type.  He analyzed situations on the basis of management theory and economic principles.  I proceeded on the strength of my salesman’s instinct and my subjective assessment of people.

(Illustration by Airdone)

Although he wasn’t perfect, Kroc excelled at picking the right people, which was central to McDonald’s success.  But Kroc couldn’t explain exactly how he did it.

Sonneborn and Kroc complemented each other in many ways.  And Fred Turner added another dimension.  For instance, the hamburger bun was an object of close attention for McDonald’s.  Fred Turner had some ideas:

We were buying our buns in the midwest from Louis Kuchuris’ Mary Ann Bakery.  At first they were cluster buns, meaning that the buns were attached to each other in clusters of four to six, and they were only partially sliced.  Fred pointed out that it would be much easier and faster for a griddle man if we had individual buns instead of clusters and if they were sliced all the way through.  The baker could afford to do it our way because of the large quantities of buns we were ordering.  Fred also worked with a cardboard box manufacturer on the design of a sturdy, reusable box for our buns.  Handling these boxes instead of the customary packages of twelve reduced the baker’s packaging cost, so he was able to give us a better price on the buns.  It also reduced our shipping costs and streamlined our operations.  With the old packages, it didn’t take long for a busy griddle man to find himself buried in paper.  Then there was the time spent opening packages, pulling buns from the cluster, and halving them.  These fractions of seconds added up to wasted minutes.  A well-run restaurant is like a winning baseball team, it makes the most of every crew member’s talents and takes advantage of every split-second opportunity to speed up service.

Many suppliers were getting the chance of a lifetime to grow with McDonald’s.  For example, Mary Ann Bakery went from being a small company to having a plant with a quarter-mile long conveyor belt.

Keep in mind that headquarters set the standards for quality, and also made recommendations for packaging.  But each franchisee did the purchasing for itself.  Headquarters also helped suppliers figure out ways to lower their costs.  These cost savings were passed to the franchisees.

Kroc describes the close attention paid to the hamburger patty:

We decided that our patties would be ten to the pound, and that soon became the standard for the industry.  Fred did a lot of experimenting in the packaging of patties, too.  There was a kind of paper that was exactly right, he felt, and he tested and tested until he found out what it was.  It had to have enough wax on it so that the patty would pop off without sticking when you slapped it onto the griddle.  But it couldn’t be too stiff or the patties would slide and refuse to stack up.  There also was a science in stacking patties.  If you made the stack too high, the ones on the bottom would be misshapen and dried out.  So we arrived at the optimum stack, and that determined the height of our meat suppliers’ packages.  The purpose of all these refinements, and we never lost sight of it, was to make our griddle man’s job easier to do quickly and well.  All the other considerations of cost cutting, inventory control, and so forth were important to be sure, but they were secondary to the critical detail of what happened there at that smoking griddle.  This was the vital passage in our assembly line, and the product had to flow through it smoothly or the whole plant would falter.



In 1960, three life insurance companies agreed to lend the company $1.5 million in exchange for 22.5 percent of the stock.  The insurance companies did well when they sold their stock a few years later for $7 to $10 million.  Had they held their stock until 1973, however, they would have gotten over $500 million dollars.  In any case, the loan was vital to the company’s rapid expansion in the 1960s.

McDonald’s hired people and paid them as little as possible, but also gave them stock.  Those who stayed did very well.  Bob Papp became vice-president in charge of construction.  John Haran helped Harry with real estate.  Dick Boylan helped Harry with finances.

One study showed that Ray Kroc had made more millionaires than any other person in history.  Kroc comments:

I don’t know about that… I’d rather say I gave a lot of men the opportunity to become millionaires.  They did it themselves.  I merely provided the means.  But I certainly do know a powerful number of success stories.

(Photo by Bjørn Hovdal)

McDonald’s doesn’t confer success on anyone.  It takes guts and staying power to make it with one of our restaurants.  At the same time, it doesn’t require any unusual aptitude or intellect.  Any man with common sense, dedication to principles, and a love of hard work can do it.  And I have stood flatfooted before big crowds of our operators and asserted that any man who gets a McDonald’s store today and works at it relentlessly will become a success, and many will become millionaires no question.

Some people go out of their way to give the competition a bad name.  Some even suggest planting spies.  Kroc has a different view, although he readily admits going through the garbage cans of competitors.

My way of fighting the competition is the positive approach.  Stress your own strengths, emphasize quality, service, cleanliness, and value

QSC and V are core values for McDonald’s:

  • Quality
  • Service
  • Cleaniness
  • Value



The McDonald brothers offered to sell McDonald’s  all the rights, the name, and the San Bernardino store — to Kroc and associates for $2.7 million, which would give each brother a million dollars after taxes.  Harry designed a brilliant way to finance the purchase.

Kroc on the formation of Hamburger University:

The idea of holding classes for new operators and managers had occurred to me when I first brought Fred Turner into headquarters.  He was enthusiastic about it, too, and it was one of those goals that keep coming up in meetings but are put aside to make room for more pressing things.  Fred refused to let the idea get buried, though.  He collaborated with Art Bender and one of our field consultants named Nick Karos to compile a training manual for operators…

(Public domain photo)

Kroc notes the growing public attention on McDonald’s:

Ours was the kind of story the American public was longing to hear.  They’d had enough of doom and gloom and cold war politics.

Dick Boylan hired a young accountant named Gerry Newman, who was brilliant.  At the time, the company had huge revenue but no cash flow.  Newman helped the situation by changing the pay period from weekly to bimonthly.

Kroc on integrity:

…I’ve worked out many a satisfactory deal on the strength of a handshake.  On the other hand, I’ve been taken to the cleaners often enough to make me a certified cynic.  But I’m just too naturally cheerful to play that role for long…



Kroc had a hard time getting Harold Freund to come out of retirement and build a bakery to serve McDonald’s operators.  But finally Freund agreed.

Kroc was also looking for a meat supplier.  He wanted Bill Moore of Golden State Foods to do it.  But Moore’s plant and equipment were outdated, and needed an infusion of capital.  When Moore told Kroc about the problem, Kroc told him to hang in there because McDonald’s was going to keep growing rapidly.  Moore hung in there.  A few years later, Moore had enough money to build a large manufacturing and warehouse complex in City of Industry, California.  Kroc:

His meat plant there now processes 300 million hamburger patties a year for McDonald’s restaurants, and in addition, he makes syrup for soft drinks and manufactures milk-shake mix.  He also has gone into distribution for McDonald’s units.  He perfected the one-stop service idea, in which a truck pulls up to one of our stores and fills all its needs, like an old-fashioned grocery store delivery truck, with a single call.  This results in great savings for both parties….

I could tell the same story about most of the suppliers who started with us in the early days and grew right along with us.



In 1963, the company built 110 stores.  Revenue was $129.6 million [over $1 billion in 2018 dollars] and net income was $2.1 million [over $17 million in 2018 dollars].  Kroc believed in decentralized management:

We had 637 stores now, and it was unwieldy to supervise them all from Chicago.  It has always been my belief that authority should be placed at the lowest possible level.  I wanted the man closest to the stores to be able to make decisions without seeking directives from headquarters.

(Illustration by ibreakstock)

Kroc writes:

…for its size [1977], McDonald’s today is the most unstructured corporation I know, and I don’t think you could find a happier, more secure, harder working group of executives anywhere.

Back to 1966:

This was in July 1966, a year in which we broke through the top of our charts again with $200 million in sales, and the scoreboards on the golden arches in front of all our stores flipped to “OVER 2 BILLION SOLD.”  Cooper and Golin sent out a blitz of press releases interpreting the magnitude of this event for a space-conscious public.  “If laid end-to-end,” they enthused, “two billion hamburgers would circle the earth 5.4 times!”  Great fun.  Even Harry Sonneborn got caught up in the spirit of promoting McDonald’s, and he pulled off a stunt that made me proud of him.  He wanted to have us represented in the big Macy’s Thanksgiving Day parade in New York, and he approved the concept of McDonald’s All-American High School Band, made up of the two best musicians from each state and the District of Columbia.  Then he hired the world’s biggest drum and had it shipped by flatcar from a university in Texas… It was a huge success.  So was the introduction of our clown, Ronald McDonald, who made his national television debut in the parade.



Harry Sonneborn listened to forecasters telling him in 1967 that the country was headed into recession.  If true, it perhaps made sense to conserve cash and not expand much (or at all).  But such forecasts are notoriously unreliable, especially as a guide to business.  No one knows when bears markets or recessions will come.

Warren Buffett puts it best:

  • We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.
  • Market forecasters will fill your ear but never fill your wallet.
  • Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.
  • [On economic forecasts:] Why spend time talking about something you don’t know anything about?  People do it all the time, but why do it?

(Illustration by Maxim Popov)

To quote Peter Lynch:

Nobody can predict interest rates, the future direction of the economy, or the stock market.  Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

Also, different individual businesses have different reactions to bear markets and recessions.  Perhaps McDonald’s could do well enough during a recession, given its cheap prices.

In any case, Harry put a moratorium on all new store development because he thought business activity was going to slow down.  But there were many dozens of new locations in the works.  Why not proceed?  Kroc thought McDonald’s should continue opening new locations.  Kroc argued with Harry and forced the issue, with the result that Harry resigned.

McDonald’s Canada did even better than McDonald’s in the United States.  There was less competition in Canada.  McDonald’s Canada achieved an average of a million dollars in sales for all their locations.  This put them ahead of the U.S. locations.



Additions to McDonald’s menu over the years usually came from ideas that operators had.  Filet-O-Fish, Big Mac, Hot Apple Pie, and Egg McMuffin, for example.  Kroc:

I keep a number of experimental menu additions in the works all the time.  Some of them now being tested in selected stores may find their way into general use.  Others, for a variety of reasons, will never make it.  We have a complete test kitchen and experimental lab on my ranch, where all of our products are tested; this is in addition to the creative facility in Oak Brook.

(Illustration by lkonstudio)

Kroc loves looking for new locations for McDonald’s stores:

Finding locations for McDonald’s is the most creatively fulfilling thing I can imagine.  I go out and check out a piece of property.  It’s nothing but bare ground, not producing a damned thing for anybody.  I put a building on it, and the operator gets into business there employing fifty or a hundred people, and there is new business for the garbage man, the landscape man, and the people who sell the meat and buns and potatoes and other things.  So out of that bare piece of ground comes a store that does, say, a million dollars a year in business.  Let me tell you, it’s great satisfaction to see that happen.



Kroc bought the San Diego Padres baseball team:

I was greeted like a hero in San Diego.  Old men and little boys stopped me in the street to thank me for saving baseball for the city.  The mayor presented me with an award in the opening ceremonies of our first home game.  The sportswriters also gave me an award…

During the first home game, Kroc grabbed the microphone in the public address booth.  He apologized to the crowd for the poor performance of the team.  He said he was “disgusted.”  This led to a new rule that no one but the official announcer can use the public address system during a game.  Kroc explains that it’s no crime to lose unless you fail to do your best.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Business Adventures

(Image:  Zen Buddha Silence by Marilyn Barbone.)

March 25, 2018

In 1991, when Bill Gates met Warren Buffett, Gates asked him to recommend his favorite business book.  Buffett immediately replied, “It’s Business Adventures, by John Brooks.  I’ll send you my copy.”  Gates wrote in 2014:

Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read.  John Brooks is still my favorite business writer.

It’s certainly true that many of the particulars of business have changed.  But the fundamentals have not.  Brooks’s deeper insights about business are just as relevant today as they were back then.  In terms of its longevity, Business Adventures stands alongside Benjamin Graham’s The Intelligent Investor, the 1949 book that Warren says is the best book on investing that he has ever read.


I’ve had the enormous pleasure of reading Business Adventures twice.  John Brooks is quite simply a terrific business writer.

Each chapter of the book is a separate business adventure.  Outline:

  • The Fluctuation
  • The Fate of the Edsel
  • A Reasonable Amount of Time
  • Xerox Xerox Xerox Xerox
  • Making the Customers Whole
  • The Impacted Philosophers
  • The Last Great Corner
  • A Second Sort of Life
  • Stockholder Season
  • One Free Bite



Brooks recounts J.P. Morgan’s famous answer when an acquaintance asked him what the stock market would do:  “It will fluctuate.”  Brooks then writes:

Apart from the economic advantages and disadvantages of stock exchanges – the advantage that they provide a free flow of capital to finance industrial expansion, for instance, and the disadvantage that they provide an all too convenient way for the unlucky, the imprudent, and the gullible to lose their money – their development has created a whole pattern of social behavior, complete with customs, language, and predictable responses to given events.

Brooks explains that the pattern emerged fully at the first important stock exchange in 1611 in Amsterdam.  Brooks mentions that Joseph de la Vega published, in 1688, a book about the first Dutch stock traders.  The book was aptly titled, Confusion of Confusions.

And the pattern persists on the New York Stock Exchange.  (Brooks was writing in the 1960’s, but many of his descriptions still apply.)  Brooks adds that a few Dutchmen haggling in the rain might seem to be rather far from the millions of participants in the 1960’s.  However:

The first stock exchange was, inadvertently, a laboratory in which new human reactions were revealed.  By the same token, the New York Stock Exchange is also a sociological test tube, forever contributing to the human species’ self-understanding.

On Monday, May 28, 1962, the Dow Jones Average dropped 34.95 points, or more than it had dropped on any day since October 28, 1929.  The volume was the seventh-largest ever.  Then on Tuesday, May 29, after most stocks opened down, the market reversed itself and surged upward with a large gain of 27.03.  The trading volume on Tuesday was the highest ever except for October 29, 1929.  Then on Thursday, May 31, after a holiday on Wednesday, the Dow rose 9.40 points on the fifth-greatest volume ever.


The crisis ran its course in three days, but needless to say, the post-mortems took longer.  One of de la Vega’s observations about the Amsterdam traders was that they were ‘very clever in inventing reasons’ for a sudden rise or fall in stock prices, and the Wall Street pundits certainly needed all the cleverness they could muster to explain why, in the middle of an excellent business year, the market had suddenly taken its second-worst nose dive ever up to that moment.

Many rated President Kennedy’s April crackdown on the steel industry’s planned price increase as one of the most likely causes.  Beyond that, there were comparisons to 1929.  However, there were more differences than similarities, writes Brooks.  For one thing, margin requirements were far higher in 1962 than in 1929.  Nonetheless, the weekend before the May 1962 crash, many securities dealers were occupied sending out margin calls.

In 1929, it was not uncommon for people to have only 10% equity, with 90% of the stock position based on borrowed money.  (The early Amsterdam exchange was similar.)  Since the crash in 1929, margin requirements had been raised to 50% equity (leaving 50% borrowed).

Brooks says the stock market had been falling for most of 1962 up until crash.  But apparently the news before the May crash was good.  Not that news has any necessary relationship with stock movements, although most financial reporting services seem to assume otherwise.  After a mixed opening – some stocks up, some down – on Monday, May 28, volume spiked as selling became predominant.  Volume kept going up thereafter as the selling continued.  Brooks:

Evidence that people are selling stocks at a time when they ought to be eating lunch is always regarded as a serious matter.

One problem in this crash was that the tape – which records the prices of stock trades – got delayed by 55 minutes due to the huge volume.  Some brokerage firms tried to devise their own systems to deal with this issue.  For instance, Merrill Lynch floor brokers – if they had time – would shout the results of trades into a floorside telephone connected to a “squawk box” in the firm’s head office.

Brooks remarks:

All that summer, and even into the following year, security analysts and other experts cranked out their explanations of what had happened, and so great were the logic, solemnity, and detail of these diagnoses that they lost only a little of their force through the fact that hardly any of the authors had had the slightest idea what was going to happen before the crisis occurred.

Brooks then points out that an unprecedented 56.8 percent of the total volume in the crash had been individual investors.  Somewhat surprisingly, mutual funds were a stabilizing factor.  During the Monday sell-off, mutual funds bought more than they sold.  And as stocks surged on Thursday, mutual funds sold more than they bought.  Brooks concludes:

In the last analysis, the cause of the 1962 crisis remains unfathomable;  what is known is that it occurred, and that something like it could occur again.



1955 was the year of the automobile, writes Brooks.  American auto makers sold over 7 million cars, a million more than in any previous year.  Ford Motor Company decided that year to make a new car in the medium-price range of $2,400 to $4,000.  Brooks continues:

[Ford] went ahead and designed it more or less in comformity with the fashion of the day, which was for cars that were long, wide, low, lavishly decorated with chrome, liberally supplied with gadgets… Two years later, in September, 1957, Ford put its new car, the Edsel, on the market, to the accompaniment of more fanfare than had attended the arrival of any new car since the same company’s Model A, brought out thirty years earlier.  The total amount spent on the Edsel before the first specimen went on sale was announced as a quarter of a billion dollars;  its launching… was more costly than any other consumer product in history.  As a starter toward getting its investment back, Ford counted on selling at least 200,000 Edsels the first year.

There may be an aborigine somewhere in a remote rainforest who hasn’t yet heard that things failed to turn out that way… on November 19, 1959, having lost, according to some outside estimates, around $350 million on the Edsel, the Ford Company permanently discontinued its production.

Brooks asks:

How could this have happened?  How could a company so mightily endowed with money, experience, and, presumably, brains have been guilty of such a monumental mistake?

Many claimed that Ford had paid too much attention to public-opinion polls and the motivational research it conducted.  But Brooks adds that some non-scientific elements also played a roll.  In particular, after a massive effort to come up with possible names for the car, science was ignored at the last minute and the Edsel was named for the father of the company’s president.  Brooks:

As for the design, it was arrived at without even a pretense of consulting the polls, and by the method that has been standard for years in the designing of automobiles – that of simply pooling the hunches of sundry company committees.

The idea for the Edsel started years earlier.  The company noticed that owners of cars would trade up to the medium-priced car as soon as they could.  The problem was that Ford owners were not trading up to the Mercury, Ford’s medium-priced car, but to the medium-priced cars of its rivals, General Motors and Chrysler.

Late in 1952, a group called the Forward Product Planning Committee gave much of the detailed work to the Lincoln-Mercury Division, run by Richard Krafve (pronounced “Kraffy”).  In 1954, after two years’ work, the Forward Product Planning Committee submitted to the executive committee a six-volume report.  In brief, the report predicted that there would be seventy million cars in the U.S. by 1965, and more than 40 percent of all cars sold would be in the medium-price range.  Brooks:

On the other hand, the Ford bosses were well aware of the enormous risks connected with putting a new car on the market.  They knew, for example, that of the 2,900 American makes that had been introduced since the beginning of the automobile age… only about twenty were still around.

But Ford executives felt optimistic.  They set up another agency, the Special Products Division, again with Krafve in charge.  The new car was referred to as the “E”-Car among Ford designers and workers.  “E” for Experimental.  Roy A. Brown was in charge of the E-car’s design.  Brown stated that they sought to make a car that was unique as compared to the other nineteen cars on the road at the time.

Brooks observes that Krafve later calculated that he and his associates would make at least four thousand decisions in designing the E-Car.  He thought that if they got every decision right, they could create the perfectly designed car.  Krafve admitted later, however, that there wasn’t really enough time for perfection.  They would make modifications, and then modifications of those modifications.  Then time would run out and they had to settle on the most recent modifications.

Brooks comments:

One of the most persuasive and frequently cited explanations of the Edsel’s failure is that it was a victim of the time lag between the decision to produce it and the act of putting it on the market.  It was easy to see a few years later, when smaller and less powerful cars, euphemistically called “compacts,” had become so popular as to turn the old automobile status-ladder upside down, that the Edsel was a giant step in the wrong direction, but it far from easy to see that in fat, tail-finny 1955.

As part of the marketing effort, the Special Products Division tapped David Wallace, director of planning for market research.  Wallace:

‘We concluded that cars are a means to a sort of dream fulfillment.  There’s some irrational factor in people that makes them want one kind of car rather than another – something that has nothing to do with the mechanism at all but with the car’s personality, as the customer imagines it.  What we wanted to do, naturally, was to give the E-Car the personality that would make the greatest number of people want it.’

Wallace’s group decided to get interviews of 1,600 car buyers.  The conclusion, in a nutshell, was that the E-Car could be “the smart car for the younger executive or professional family on its way up.”

As for the name of the car, Krafve had suggested to the members of the Ford family that the new car be named the Edsel Ford – the name of their father.  The three Ford brothers replied that their father probably wouldn’t want the car named after him.  Therefore, they suggested that the Special Products Division look for another name.

The Special Products Division conducted a large research project regarding the best name for the E-Car.  At one point, Wallace interviewed the poet Marianne Moore about a possible name.  A bit later, the Special Products Division contacted Foote, Cone & Belding, an advertising agency, to help with finding a name.

The advertising agency produced 18,000 names, which they then carefully pruned to 6,000.  Wallace told them that was still way too many names from which to pick.  So Foote, Cone & Belding did an all-out three-day session to cut the list down to 10 names.  They divided into two groups for this task.  By chance, when each group produced its list of 10 names, 4 of the names were the same:  Corsair, Citation, Pacer, and Ranger.

Wallace thought that Corsair was clearly the best name.  However, the Ford executive committee had a meeting at a time when all three Ford brothers were away.  Executive vice-president Ernest R. Breech, chairman of the board, led the meeting.  When Breech saw the final list of 10 names, he said he didn’t like any of them.

So Breech and the others were shown another list of names that hadn’t quite made the top 10.  The Edsel had been kept on this second list – despite the three Ford brothers being against it – for some reason, perhaps because it was the originally suggested name.  When the group came to the name “Edsel,” Breech firmly said, “Let’s call it that.”  Breech added that since there were going to be four models of the E-Car, the four favorite names – Corsair, Citation, Pacer, and Ranger – could still be used as sub-names.

Brooks writes that Foote, Cone & Belding presumably didn’t react well to the chosen name, “Edsel,” after their exhaustive research to come up with the best possible names.  But the Special Products Division had an even worse reaction.  However, there were a few, including Krafve, would didn’t object to the name.

Krafve was named Vice-President of the Ford Motor Company and General Manager, Edsel Division.  Meanwhile, Edsels were being road-tested.  Brown and other designers were already working on the subsequent year’s model.  A new set of retail dealers was already being put together.  Foote, Cone & Belding was hard at work on strategies for advertising and selling Edsels.  In fact, Fairfax M. Cone himself was leading this effort.

Cone decided to use Wallace’s idea of “the smart car for the younger executive or professional family on its way up.”  But Cone amended it to: “the smart car for the younger middle-income family or professional family on its way up.”  Cone was apparently quite confident, since he described his advertising ideas for the Edsel to some reporters.  Brooks notes with amusement:

Like a chess master that has no doubt that he will win, he could afford to explicate the brilliance of his moves even as he made them.

Normally, a large manufacturer launches a new car through dealers already handling some of its other makes.  But Krafve got permission to go all-out on the Edsel.  He could contact dealers for other car manufacturers and even dealers for other divisions of Ford.  Krafve set a goal of signing up 1,200 dealers – who had good sales records – by September 4, 1957.

Brooks remarks that Krafve had set a high goal, since a dealer’s decision to sell a new car is major.  Dealers typically have one hundred thousand dollars – more than 8x that in 2018 dollars – invested in their dealerships.

J. C. (Larry) Doyle, second to Krafve, led the Edsel sales effort.  Doyle had been with Ford for 40 years.  Brooks records that Doyle was somewhat of a maverick in his field.  He was kind and considerate, and he didn’t put much stock in the psychological studies of car buyers.  But he knew how to sell cars, which is why he was called on for the Edsel campaign.

Doyle put Edsels into a few dealerships, but kept them hidden from view.  Then he went about recruiting top dealers.  Many dealers were curious about what the Edsel looked like.  But Doyle’s group would only show dealers the car if they listened to a one-hour pitch.  This approach worked.  It seems that quite a few dealers were so convinced by the pitch that they signed up without even looking at the car in any detail.

C. Gayle Warnock, director of public relations at Ford, was in charge of keeping public interest in the Edsel – which was already high – as strong as possible.  Warnock told Krafve that public interest might be too strong, to the extent that people would be disappointed when they discovered that the Edsel was a car.  Brooks:

It was agreed that the safest way to tread the tightrope between overplaying and underplaying the Edsel would be to say nothing about the car as a whole but to reveal its individual charms a little at a time – a sort of automotive strip tease…

Brooks continues:

That summer, too, was a time of speechmaking by an Edsel foursome consisting of Krafve, Doyle, J. Emmet Judge, who was Edsel’s director of merchandise and product planning, and Robert F. G. Copeland, its assistant general sales manager for advertising, sales promotion, and training.  Ranging separately up and down and across the nation, the four orators moved around so fast and so tirelessly, that Warnock, lest he lost track of them, took to indicating their whereabouts with colored pins on a map in his office.  ‘Let’s see, Krafve goes from Atlanta to New Orleans, Doyle from Council Bluffs to Salt Lake City,’ Warnock would muse of a morning in Dearborn, sipping his second cup of coffee and then getting up to yank the pins out and jab them in again.

Needless to say, this was by far the largest advertising campaign ever conducted by Ford.  This included a three-day press preview, with 250 reporters from all over the country.  On one afternoon, the press were taken to the track to see stunt drivers in Edsels doing all kinds of tricks.  Brooks quotes the Foote, Cone man:

‘You looked over this green Michigan hill, and there were those glorious Edsels, performing gloriously in unison.  It was beautiful.  It was like the Rockettes.  It was exciting.  Morale was high.’

Brooks then writes about the advertising on September 3 – “E-Day-minus-one”:

The tone for Edsel Day’s blizzard of publicity was set by an ad, published in newspapers all over the country, in which the Edsel shared the spotlight with the Ford Company’s President Ford and Chairman Breech.  In the ad, Ford looked like a dignified young father, Breech like a dignified gentleman holding a full house against a possible straight, the Edsel just looked like an Edsel.  The accompanying text declared that the decision to produce the car had been ‘based on what we knew, guessed, felt, believed, suspected – about you,’ and added, ‘YOU are the reason behind the Edsel.’  The tone was calm and confident.  There did not seem to be much room for doubt about the reality of that full house.

The interior of the Edsel, as predicted by Krafve, had an almost absurd number of push-buttons.

The two larger models – the Corsair and the Citation – were 219 inches long, two inches longer than the biggest of the Oldsmobiles.  And they were 80 inches wide, “or about as wide as passenger cars ever get,” notes Brooks.  Each had 345 horsepower, making it more powerful than any other American car at the time of launching.

Brooks records that the car received mixed press after it was launched.  In January, 1958, Consumer Reports wrote:

The Edsel has no important basic advantage over other brands.  The car is almost entirely conventional in construction…

Three months later, Consumer Reports wrote:

[The Edsel] is more uselessly overpowered… more gadget bedecked, more hung with expensive accessories than any other car in its price class.

This report gave the Corsair and the Citation the bottom position in its competitive ratings.

Brooks says there were several factors in the downfall of the Edsel.  It wasn’t just that the design fell short, nor was it simply that the company relied too much on psychological research.  For one, many of the early Edsels suffered from a surprising variety of imperfections.  It turned out that only about half the early Edsels functioned properly.

Brooks recounts:

For the first ten days of October, nine of which were business days, there were only 2,751 deliveries – an average of just over three hundred cars a day.  In order to sell the 200,000 cars per year that would make the Edsel operation profitable the Ford Motor Company would have to move an average of between six and seven hundred each business day – a good many more than three hundred a day.  On the night of Sunday, October 13th, Ford put on a mammoth television spectacular for Edsel, pre-empting the time ordinarily allotted to the Ed Sullivan show, but though the program cost $400,000 and starred Bing Crosby and Frank Sinatra, it failed to cause any sharp spurt in sales.  Now it was obvious that things were not going well at all.

Among the former executives of the Edsel Division, opinions differ as to the exact moment when the portents of doom became unmistakable… The obvious sacrificial victim was Brown, whose stock had gone through the roof at the time of the regally accoladed debut of his design, in August, 1955.  Now, without having done anything further, for either better or worse, the poor fellow became the company scapegoat…

Ford re-committed to selling the Edsel in virtually every way that it could.  Sales eventually increased, but not nearly enough.  Ultimately, the company had to stop production.  The net loss for Ford was roughly $350 million.

Krafve rejects that the Edsel failed due to a poor choice of the name.  He maintains that it was a mistake of timing.  Had they produced the car two years earlier, when medium-sized cars were still highly popular, the Edsel would have been a success.  Brown agrees with Krafve that it was a mistake of timing.

Doyle says it was a buyers’ strike.  He claims not to understand at all why the American public suddenly switched its taste from medium-sized cars to smaller-sized cars.

Wallace argued that the Russian launch of the sputnik had caused many Americans to start viewing Detroit products as bad, especially medium-priced cars.

Brooks concludes by noting that Ford did not get hurt by this setback, nor did the majority of people associated with the Edsel.  In 1958, net income per share dropped from $5.40 to $2.12, and Ford stock dropped from a 1957 high of $60 to a low of $40.  However, by 1959, net income per-share jumped to $8.24 and the stock hit $90.

The Ford executives associated with the Edsel advanced in their careers, for the most part.  Moreover, writes Brooks:

The subsequent euphoria of these former Edsel men did not stem entirely from the fact of their economic survival;  they appear to have been enriched spiritually.  They are inclined to speak of their Edsel experience – except for those still with Ford, who are inclined to speak of it as little as possible – with the verve and garrulity of old comrades-in-arms hashing over their most thrilling campaign.




Most nineteenth-century American fortunes were enlarged by, if they were not actually founded on, the practice of insider trading…

Not until 1934 did Congress pass the Securities Exchange Act, which forbids insider trading.  Later, a 1942 rule 10B-5 held that no stock trader could “make any untrue statement of a material fact or… omit to state a material fact.”  However, observes Brooks, this rule had basically been overlooked for the subsequent couple of decades.  It was argued that insiders needed the incentive of being able to profit in order to bring forth their best efforts.  Further, some authorities said that insider trading helped the markets function more smoothly.  Finally, it was held that most stock traders “possess and conceal information of one sort or another.”

In short, the S.E.C. seemed to be refraining from doing anything regarding insider trading.  But this changed when a civil complaint was made against Texas Gulf Sulphur Company.  The case was tried in the United States District Court in Foley Square May 9 to June 21, 1966.  The presiding judge was Dudley J. Bonsal, says Brooks, who remarked at one point, “I guess we all agree that we are plowing new ground here to some extent.”

In March 1959, Texas Gulf, a New York-based company and the world’s leader producer of sulphur, began conducting aerial surveys over a vast area of eastern Canada.  They weren’t looking for sulphur or gold, but for sulphides – sulphur in combination with other useful minerals such as zinc and copper.  Texas Gulf wanted to diversify its production.

These surveys took place over two years.  Many areas of interest were noted.  The company concluded that several hundred areas were most promising, including a segment called Kidd-55, which was fifteen miles north of Timmins, Ontario, an old gold-mining town several hundred miles northwest of Toronto.

The first challenge was to get title to do exploratory drilling on Kidd-55.  It wasn’t until June, 1963, that Texas Gulf was able to begin exploring on the northeast quarter of Kidd-55.  After Texas Gulf engineer, Richard H. Clayton, completed a ground electromagnetic survey and was convinced the area had potential, the company decided to drill.  Drilling began on November 8.  Brooks writes:

The man in charge of the drilling crew was a young Texas Gulf geologist named Kenneth Darke, a cigar smoker with a rakish gleam in his eye, who looked a good deal more like the traditional notion of a mining prospector than that of the organization man that he was.

A cylindrical sample an inch and a quarter in diameter was brought out of the earth.  Darke studied it critically inch by inch using only his eyes and his knowledge.  On November 10, Darke telephoned his immediate superior, Walter Holyk, chief geologist of Texas Gulf, to report the findings at that point.

The same night, Holyk called his superior, Richard D. Mollison, a vice president of Texas Gulf.  Mollison then called his superior, Charles F. Fogarty, executive vice president and the No. 2 man at the company.  Further reports were made the next day.  Soon Holyk, Mollison, and Fogarty decided to travel to Kidd-55 to take a look for themselves.

By November 12, Holyk was on site helping Darke examine samples.  Holyk was a Canadian in his forties with a doctorate in geology from MIT.  The weather had turned bad.  Also, much of the stuff came up covered in dirt and grease, and had to be washed with gasoline.  Nonetheless, Holyk arrived at an initial estimate of the core’s content.  There seemed to be average copper content of 1.15% and average zinc content of 8.64%.  If true and if it was not just in one narrow area, this appeared to be a huge discovery.  Brooks:

Getting title would take time if it were possible at all, but meanwhile there were several steps that the company could and did take.  The drill rig was moved away from the site of the test hole.  Cut saplings were stuck in the ground around the hole, to restore the appearance of the place to a semblance of its natural state.  A second test hole was drilled, as ostentatiously as possible, some distance away, at a place where a barren core was expected – and found.  All of these camouflage measures, which were in conformity with long-established practice among miners who suspect that they have made a strike, were supplemented by an order from Texas Gulf’s president, Claude O. Stephens, that no one outside the actual exploration group, even within the company, should be told what had been found.  Late in November, the core was shipped off, in sections, to the Union Assay Office in Salt Lake City for scientific analysis of its contents.  And meanwhile, of course, Texas Gulf began discreetly putting out feelers for the purchase of the rest of Kidd-55.

Brooks adds:

And meanwhile other measures, which may or may not have been related to the events of north of Timmins, were being taken.  On November 12th, Fogarty bought three hundred shares of Texas Gulf stock;  on the 15th he added seven hundred more shares, on November 19th five hundred more, and on November 26th two hundred more.  Clayton bought two hundred on the 15th, Mollison one hundred on the same day; and Mrs. Holyk bought fifty on the 29th and one hundred more on December 10th.  But these purchases, as things turned out, were only the harbingers of a period of apparently intense affection for Texas Gulf stock among certain of its officers and employees, and even some of their friends.

The results of the sample test confirmed Holyk’s estimates.  Also found were 3.94 ounces of silver per ton.  In late December, while in the Washington, D.C. area, Darke recommended Texas Gulf stock to a girl he knew there and her mother.  They later became known as “tippees,” while a few people they later told naturally became “sub-tippees.”  Between December 30 and February 17, Darke’s tippees and sub-tippees purchased 2,100 shares of Texas Gulf stock and also bought calls on another 1,500 shares.

In the first three months of 1964, Darke bought 300 shares of Texas Gulf stock, purchased calls on 3,000 more shares, and added several more persons to his burgeoning list of tippees.  Holyk and his wife bought a large number of calls on Texas Gulf stock.  They’d hardly heard of calls before, but calls “were getting to be quite the rage in Texas Gulf circles.”

Finally in the spring, Texas Gulf had the drilling rights it needed and was ready to proceed.  Brooks:

After a final burst of purchases by Darke, his tippees, and his sub-tippees on March 30th and 31st (among them all, six hundred shares and calls on 5,100 more shares for the two days), drilling was resumed in the still-frozen muskeg at Kidd-55, with Holyk and Darke both on the site this time.

While the crew stayed on site, the geologists almost daily made the fifteen-mile trek to Simmins.  With seven-foot snowdrifts, the trip took three and a half to four hours.

At some stage – later a matter of dispute – Texas Gulf realized that it had a workable mine of large proportions.  Vice President Mollison arrived on site for a day.  Brooks:

But before going he issued instructions for the drilling of a mill test hole, which would produce a relatively large core that could be used to determine the amenability of the mineral material to routine mill processing.  Normally, a mill test hole is not drilled until a workable mine is believed to exist.  And so it may have been in this case;  two S.E.C. mining experts were to insist later, against contrary opinions of experts for the defense, that by the time Mollison gave his order, Texas Gulf had information on the basis of which it could have calculated that the ore reserves at Kidd-55 had a gross assay value of at least two hundred million dollars.

Brooks notes:

The famous Canadian mining grapevine was humming by now, and in retrospect the wonder is that it had been relatively quiet for so long.

On April 10, President Stephens had become concerned enough to ask a senior member of the board – Thomas S. Lamont of Morgan fame – whether Texas Gulf should issue a statement.  Lamont told him he could wait until the reports were published in U.S. papers, but then he should issue a statement.

The following day, April 11, the reports poured forth in the U.S. papers.  The Herald Tribune called it “the biggest ore strike since gold was discovered more than 60 years ago in Canada.”  Stephens instructed Fogarty to begin preparing a statement to be issued on Monday, April 13.  Meanwhile, the estimated value of the mine seemed to be increasing by the hour as more and more copper and zinc ore was brought to the surface.  Brooks writes:

However, Fogarty did not communicate with Timmins after Friday night, so the statement that he and his colleagues issued to the press on Sunday afternoon was not based on the most up-to-the-minute information.  Whether because of that or for some other reason, the statement did not convey the idea that Texas Gulf thought it had a new Comstock Lode.  Characterizing the published reports as exaggerated and unreliable, it admitted that recent drilling on ‘one property near Timmins’ had led to ‘preliminary indications that more drilling would be required for proper evaluation of the prospect;’  went on to say that ‘the drilling done to date has not been conclusive;’  and then, putting the same thought in what can hardly be called another way, added that ‘the work done to date has not been sufficient to reach definitive conclusions.’

The wording of this press release was sufficient to put a damper on any expectations that may have arisen due to the newspaper stories the previous Friday.  Texas Gulf stock had gone from around $17 the previous November to around $30 just before the stories.  On Monday, the stock went to $32, but then came back down and even dipped below $29 in the subsequent two days.

Meanwhile, at Kidd-55, Mollison, Holyk, and Darke talked with a visiting reporter who had been shown around the place.  Brooks:

The things they told the reporter make it clear, in retrospect, that whatever the drafters of the release may have believed on Sunday, the men at Kidd-55 knew on Monday that they had a mine and a big one.  However, the world was not to know it, or at least not from that source, until Thursday morning, when the next issue of the Miner would appear in subscribers’ mail and on newstands.

Mollison and Holyk flew to Montreal Tuesday evening for the annual convention of the Canadian Institute of Mining and Metallurgy.  They had arranged for that Wednesday, in the company of the Minister of Mines of the Province of Ontario and his deputy, to attend the convention.  En route, they briefed the minister on Kidd-55.  The minister decided he wanted to make an announcement as soon as possible.  Mollison helped the minister draft the statement.

According to the copy Mollison kept, the announcement stated that “the information now in hand… gives the company confidence to allow me to announce that Texas Gulf Sulphur has a mineable body of zinc, copper, and silver ore of substantial dimensions that will be developed and brought to production as soon as possible.”  Mollison and Holyk believed that the minister would make the announcement that evening.  But for some reason, the minister didn’t.

Texas Gulf was to have a board of directors meeting that Thursday.  Since better and better news had been coming in from Kidd-55, the company officers decided they should write a new press release, to be issued after the Thursday morning board meeting.  This statement was based on the very latest information and it read, in part, “Texas Gulf Sulphur Company has made a major strike of zinc, copper, and silver in the Timmins area… Seven drill holes are now essentially complete and indicate an ore body of at least 800 feet in length, 300 feet in width, and having a vertical depth of more than 800 feet.  This is a major discovery.  The preliminary data indicate a reserve of more than 25 million tons of ore.”

The statement also noted that “considerably more data has been accumulated,” in order to explain the difference between this statement and the previous one.  Indeed, the value of the ore was not the two hundred million dollars alleged to have been estimable a week earlier, but many times that.

The same day, engineer Clayton and company secretary Crawford bought 200 and 300 shares, respectively.  The next morning, Crawford doubled his order.

The directors’ meeting ended at ten o’clock.  Then 22 reporters entered the room.  President Stephens read the new press release.  Most reporters rushed out before he was finished to report the news.

The actions of two Texas Gulf directors, Coates and Lamont, during the next half hour were later to lead to the most controversial part of the S.E.C.’s complaint.  As Brooks writes, the essence of the controversy was timing.  The Texas Gulf news was released by the Dow Jones News Service, the well-known spot-news for investors.  In fact, a piece of news is considered to be public the moment it crosses “the broad tape.”

The morning of April 16, 1964, a Dow Jones reporter was among those who attended the Texas Gulf press conference.  He left early and called in the news around 10:10 or 10:15, according to his recollection.  Normally, a news item this important would be printed on the Dow Jones machines two or three minutes after being phoned in.  But for reasons unknown, the Texas Gulf story did not appear on the tape until 10:54.  This delay was left unexplained during the trial based on irrelevance, says Brooks.

Coates, the Texan, around the end of the press conference, called his son-in-law, H. Fred Haemisegger, a stockbroker in Houston.  Coates told Haemisegger about the Texas Gulf discovery, also saying that he waited to call until “after the public announcement” because he was “too old to get in trouble with the S.E.C.”  Coates next placed an order for 2,000 shares of Texas Gulf stock for four family trusts.  He was a trustee, but not a beneficiary.  The stock had opened at $30.  Haemisegger, by acting quickly, was able to buy a bit over $31.

Lamont hung around the press conference area for 20 minutes or so.  He recounts that he “listened to chatter” and “slapped people on the back.”  Then at 10:39 or 10:40, he called a friend at Morgan Guaranty Trust Company – Longstreet Hinton, the bank’s executive vice president and head of its trust department.  Hinton had asked Lamont earlier in the week if he knew anything about the rumors of an ore discovery made by Texas Gulf.  Lamont had said no then.

But during this phone call, Lamont told Hinton that he had some news now.  Hinton asked whether it was good.  Lamont replied either “pretty good” or “very good.”  (Brooks notes that they mean the same thing in this context.)  Hinton immediately called the bank’s trading department, got a quote on Texas Gulf, and placed an order for 3,000 shares for the account of the Nassau Hospital, of which he was treasurer.  Hinton never bothered to look at the tape – despite being advised to do so by Lamont – because Hinton felt he already had the information he needed.  (Lamont didn’t know about the inexplicable forty minute delay before the Texas Gulf news appeared on the tape.)

Then Hinton went to the office of the Morgan Guaranty officer in charge of pension trusts.  Hinton recommended buying Texas Gulf.  In less than half an hour, the bank had ordered 7,000 shares for its pension fund and profit-sharing account.

An hour after that – at 12:33 – Lamont purchased 3,000 shares for himself and his family, paying $34 1/2 for them.  The stock closed above $36.  It hit a high of over $58 later that month.  Brooks:

…and by the end of 1966, when commercial production of ore was at last underway at Kidd-55 and the enormous new mine was expected to account for one-tenth of Canada’s total annual production of copper and one-quarter of its total annual production of zinc, the stock was selling at over 100.  Anyone who had bought Texas Gulf between November 12th, 1963 and the morning (or even the lunch hour) of April 16th, 1964 had therefore at least tripled his money.

Brooks then introduces the trial:

Perhaps the most arresting aspect of the Texas Gulf trial – apart from the fact that a trial was taking place at all – was the vividness and variety of the defendants who came before Judge Bonsal, ranging as they did from a hot-eyed mining prospector like Clayton (a genuine Welchman with a degree in mining from the University of Cardiff) through vigorous and harried corporate nabobs like Fogarty and Stephens to a Texas wheeler-dealer like Coates and a polished Brahmin of finance like Lamont.

Darke did not appear at the trial, claiming his Canadian nationality.  Brooks continues:

The S.E.C., after its counsel, Frank E. Kennamer Jr. had announced his intention to “drag to light and pillory the misconduct of these defendants,” asked the court to issue a permanent injunction forbidding Fogarty, Mollison, Clayton, Holyk, Darke, Crawford, and several other corporate insiders who had bought stock or calls between November 8th, 1963 and April 15th, 1964, from ever again “engaging in any act… which operates or would operate as a fraud or deceit upon any person in connection with purchase or sale of securities”;  further – and here it was breaking entirely new ground – it prayed that the court order the defendants to make restitution to the persons they had allegedly defrauded by buying stock or calls from them on the basis of inside information.  The S.E.C. also charged that the pessimistic April 12th press release was deliberately deceptive, and asked that because of it Texas Gulf be enjoined from “making any untrue statement of material fact or omitting to state a material fact.”  Apart from any question of loss of corporate face, the nub of the matter here lay in the fact that such a judgment, if granted, might well open the way for legal action against the company by any stockholder who had sold his Texas Gulf stock to anybody in the interim between the first press release and the second one, and since the shares that had changed hands during that period had run into the millions, it was a nub indeed.

Regarding the November purchases, the defense argued that a workable mine was far from a sure thing based only on the first drill hole.  Some even argued that the hole could have turned out to be a liability rather than an asset for Texas Gulf, based on what was known then.  The people who bought stock or calls during the winter claimed that the hole had little or nothing to do with their decision.  They stated that they thought Texas Gulf was a good investment in general.  Clayton said his sudden appearance as a large investor was because he had just married a well-to-do wife.  Brooks:

The S.E.C. countered with its own parade of experts, maintaining that the nature of the first core had been such as to make the existence of a rich mine an overwhelming probability, and that therefore those privy to the facts about it had possessed a material fact.

The S.E.C. also made much of the fact that Fogarty based the initial press release on information that was two days old.  The defense countered that the company had been in a sensitive position.  If it had issued an optimistic report that later turned out to be false, it could well be accused of fraud for that.

Judge Bonsal concluded that the definition of materiality must be conservative.  He therefore decided that up until April 9th, when three converging drill holes positively established the three-dimensionality of the ore deposit, material information had not been in hand.  Therefore, the decisions of insiders to buy stock before that date, even if based on initial drilling results, were legal “educated guesses.”

Case was thus dismissed against all educated guessers who had bought stock or calls, or recommended others do so, before the evening of April 9th.  Brooks:

With Clayton and Crawford, who had been so injudicious as to buy or order stock on April 15th, it was another matter.  The judge found no evidence that they had intended to deceive or defraud anyone, but they had made their purchases with the full knowledge that a great mine had been found and that it would be announced the next day – in short, with material private information in hand.  Therefore they were found to have violated Rule 10B-5, and in due time would presumably be enjoined from doing such a thing again and made to offer restitution to the persons they bought their April 15th shares from – assuming, of course, that such persons can be found…

On the matter of the April 12th press release, the judge found that it was not false or misleading.

Still to be settled was the matter of Coates and Lamont making their purchases.  The question was when it can be said that the information has officially been made public.  This was the most important issue and would likely set a legal precedent.

The S.E.C. argued that the actions of Coates and Lamont were illegal because they occurred before the ore strike news had crossed the Dow Jones broad tape.  The S.E.C. argued, furthermore, that even if Coates and Lamont had acted after the “official” announcement, it still would be illegal unless enough time had passed so that those who hadn’t attended the press conference, or even those who hadn’t seen the initial news cross the broad tape, had enough time to absorb the information.

Defense argued first that Coates and Lamont had every reason to believe that the news was already out, since Stephens said it had been released by the Ontario Minister of Mines the previous evening.  So Coates and Lamont acted in good faith.  Second, counsel argued that for all practical purposes, the news was out, via osmosis and The Northern Miner.  Brokerage offices and the Stock Exchange had been buzzing all morning.  Lamont’s lawyers also argued that Lamont had merely told Hinton to look at the tape, not to buy any stock.  Defense argued that the S.E.C. was asking the court to write new rules and then apply them retroactively, while the plaintiff was merely asking that an old rule 10B-5, be applied broadly.

As for Lamont’s waiting for two hours, until 12:33, before buying stock for himself, the S.E.C. took issue, as Brooks records:

‘It is the Commission’s position that even after corporate information has been published in the news media, insiders, are still under a duty to refrain from securities transactions until there had elapsed a reasonable amount of time in which the securities industry, the shareholders, and the investing public can evaluate the development and make informed investment decisions… Insiders must wait at least until the information is likely to have reached the average investor who follows the market and he has had some opportunity to consider it.’

In the Texas Gulf case, the S.E.C. argued that one hour and thirty-nine minutes was not “a reasonable amount of time.”  What, then, is “a reasonable amount of time,” the S.E.C. was asked?  The S.E.C.’s counsel, Kennamer, said it “would vary from case to case.”  Kennamer added that it would be “a nearly impossible task to formulate a rigid set of rules that would apply in all situations of this sort.”

Brooks sums it up with a hint of irony:

Therefore, in the S.E.C.’s canon, the only way an insider could find out whether he had waited long enough before buying his company’s stock was by being hauled into court and seeing what the judge would decide.

Judge Bonsal rejected this argument by the S.E.C.  Moreover, he took a narrower view that, based on legal precedent, the key moment was when the press release was read.  The judge admitted that a better rule might be formulated according to which insiders had to wait at least some amount time after the initial press release so that other investors could absorb it.  However, he didn’t think he should write such a rule.  Nor should this matter be left up to the judge on a case-by-base basis.  Thus, the complaints against Coates and Lamont were dismissed.

The S.E.C. appealed all the dismissals.  Brooks concludes:

…in August, 1968, the U.S. Court of Appeals for the Second Circuit handed down a decision which flatly reversed Judge Bonsal’s findings on just about every score except the findings against Crawford and Clayton, which were affirmed.  The Appeals Court found that the original November drill hole had provided material evidence of a valuable ore deposit, and that therefore Fogarty, Mollison, Darke, Holyk, and all other insiders who had bought Texas Gulf stock or calls on it during the winter were guilty of violations of the law;  that the gloomy April 12th press release had been ambiguous and perhaps misleading;  and that Coates had improperly and illegally jumped the gun in placing his orders right after the April 16th press conference.  Only Lamont – the charges against whom had been dropped following his death shortly after the lower court decision – and a Texas Gulf office manager, John Murray, remained exonerated.



There was no economical and practical way of making copies until after 1950.  Brooks writes that the 1950’s were the pioneering years for mechanized office copying.  Although people were starting to show a compulsion to make copies, the early copying machines suffered from a number of problems.  Brooks:

…What was needed for the compulsion to flower into a mania was a technological breakthrough, and the breakthrough came at the turn of the decade with the advent of a machine that worked on a new principle, known as xerography, and was able to make dry, good-quality, permanent copies on ordinary paper with a minimum of trouble.  The effect was immediate.  Largely as a result of xerography, the estimated number of copies (as opposed to duplicates) made annually in the United States sprang from some twenty million in the mid-fifties to nine and a half billion in 1964, and to fourteen billion in 1966 – not to mention billions more in Europe, Asia, and Latin America.  More than that, the attitude of educators towards printed textbooks and of business people toward written communication underwent a discernable change;  avant-garde philosophers took to hailing xerography as a revolution comparable in importance to the invention of the wheel;  and coin-operated copy machines began turning up in candy stores and beauty parlors…

The company responsible for the great breakthrough and the one on whose machines the majority of these billions of copies were made was of course, the Xerox Corporation, of Rochester, New York.  As a result, it became the most spectacular big-business success of the nineteen-sixties.  In 1959, the year the company – then called Haloid Xerox, Inc. – introduced its first automatic xerographic office copier, its sales were thirty-three million dollars.  In 1961, they were sixty-six million, in 1963 a hundred and seventy-six million, and in 1966 over half a billion.

The company was extremely profitable.  It ranked two hundred and seventy-first in Fortune’s ranking in 1967.  However, in 1966 the company ranked sixty-third in net profits and probably ninth in the ratio of profits to sales and fifteenth in terms of market value.  Brooks continues:

…Indeed, the enthusiasm the investing public showed for Xerox made its shares the stock market Golconda of the sixties.  Anyone who bought its stock toward the end of 1959 and held on to it until early 1967 would have found his holding worth about sixty-six times its original price, and anyone who was really fore-sighted and bought Haloid in 1955 would have seen his original investment grow – one might almost say miraculously – a hundred and eighty times.  Not surprisingly, a covey of “Xerox millionaires” sprang up – several hundred of them all told, most of whom either lived in the Rochester area or had come from there.

The Haloid company was started in Rochester in 1906.  It manufactured photographic papers.  It survived OK.  But after the Second World War, due to an increase in competition and labor costs, the company was looking for new products.

More than a decade earlier, in 1938, an obscure thirty-two year-old inventor, Chester F. Carlson, was spending his spare time trying to invent an office copying machine.  Carlson had a degree in physics from the California Institute of Technology.  Carlson had hired Otto Kornei, a German refugee physicist, to help him.  Their initial copying machine was unwieldy and produced much smoke and stench.  Brooks:

The process, which Carlson called electrophotography, had – and has – five basic steps:  sensitizing a photoconductive surface to light by giving it an electrostatic charge (for example, by rubbing it with fur);  exposing this surface to a written page to form an electrostatic image;  developing the latest image by dusting the surface with a powder that will adhere only to the charged areas;  transferring the image to some sort of paper;  and fixing the image by the application of heat.

Although each individual step was already used in other technologies, this particular combination of steps was new.  Carlson carefully patented the process and began trying to sell it.  Over the ensuing five years, Carlson tried to sell the rights to every important office-equipment company in the country.  He was turned down every time.  In 1944, Carlson finally convinced Battelle Memorial Institute to conduct further development work on the process in exchange for three-quarters of any future royalties.

In 1946, various people at Haloid, including Joseph C. Wilson – who was about to become president – had noticed the work that Battelle was doing.  Wilson asked a friend of his, Sol M. Linowitz, a smart, public-spirited lawyer just back from service in the Navy, to research the work at Battelle as a “one-shot” job.  The result was an agreement giving Haloid the rights to the Carlson process in exchange for royalties for Battelle and Carlson.

At one point in the research and development process, the Haloid people got so discouraged that they considered selling most of their xerography rights to International Business Machines.  The research process became quite costly.  But Haloid committed itself to seeing it through.  It took full title of the Carlson process and assumed the full cost of development in exchange for shares in Haloid (for Battelle and Carlson).  Brooks:

…The cost was staggering.  Between 1947 and 1960, Haloid spent about seventy-five million dollars [over $800 million in 2018 dollars] on research in xerography, or about twice what it earned from its regular operations during that period;  the balance was raised through borrowing and through the wholesale issuance of common stock to anyone who was kind, reckless, or prescient enough to take it.  The University of Rochester, partly out of interest in a struggling local industry, bought an enormous quantity for its endowment fund at a price that subsequently, because of stock splits, amounted to fifty cents a share.  ‘Please don’t be mad at us if we have to sell our Haloid stock in a couple of years to cut our losses on it,’ a university official nervously warned Wilson.  Wilson promised not to be mad.  Meanwhile, he and other executives of the company took most of their pay in the form of stock, and some of them went as far as to put up their savings and the mortgages on their houses to help the cause along.

In 1961, the company changed its name to Xerox Corporation.  One unusual aspect to the story is that Xerox became rather public-minded.  Brooks quotes Wilson:

‘To set high goals, to have almost unattainable aspirations, to imbue people with the belief that they can be achieved – these are as important as the balance sheet, perhaps more so.’

This rhetoric is not uncommon.  But Xerox followed through by donating one and a half percent of its profits to educational and charitable institutions in 1965-1966.  In 1966, Xerox committed itself to the “one-per-cent program,” also called the Cleveland Plan, according to which the company gives one percent of its pre-tax income annually to educational institutions, apart from any other charitable activities.

Furthermore, President Wilson said in 1964, “The corporation cannot refuse to take a stand on public issues of major concern.”  As Brooks observes, this is “heresy” for a business because it could alienate customers or potential customers.  Xerox’s chief stand was in favor of the United Nations.  Brooks:

Early in 1964, the company decided to spend four million dollars – a year’s advertising budget – on underwriting a series of network-television programs dealing with the U.N., the programs to be unaccompanied by commercials or any other identification of Xerox apart from a statement at the beginning and end of each that Xerox had paid for it.

Xerox was inundated with letters opposing the company’s support of the U.N.  Many said that the U.N. charter had been written by American Communists and that the U.N. was an instrument for depriving Americans of their Constitutional rights.  Although only a few of these letters came from the John Birch Society, it turned out later that most of the letters were part of a meticulously planned Birch campaign.  Xerox officers and directors were not intimidated.  The U.N. series appeared in 1965 and was widely praised.

Furthermore, Xerox consistently committed itself to informing the users of its copiers of their legal responsibilities.  It took this stand despite their commercial interest.

Brooks visited Xerox in order to talk with some of its people.  First he spoke with Dr. Dessauer, a German-born engineer who had been in charge of the company’s research and engineering since 1938.  It was Dessauer who first brought Carlson’s invention to the attention of Joseph Wilson.  Brooks noticed a greeting card from fellow employees calling Dessauer the “Wizard.”

Dr. Dessauer told Brooks about the old days.  Dessauer said money was the main problem.  Many team members gambled heavily on the xerox project.  Dessauer himself mortgaged his house.  Early on, team members would often say the damn thing would never work.  Even if it did work, the marketing people said there was only a market for a few thousand of the machines.

Next Brooks spoke with Dr. Harold E. Clark, who had been a professor of physics before coming to Haloid in 1949.  Dr. Clark was in charge of the xerography-development program under Dr. Dessauer.  Dr. Clark told Brooks that Chet Carlson’s invention was amazing.  Also, no one else invented something similar at the same time, unlike the many simultaneous discoveries in scientific history.  The only problem, said Dr. Clark, was that it wasn’t a good product.

The main trouble was that Carlson’s photoconductive surface, which was coated with sulphur, lost its qualities after it had made a few copies and became useless.  Acting on a hunch unsupported by scientific theory, the Battelle researchers tried adding to the sulphur a small quantity of selenium, a non-metallic element previously used chiefly in electrical resistors and as a coloring material to redden glass.  The selenium-and-sulphur surface worked a little better than the all-sulphur one, so the Battelle men tried adding a little more selenium.  More improvement.  They gradually kept increasing the percentage until they had a surface consisting entirely of selenium – no sulphur.  That one worked best of all, and thus it was found, backhandedly, that selenium and selenium alone could make xerography practical.

Dr. Clark went on to tell Brooks that they basically patented one of the elements, of which there are not many more than one hundred.  What is more, they still don’t understand how it works.  There are no memory effects – no traces of previous copies are left on the selenium drum.  A selenium-coated drum in the lab can last a million processes, or theoretically an infinite number.  They don’t understand why.  Dr. Clark concluded that they combined “Yankee tinkering and scientific inquiry.”

Brooks spoke with Linowitz, who only had a few minutes because he had just been appointed U.S. Ambassador to the Organization of American States.  Linowitz told him:

…the qualities that made for the company’s success were idealism, tenacity, the courage to take risks, and enthusiasm.

Joseph Wilson told Brooks that his second major had been English literature.  He thought he would be a teacher or work in administration at a university.  Somehow he ended up at Harvard Business School, where he was a top student.  After that, he joined Haloid, the family business, something he’d never planned on doing.

Regarding the company’s support of the U.N., Wilson explained that world cooperation was the company’s business, because without it there would be no world and thus no business.  He went on to explain that elections were not the company’s business.  But university education, civil rights, and employment of African-Americans were their business, to name just a few examples.  So far, at least, Wilson said there hadn’t been a conflict between their civic duties and good business.  But if such a conflict arose, he hoped that the company would honor its civic responsibilities.



On November 19th, 1963, the Stock Exchange became aware that two of its member firms – J. R. Williston & Beane, Inc., and Ira Haupt & Co. – were in serious financial trouble.  This later became a crisis that was made worse by the assassination of JFK on November 22, 1963.  Brooks:

It was the sudden souring of a speculation that these two firms (along with various brokers not members of the Stock Exchange) had become involved in on behalf of a single customer – the Allied Crude Vegetable Oil & Refining Co., of Bayonne, New Jersey.  The speculation was in contracts to buy vast quantities of cotton-seed oil and soybean oil for future delivery.

Brooks then writes:

On the two previous business days – Friday the fifteenth and Monday the eighteenth – the prices had dropped an average of a little less than a cent and a half per pound, and as a result Haupt had demanded that Allied put up about fifteen million dollars in cash to keep the account seaworthy.  Allied had declined to do this, so Haupt – like any broker when a customer operating on credit has defaulted – was faced with the necessity of selling out the Allied contracts to get back what it could of its advances.  The suicidal extent of the risk that Haupt had undertaken is further indicated by the fact that while the firm’s capital in early November had amounted to only about eight million dollars, it had borrowed enough money to supply a single customer – Allied – with some thirty-seven million dollars to finance the oil speculations.  Worse still, as things turned out it had accepted as collateral for some of these advances enormous amounts of actual cottonseed oil and soybean oil from Allied’s inventory, the presence of which in tanks at Bayonne was attested to by warehouse receipts stating the precise amount and kind of oil on hand.  Haupt had borrowed the money it supplied Allied from various banks, passing along most of the warehouse receipts to the banks as collateral.  All this would have been well and good if it had not developed later that many of the warehouse receipts were forged, that much of the oil they attested to was not, and probably never had been, in Bayonne, and that Allied’s President, Anthony De Angelis (who was later sent to jail on a whole parcel of charges), had apparently pulled off the biggest commercial fraud since that of Ivar Kreuger, the match king.

What began to emerge as the main issue was that Haupt had about twenty thousand individual stock-market customers, who had never heard of Allied or commodity trading.  Williston & Beane had nine thousand individual customers.  All these accounts were frozen when the two firms were suspended by the Stock Exchange.  (Fortunately, the customers of Williston & Beane were made whole fairly rapidly.)

The Stock Exchange met with its member firms.  They decided to make the customers of Haupt whole.  G. Keith Funston, President of the Stock Exchange, urged the member firms to take over the matter.  The firms replied that the Stock Exchange should do it.  Funston replied, “If we do, you’ll have to repay us the amount we pay out.”  So it was agreed that the payment would come out of the Exchange’s treasury, to be repaid later by the member firms.

Funston next led the negotiations with Haupt’s creditor banks.  Their unanimous support was essential.  Chief among the creditors were four local banks – Chase Manhattan, Morgan Guaranty Trust, First National City, and Manufacturers Hanover Trust.  Funston proposed that the Exchange would put up the money to make the Haupt customers whole – about seven and a half million dollars.  In return, for every dollar the Exchange put up, the banks would agree to defer collection on two dollars.  So the banks would defer collection on about fifteen million.

The banks agreed to this on the condition that the Exchange’s claim to get back any of its contribution would come after the banks’ claims for their loans.  Funston and his associates at the Exchange agreed to that.  After more negotiating, there was a broad agreement on the general plan.

Early on Saturday, the Exchange’s board met and learned from Funston what was proposed.  Almost immediately, several governors rose to state that it was a matter of principle.  And so the board agreed with the plan.  Later, Funston and his associates decided to put the Exchange’s chief examiner in charge of the liquidation of Haupt in order to ensure that its twenty thousand individual customers were made whole as soon as the Exchange had put up the cash.  (The amount of cash would be at least seven and a half million, but possibly as high as twelve million.)

Fortunately, the American banks eventually all agreed to the final plan put forth by the Exchange.  Brooks notes that the banks were “marvels of cooperation.”  But agreement was still needed from the British banks.  Initially, Funston was going to make the trip to England, but he couldn’t be spared.

Several other governors quickly volunteered to go, and one of them, Gustave L. Levy, was eventually selected, on the ground that his firm, Goldman, Sachs & Co., had had a long and close association with Kleinwort, Benson, one of the British banks, and that Levy himself was on excellent terms with some of the Kleinwort, Benson partners.

The British banks were very unhappy.  But since their loans to Allied were unsecured, they didn’t have any room to negotiate.  Still, they asked for time to think the matter over.  This gave Levy an opportunity to meet with this Kleinwort, Benson friends.  Brooks:

The circumstances of the reunion were obviously less than happy, but Levy says that his friends took a realistic view of their situation and, with heroic objectivity, actually helped their fellow-Britons to see the American side of the question.

The market was closed Monday for JFK’s funeral.  Funston was still waiting for the call from Levy.  After finally getting agreement from all the British banks, Levy placed the call to Funston.

Funston felt at this point that the final agreement had been wrapped up, since all he needed was the signatures of the fifteen Haupt general partners.  The meeting with the Haupt partners ended up taking far longer than expected.  Brooks:

One startling event broke the even tenor of this gloomy meeting… someone noticed an unfamiliar and strikingly youthful face in the crowd and asked its owner to identify himself.  The unhesitating reply was, ‘I’m Russell Watson, a reporter for the Wall Street Journal.’  There was a short, stunned silence, in recognition of the fact that an untimely leak might still disturb the delicate balance of money and emotion that made up the agreement.  Watson himself, who was twenty-four and had been on the Journal for a year, has since explained how he got into the meeting, and under what circumstances he left it.  ‘I was new on the Stock Exchange beat then,’ he said afterward.  ‘Earlier in the day, there had been word that Funston would probably hold a press conference sometime that evening, so I went over to the Exchange.  At the main entrance, I asked a guard where Mr. Funston’s conference was.  The guard said it was on the sixth floor, and ushered me into an elevator.  I suppose he thought I was a banker, a Haupt partner, or a lawyer.  On the sixth floor, people were milling around everywhere.  I just walked off the elevator and into the office where the meeting was – nobody stopped me.  I didn’t understand much of what was going on.  I got the feeling that whatever was at stake, there was general agreement but still a lot of haggling over details to be done.  I didn’t recognize anybody there but Funston.  I stood around quietly for about five minutes before anybody noticed me, and then everybody said, pretty much at once, “Good God, get out of here!”  They didn’t exactly kick me out, but I saw it was time to go.’

At fifteen minutes past midnight, finally all the parties signed an agreement.

As soon as the banks opened on Tuesday, the Exchange deposited seven and a half million dollars in an account on which the Haupt liquidator – James P. Mahony – could draw.  The stock market had its greatest one-day rise in history.  A week later, by December 2, $1,750,000 had been paid out to Haupt customers.  By December 12, it was $5,400,000.  And by Christmas, it was $6,700,000.  By March 11, the pay-out had reached nine and a half million dollars and all the Haupt customers had been made whole.

  • Note:  $9.5 million in 1963 would be approximately $76 million dollars today (in 2018), due to inflation.

Brooks describes the reaction:

In Washington, President Johnson interrupted his first business day in office to telephone Funston and congratulate him.  The chairman of the S.E.C., William L. Cary, who was not ordinarily given to throwing bouquets at the Stock Exchange, said in December that it had furnished ‘a dramatic, impressive demonstration of its strength and concern for the public interest.’

Brooks later records:

Oddly, almost no one seems to have expressed gratitude to the British and American banks, which recouped something like half of their losses.  It may be that people simply don’t thank banks, except in television commercials.



Brooks opens this chapter by observing that communication is one of the biggest problems in American industry.  (Remember he was writing in the 1960’s).  Brooks:

This preoccupation with the difficulty of getting a thought out of one head and into another is something the industrialists share with a substantial number of intellectuals and creative writers, more and more of whom seemed inclined to regard communication, or the lack of it, as one of the greatest problems not just of industry, but of humanity.

Brooks then adds:

What has puzzled me is how and why, when foundations sponsor one study of communication after another, individuals and organizations fail so consistently to express themselves understandably, or how and why their listeners fail to grasp what they hear.

A few years ago, I acquired a two-volume publication of the United States Government Printing Office entitled Hearings Before the Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, United States Senate, Eighty-Seventh Congress, First Session, Pursuant to S. Res. 52, and after a fairly diligent perusal of its 1,459 pages I thought I could begin to see what the industrialists are talking about.

The hearings were conducted in April, May, and June of 1961 under the chairmanship of Senator Estes Kefauver of Tennessee.  They concerned price-fixing and bid-rigging in conspiracies in the electrical-manufacturing industry.  Brooks:

…Senator Kefauver felt that the whole matter needed a good airing.  The transcript shows that it got one, and what the airing revealed – at least within the biggest company involved – was a breakdown in intramural communication so drastic as to make the building of the tower of Babel seem a triumph of organizational rapport.

Brooks explains a bit later:

The violations, the government alleged, were committed in connection with the sale of large and expensive pieces of apparatus of a variety that is required chiefly by public and private electric-utility companies (power transformers, switchgear assemblies, and turbine-generator units, among many others), and were the outcome of a series of meetings attended by executives of the supposedly competing companies – beginning at least as early as 1956 and continuing into 1959 – at which noncompetitive price levels were agreed upon, nominally sealed bids on individual contracts were rigged in advance, and each company was allocated a certain percentage of the available business.

Brooks explains that in an average year at the time of the conspiracies, about $1.75 billion – $14 billion in 2018 dollars – was spent on the sorts of machines in question, with nearly a quarter of that local, state, and federal government spending.  Brooks gives a specific example, a 500,000-kilowatt turbine-generator, which sold for about $16 million (nearly $130 million in 2018 dollars), but was often discounted by 25 percent.  If the companies wanted to, they could effectively charge $4 million extra (nearly $32 million extra in 2018 dollars).  Any such additional costs as a result of price-fixing would, in the case of government purchases, ultimately fall on the taxpayer.

Brooks again:

To top it all off, there was a prevalent suspicion of hypocrisy in the very highest places.  Neither the chairman of the board nor the president of General Electric, the largest of the corporate defendants, had been caught on the government’s dragnet, and the same was true of Westinghouse Electric, the second-largest;  these four ultimate bosses let it be known that they had been entirely ignorant of what had been going on within their commands right up to the time the first testimony on the subject was given to the Justice Department.  Many people, however, were not satisfied by these disclaimers, and, instead, took the position that the defendant executives were men in the middle, who had broken the law only in response either to actual orders or to a corporate climate favoring price-fixing, and who were now being allowed to suffer for the sins of their superiors.  Among the unsatisfied was Judge Ganey himself, who said at the time of the sentencing, ‘One would be most naive indeed to believe that these violations of the law, so long persisted in, affecting so large a segment of the industry, and, finally, involving so many millions upon millions of dollars, were facts unknown to those responsible for the conduct of the corporation… I am convinced that in the great number of these defendants’ cases, they were torn between conscience and approved corporate policy, with the rewarding objectives of promotion, comfortable security, and large salaries.’

General Electric got most of the attention.  It was, after all, by far the largest of those companies involved.  General Electric penalized employees who admitted participation in the conspiracy.  Some saw this as good behavior, while others thought it was G.E. trying to save higher-ups by making a few sacrifices.

G.E. maintained that top executives didn’t know.  Judge Ganey thought otherwise.  But Brooks realized it couldn’t be determined:

…For, as the testimony shows, the clear waters of moral responsibility at G.E. became hopelessly muddied by a struggle to communicate – a struggle so confused that in some cases, it would appear, if one of the big bosses at G.E. had ordered a subordinate to break the law, the message would somehow have been garbled in its reception, and if the subordinate had informed the boss that he was holding conspiratorial meetings with competitors, the boss might well have been under the impression that the subordinate was gossiping idly about lawn parties or pinochle lessons.

G.E., for at least eight years, has had a rule, Directive Policy 20.5, which explicitly forbids price-fixing, bid-rigging, and similar anticompetitive practices.  The company regularly reissued 20.5 to new executives and asked them to sign their names to it.

The problem was that many, including those who signed, didn’t take 20.5 seriously.  They thought it was just a legal device.  They believed that meeting illegally with competitors was the accepted and standard practice.  They concluded that if a superior told them to comply with 20.5, he was actually ordering him to violate it.  Brooks:

Illogical as it might seem, this last assumption becomes comprehensible in light of the fact that, for a time, when some executives orally conveyed, or reconveyed, the order, they were apparently in the habit of accompanying it with an unmistakable wink.

Brooks gives an example of just such a meeting of sales managers in May 1948.  Robert Paxton, an upper-level G.E. executive who later became the company’s president, addressed the group and gave the usual warnings about antitrust violations.  William S. Ginn, a salesman under Paxton, interjected, “We didn’t see you wink.”  Paxton replied, “There was no wink.  We mean it, and these are the orders.”

Senator Kefauver asked Paxton how long he had known about such winks.  Paxton said that in 1935, he saw his boss do it following an order.  Paxton recounts that he became incensed.  Since then, he had earned a reputation as an antiwink man.

In any case, Paxton’s seemingly unambiguous order in 1948 failed to get through to Ginn, who promptly began pricing-fixing with competitors.  When asked about it thirteen years later, Ginn – having recently gotten out of jail and having lost his $135,000 a year job at G.E. – said he had gotten a contrary order from two other superiors, Henry V. B. Erben and Francis Fairman.  Brooks:

Erben and Fairman, Ginn said, had been more articulate, persuasive, and forceful in issuing their order than Paxton had been in issuing his;  Fairman, especially, Ginn stressed, had proved to be ‘a great communicator, a great philosopher, and, frankly, a great believer in stability of prices.’  Both Erben and Fairman had dismissed Paxton as naive, Ginn testified, and, in further summary of how he had been led astray, he said that ‘the people who were advocating the Devil were able to sell me better than the philosophers that were selling me the Lord.’

Unfortunately, Erben and Fairman had passed away before the hearing.  So we don’t have their testimonies.  Ginn consistently described Paxton as a philosopher-salesman on the side of the Lord.

In November, 1954, Ginn was made general manager of the transformer division.  Ralph J. Cordiner, chairman of the board at G.E. since 1949, called Ginn down to New York to order him to comply strictly with Directive 20.5.  Brooks:

Cordiner communicated this idea so successfully that it was clear enough to Ginn at the moment, but it remained so only as long as it took him, after leaving the chairman, to walk to Erben’s office.

Erben, Ginn’s direct superior, countermanded Cordiner’s order.

Erben’s extraordinary communicative prowess carried the day, and Ginn continued to meet with competitors.

At the end of 1954, Paxton took over Erben’s job and was thus Ginn’s direct superior.  Ginn kept meeting with competitors, but he didn’t tell Paxton about it, knowing his opposition to the practice.

In January 1957, Ginn became general manager of G.E.’s turbine-generator division.  Cordiner called him down again to instruct him to follow 20.5.  This time, however, Ginn got the message.  Why?  “Because my air cover was gone,” Ginn explained to the Subcommittee.  Brooks:

If Erben, who had not been Ginn’s boss since late in 1954, had been the source of his air cover, Ginn must have been without its protection for over two years, but, presumably, in the excitement of the price war he had failed to notice its absence.

In any case, Ginn apparently had reformed.  Ginn circulated copies of 20.5 among all his division managers.  He then instructed them not to even socialize with competitors.

It appears that Ginn had not been able to impart much of his shining new philosophy to others, and that at the root of his difficulty lay that old jinx, the problem of communicating.

Brooks quotes Ginn:

‘I have got to admit that I made a communication error.  I didn’t sell this thing to the boys well enough… The price is so important in the complete running of a business that, philosophically, we have got to sell people not only just the fact that it is against the law, but… that it shouldn’t be done for many, many reasons.  But it has got to be a philosophical approach and a communication approach…’

Frank E. Stehlik was general manager of the low-voltage-switchgear department from May, 1956 to February, 1960.  Stehlik not only heard 20.5 directly from his superiors in oral and written communications.  But, in addition, Stehlik was open to a more visceral type of communication he called “impacts.”  Brooks explains:

Apparently, when something happened within the company that made an impression on him, he would consult an internal sort of metaphysical voltmeter to ascertain the force of the jolt he had received, and, from the reading he got, would attempt to gauge the true drift of company policy.

In 1956, 1957, and for most of 1958, Stehlik believed that company policy clearly required compliance with 20.5.  But in the fall of 1958, Stehlik’s immediate superior, George E. Burens, told him that Paxton had told him (Burens) to have lunch with a competitor.  Paxton later testified that he categorically told Burens not to discuss prices.  But Stehlik got a different impression.

In Stehlik’s mind, this fact made an “impact.”  He felt that company policy was now in favor of disobeying 20.5.  So, late in 1958, when Burens told him to begin having price meetings with a competitor, he was not at all surprised.  Stehlik complied.

Brooks next describes the communication problem from the point of view of superiors.  Raymond W. Smith was general manager of G.E.’s transformer division, while Arthur F. Vinson was vice-president in charge G.E.’s apparatus group.  Vinson ended up becoming Smith’s immediate boss.

Smith testified that Cordiner gave him the usual order on 20.5.  But late in 1957, price competition for transformers was so intense that Smith decided on his own to start meeting with competitors to see if prices could be stabilized.  Smith thought company policy and industry practice both supported his actions.

When Vinson became Smith’s boss, Smith felt he should let him know what he was doing.  So on several occasions, Smith told Vinson, “I had a meeting with the clan this morning.”

Vinson, in his testimony, said he didn’t even recall Smith use the phrase, “meeting of the clan.”  Vinson only recalled that Smith would say things like, “Well, I am going to take this new plan on transformers and show it to the boys.”  Vinson testified that he thought Smith meant the G.E. district salespeople and the company’s customers.  Vinson claimed to be shocked when he learned that Smith was referring to price-fixing meetings with competitors.

But Smith was sure that his communication had gotten through to Vinson.  “I never got the impression that he misunderstood me,” Smith testified.

Senator Kefauver asked Vinson if he was so naive as to not know to whom “the boys” referred.  Vinson replied, “I don’t think it is too naive.   We have a lot of boys… I may be naive, but I am certainly telling the truth, and in this kind of thing I am sure I am naive.”

Kefauver pressed Vinson, asking how he could have become vice-president at $200,000 a year if he were naive.  Vinson:  “I think I could well get there by being naive in this area.  It might help.”

Brooks asks:

Was Vinson really saying to Kefauver what he seemed to be saying – that naivete about antitrust violations might be a help to a man in getting and holding a $200,000-a-year job at General Electric?  It seems unlikely.  And yet what else could he have meant?

Vinson was also implicated in another part of the case.  Four switchgear executives – Burens, Stehlik, Clarence E. Burke, and H. Frank Hentschel – testified before the grand jury (and later before the Subcommittee) that in mid-1958, Vinson had lunch with them in Dining Room B of G.E.’s switchgear works in Philadelphia, and that Vinson told them to hold price meetings with competitors.

This led the four switchgear executives to hold a series of meetings with competitors.  But Vinson told prosecutors that the lunch never took place and that he had had no knowledge at all of the conspiracy until the case broke.  Regarding the lunch, Burens, Stehlik, Burke, and Hentschel all had lie-detector tests, given by the F.B.I., and passed them.

Brooks writes:

Vinson refused to take a lie-detector test, at first explaining that he was acting on advice of counsel and against his personal inclination, and later, after hearing how the four other men had fared, arguing that if the machine had not pronounced them liars, it couldn’t be any good.

It was shown that there were only eight days in mid-1958 when Burens, Stehlik, Burke, and Hentschel all had been together at the Philadelphia plant and could have had lunch together.  Vinson produced expense accounts showing that he had been elsewhere on each of those eight days.  So the Justice Department dropped the case against Vinson.

The upper level of G.E. “came through unscathed.”  Chairman Cordiner and President Paxton did seem to be clearly against price-fixing, and unaware of all the price-fixing that had been occurring.  Paxton, during his testimony, said that he learned from his boss, Gerard Swope, that the ultimate goal of business was to produce more goods for people at lower cost.  Paxton claimed to be deeply impacted by this philosophy, explaining why he was always strongly against price-fixing.

Brooks concludes:

Philosophy seems to have reached a high point at G.E., and communication a low one.  If executives could just learn to understand one another, most of the witnesses said or implied, the problem of antitrust violations would be solved.  But perhaps the problem is cultural as well as technical, and has something to do with a loss of personal identity that comes with working in a huge organization.  The cartoonist Jules Feiffer, contemplating the communication problem in a nonindustrial context, has said, ‘Actually, the breakdown is between the person and himself.  If you’re not able to communicate successfully between yourself and yourself, how are you supposed to make it with the strangers outside?’  Suppose, purely as a hypothesis, that the owner of a company who orders his subordinates to obey the antitrust laws has such poor communication with himself that he does not really know whether he wants the order to be complied with or not.  If his order is disobeyed, the resulting price-fixing may benefit his company’s coffers;  if it is obeyed, then he has done the right thing.  In the first instance, he is not personally implicated in any wrongdoing, while in the second he is positively involved in right doing.  What, after all, can he lose?  It is perhaps reasonable to suppose that such an executive will communicate his uncertainty more forcefully than his order.



Piggly Wiggly Stores – a chain of retail self-service markets mostly in the South and West, and headquartered in Memphis – was first listed on the New York Stock Exchange in June, 1922.  Clarence Saunders was the head of Piggly Wiggly.  Brooks describes Saunders:

…a plump, neat, handsome man of forty-one who was already something of a legend in his home town, chiefly because of a house he was putting up there for himself.  Called the Pink Palace, it was an enormous structure faced with pink Georgia marble and built around an awe-inspiring white-marble Roman atrium, and, according to Saunders, it would stand for a thousand years.  Unfinished though it was, the Pink Palace was like nothing Memphis had ever seen before.  Its grounds were to include a private golf course, since Saunders liked to do his golfing in seclusion.

Brooks continues:

The game of Corner – for in its heyday it was a game, a high-stakes gambling game, pure and simple, embodying a good many of the characteristics of poker – was one phase of the endless Wall Street contest between bulls, who want the price of a stock to go up, and bears, who want it to go down.  When a game of Corner was underway, the bulls’ basic method of operation was, of course, to buy stock, and the bears’ was to sell it.

Since most bears didn’t own the stock, they would have to conduct a short sale.  This means they borrow stock from a broker and sell it.  But they must buy the stock back later in order to return it to the broker.  If they buy the stock back at a lower price, then the difference between where they initially sold the stock short, and where they later buy it back, represents their profit.  If, however, they buy the stock back at a higher price, then they suffer a loss.

There are two related risks that the short seller (the bear) faces.  First, the short seller initially borrows the stock from the broker in order to sell it.  If the broker is forced to demand the stock back from the short seller – either because the “floating supply” needs to be replenished, or because the short seller has insufficient equity (due to the stock price moving to high) – then the short seller can be forced to take a loss.  Second, technically there is no limit to how much the short seller can lose because there is no limit to how high a stock can go.

The danger of potentially unlimited losses for a short seller can be exacerbated in a Corner.  That’s because the bulls in a Corner can buy up so much of the stock that there is very little supply of it left.  As the stock price skyrockets and the supply of stock shrinks, the short seller can be forced to buy the stock back – most likely from the bulls – at an extremely high price.  This is precisely what the bulls are trying to accomplish in a Corner.

On the other hand, if the bulls end up owning most of the publicly available stock, and if the bears can ride out the Corner, then to whom can the bulls sell their stock?  If there are virtually no buyers, then the bulls have no chance of selling most of their holding.  In this case, the bulls can get stuck with a mountain of stock they can’t sell.  The achievable value of this mountain can even approach zero in some extreme cases.

Brooks explains that true Corners could not happen after the new securities legislation in the 1930’s.  Thus, Saunders was the last intentional player of the game.

Saunders was born to a poor family in Amherst County, Virginia, in 1881.  He started out working for practically nothing for a local grocer.  He then worked for a wholesale grocer in Clarksville, Tennessee, and then for another one in Memphis.  Next, he organized a retail food chain, which he sold.  Then he was a wholesale grocer before launching the retail self-service food chain he named Piggly Wiggly Stores.

By the fall of 1922, there were over 1,200 Piggly Wiggly Stores.  650 of these were owned outright by Saunders’ Piggly Wiggly Stores, Inc.  The rest were owned independently, but still paid royalties to the parent company.  For the first time, customers were allowed to go down any aisle and pick out whatever they wanted to buy.  Then they paid on their way out of the store.  Saunders didn’t know it, but he had invented the supermarket.

In November, 1922, several small companies operating Piggly Wiggly Stores in New York, New Jersey, and Connecticut went bankrupt.  These were independently owned, having nothing to do with Piggly Wiggly Stores, Inc.  Nonetheless, several stock-market operators saw what they believed was a golden opportunity for a bear raid.  Brooks:

If individual Piggly Wiggly stores were failing, they reasoned, then rumors could be spread that would lead the uninformed public to believe that the parent firm was failing, too.  To further this belief, they began briskly selling Piggly Wiggly short, in order to force the price down.  The stock yielded readily to their pressure, and within a few weeks its price, which earlier in the year had hovered around fifty dollars a share, dropped to below forty.

Saunders promptly announced to the press that he was going to “beat the Wall Street professionals at their own game” through a buying campaign.  At that point, Saunders had no experience at all with owning stock, Piggly Wiggly being the only stock he had ever owned.  Moreover, there is no reason to think Saunders was going for a Corner at this juncture.  He merely wanted to support his stock on behalf of himself and other stockholders.

Saunders borrowed $10 million dollars – about $140 million in 2018 dollars – from bankers in Memphis, Nashville, New Orleans, Chattanooga, and St. Louis.  Brooks:

Legend has it that he stuffed his ten million-plus, in bills of large denomination, into a suitcase, boarded a train for New York, and, his pockets bulging with currency that wouldn’t fit in the suitcase, marched on Wall Street, ready to do battle.

Saunders later denied this, saying he conducted his campaign from Memphis.  Brooks continues:

Wherever he was at the time, he did round up a corp of some twenty brokers, among them Jesse L. Livermore, who served as his chief of staff.  Livermore, one of the most celebrated American speculators of this century, was then forty-five years old but was still occasionally, and derisively, referred to by the nickname he had earned a couple of decades earlier – the Boy Plunger of Wall Street.  Since Saunders regarded Wall Streeters in general and speculators in particular as parasitic scoundrels intent only on battering down his stock, it seemed likely that his decision to make an ally of Livermore was a reluctant one, arrived at simply with the idea of getting the enemy chieftain into his own camp.

Within a week, Saunders had bought 105,000 shares – more than half of the 200,000 shares outstanding.  By January 1923, the stock hit $60 a share, its highest level ever.  Reports came from Chicago that the stock was cornered.  The bears couldn’t find any available supply in order to cover their short positions by buying the stock back.  The New York Stock Exchange immediately denied the rumor, saying ample amounts of Piggly Wiggly stock were still available.

Saunders then made a surprising but exceedingly crafty move.  The stock was pushing $70, but Saunders ran advertisements offering to sell it for $55.  Brooks explains:

One of the great hazards in Corner was always that even though a player might defeat his opponents, he would discover that he had won a Pyrrhic victory.  Once the short sellers had been squeezed dry, that is, the cornerer might find that the reams of stock he had accumulated in the process were a dead weight around his neck;  by pushing it all back into the market in one shove, he would drive its price down close to zero.  And if, like Saunders, he had had to borrow heavily to get into the game in the first place, his creditors could be expected to close in on him and perhaps not only divest him of his gains but drive him into bankruptcy.  Saunders apparently anticipated this hazard almost as soon as a corner was in sight, and accordingly made plans to unload some of his stock before winning instead of afterward.  His problem was to keep the stock he sold from going right back into the floating supply, thus breaking his corner;  and his solution was to sell his fifty-five-dollar shares on the installment plan.

Crucially, the buyers on the installment plan wouldn’t receive the certificates of ownership until they had paid their final installment.  This meant they couldn’t sell their shares back into the floating supply until they had finished making all their installment payments.

By Monday, March 19, Saunders owned nearly all of the 200,000 shares of Piggly Wiggly stock.  Livermore had already bowed out of the affair on March 12 because he was concerned about Saunders’ financial position.  Nonetheless, Saunders asked Livermore to spring the bear trap.  Livermore wouldn’t do it.  So Saunders himself had to do it.

On Tuesday, March 20, Saunders called for delivery all of his Piggly Wiggly stock.  By the rules of the Exchange, stock so called for had to be delivered by 2:15 the following afternoon.  There were a few shares around owned in small amounts by private investors.  Short sellers were frantically trying to find these folks.  But on the whole, there were basically no shares available outside of what Saunders himself owned.

This meant that Piggly Wiggly shares had become very illiquid – there were hardly any shares trading.  A nightmare, it seemed, for short sellers.  Some short sellers bought at $90, some at $100, some at $110.  Eventually the stock reached $124.  But then a rumor reached the floor that the governors of the Exchange were considering a suspension of trading in Piggly Wiggly, as well as an extension of the deadline for short sellers.  Piggly Wiggly stock fell to $82.

The Governing Committee of the Exchange did, in fact, made such an announcement.  They claimed that they didn’t want to see a repeat of the Northern Pacific panic.  However, many wondered whether the Exchange was just helping the short sellers, among whom were some members of the Exchange.

Saunders still hadn’t grasped the fundamental problem he now faced.  He still seemed to have several million in profits.  But only if he could actually sell his shares.

Next, the Stock Exchange announced a permanent suspension of trading in Piggly Wiggly stock and a full five day extension for short sellers to return their borrowed shares.  Short sellers had until 2:15 the following Monday.

Meanwhile, Piggly Wiggly Stores, Inc., released its annual financial statement, which revealed that sales, profits, and assets had all sharply increased from the previous year.  But everyone ignored the real value of the company.  All that mattered at this point was the game.

The extension allowed short sellers the time to find shareholders in a variety of locations around the country.  These shareholders were of course happy to dig out their stock certificates and sell them for $100 a share.  In this way, the short sellers were able to completely cover their short positions by Friday evening.  And instead of paying Saunders cash for some of his shares, the short sellers gave him more shares to settle their debt, which is the last thing Saunders wanted just then.  (A few short sellers had to pay Saunders directly.)

The upshot was that all the short sellers were in the clear, whereas Saunders was stuck owning nearly every single share of Piggly Wiggly stock.  Saunders, who had already started complaining loudly, repeated his charge that Wall Street had changed its own rule in order to let “a bunch of welchers” off the hook.

In response, the Stock Exchange issued a statement explaining its actions:

‘The enforcement simultaneously of all contracts for the return of stock would have forced the stock to any price that might be fixed by Mr. Saunders, and competitive bidding for the insufficient supply might have brought about conditions illustrated by other corners, notably the Northern Pacific corner in 1901.’

Furthermore, the Stock Exchange pointed out that its own rules allowed it to suspend trading in a stock, as well as to extend the deadline for the return of borrowed shares.

It is true that the Exchange had the right to suspend trading in a stock.  But it is unclear, to say the least, about whether the Exchange had any right to postpone the deadline for the delivery of borrowed shares.  In fact, two years after Saunders’ corner, in June, 1925, the Exchange felt bound to amend its constitution with an article stating that “whenever in the opinion of the Governing Committee a corner has been created in a security listed on the Exchange… the Governing Committee may postpone the time for deliveries on Exchange contracts therein.”



According to Brooks, other than FDR himself, perhaps no one typified the New Deal better than David Eli Lilienthal.  On a personal level, Wall Streeters found Lilienthal a reasonable fellow.  But through his association with Tennessee Valley Authority from 1933 to 1946, Lilienthal “wore horns.”  T.V.A. was a government-owned electric-power concern that was far larger than any private power corporation.  As such, T.V.A. was widely viewed on Wall Street as the embodiment of “galloping Socialism.”

In 1946, Lilienthal became the first chairman of the United States Atomic Energy Commission, which he held until February, 1950.

Brooks was curious what Lilienthal had been up to since 1950, so he did some investigating.  He found that Lilienthal was co-founder and chairman of Development & Resources Corporation.  D. & R. helps governments set up programs similar to the T.V.A.  Brooks also found that as of June, 1960, Lilienthal was a director and major shareholder of Minerals & Chemicals Corporation of America.

Lastly, Brooks discovered Lilienthal had published his third book in 1953, “Big Business: A New Era.”  In the book, he argues that:

  • the productive superiority of the United States depends on big business;
  • we have adequate safeguards against abuses by big business;
  • big businesses tend to promote small businesses, not destroy them;
  • and big business promotes individualism, rather than harms it, by reducing poverty, disease, and physical insecurity.

Lilienthal later agreed with his family that he hadn’t spent enough time on the book, although its main points were correct.  Also, he stressed that he had conceived of the book before he ever decided to transition from government to business.

In 1957, Lilienthal and his wife Helen Lamb Lilienthal had settled in a house in Princeton.  It was a few years later, at this house, that Brooks went to interview Lilienthal.  Brooks was curious to hear about how Lilienthal thought about his civic career as compared to his business career.

Lilienthal had started out as a lawyer in Chicago and he done quite well.  But he didn’t want to practice the law.  Then – in 1950 – his public career over, he was offered various professorship positions at Harvard.  He didn’t want to be a professor.  Then various law firms and businesses approached Lilienthal.  He still had no interest in practicing law.  He also rejected the business offers he received.

In May, 1950, Lilienthal took a job as a part-time consultant for Lazard Freres & Co., whose senior partner, Andre Meyer, he had met through Albert Lasker, a mutual friend.  Through Lazard Freres and Meyer, Lilienthal became a consultant and then an executive of a small company, the Minerals Separation North American Corporation.  Lazard Freres had a large interest in the concern.

The company was in trouble, and Meyer thought Lilienthal was the man to solve the case.  Through a series of mergers, acquisitions, etc., the firm went through several name changes ending, in 1960, with the name, Minerals & Chemicals Philipp Corporation.  Meanwhile, annual sales for the company went from $750,000 in 1952 to more than $274,000,000 in 1960.  (In 2018 dollars, this would be a move from $6,750,000 to $2,466,000,000.)  Brooks writes:

For Lilienthal, the acceptance of Meyer’s commission to look into the company’s affairs was the beginning of a four-year immersion in the day-to-day problems of managing a business;  the experience, he said decisively, turned out to be one of his life’s richest, and by no means only in the literal sense of that word.

Minerals Separation North American, founded in 1916 as an offshoot from a British company, was a patent firm.  It held patents on processes used to refine copper ore and other nonferrous minerals.  In 1952, Lilienthal became the president of the company.  In order to gain another source of revenue, Lilienthal arranged a merger between Minerals Separation and Attapulgus Clay Company, a producer of a rare clay used in purifying petroleum products and also a manufacturer of various household products.

The merger took place in December, 1952, thanks in part to Lilienthal’s work to gain agreement from the Attapulgus people.  The profits and stock price of the new company went up from there.  Lilienthal managed some of the day-to-day business.  And he helped with new mergers.  One in 1954, with Edgar Brothers, a leading producer of kaolin for paper coating.  Two more in 1955, with limestone firms in Ohio and Virginia.  Brooks notes that the company’s net profits quintupled between 1952 and 1955.

Lilienthal received stock options along the way.  Because the stock went up a great deal, he exercised his options and by August, 1955, Lilienthal had 40,000 shares.  Soon the stock hit $40 and was paying a $0.50 annual dividend.  Lilienthal’s financial worries were over.

Brooks asked Lilienthal how all of this felt.  Lilienthal:

‘I wanted an entrepreneurial experience.  I found a great appeal in the idea of taking a small and quite crippled company and trying to make something of it.  Building.  That kind of building, I thought, is the central thing in American free enterprise, and something I’d missed in all my government work.  I wanted to try my hand at it.  Now, about how it felt.  Well, it felt plenty exciting.  It was full of intellectual stimulation, and a lot of my old ideas changed.  I conceived a great new respect for financiers – men like Andre Meyer.  There’s a correctness about them, a certain high sense of honor, that I’d never had any conception of.  I found that business life is full of creative, original minds – along with the usual number of second-guessers, of course.  Furthermore, I found it seductive.  In fact, I was in danger of becoming a slave… I found that the things you read – for instance, that acquiring money for its own sake can become an addiction if you’re not careful – are literally true.  Certain good friends helped keep me on track… Oh, I had my problems.  I questioned myself at every step.  It was exhausting.’

A friend of Lilienthal’s told Brooks that Lilienthal had a marvelous ability to immerse himself totally in the work.  The work may not always be important.  But Lilienthal becomes so immersed, it’s as if the work becomes important simply because he’s doing it.

On the matter of money, Lilienthal said it doesn’t make much difference as long as you have enough.  Money was something he never really thought about.

Next Brooks describes Lilienthal’s experience at Development & Resources Corporation.  The situation became ideal for Lilienthal because it combined helping the world directly with the possibility of also earning a profit.

In the spring of 1955, Lilienthal and Meyer had several conversations.  Lilienthal told Meyer that he knew dozens of foreign dignitaries and technical personnel who had visited T.V.A. and shown strong interest.  Many of them told Lilienthal that at least some of their own countries would be interested in starting similar programs.

The idea for D. & R. was to accomplish very specific projects and, incidentally, to make a profit.  Meyer liked the idea – although he expected no profit – so they went forward, with Lazard Freres owning half the firm.  The executive appointments for D.& R. included important alumni from T.V.A., people with deep experience and knowledge in management, engineering, dams, electric power, and related areas.

In September, 1955, Lilienthal was at a World Bank meeting in Istanbul and he ended up speaking with Abolhassan Ebtehaj, head of a 7-year development plan in Iran.  Iran had considerable capital with which to pay for development projects, thanks to royalties from its nationalized oil industry.  Moreover, what Iran badly needed was technical and professional guidance.  Lilienthal and a colleague later visited Iran as guests of the Shah to see what could be done about Khuzistan.

Lilienthal didn’t know anything about the region at first.  But he learned that Khuzistan was in the middle of the Old Testament Elamite kingdom and later of the Persian Empire.  The ruins of Persepolis are close by.  The ruins of Susa, where King Darius had a winter palace, are at the center of Khuzistan.  Brooks quotes Lilienthal (in the 1960’s):

Nowadays, Khuzistan is one of the world’s richest oil fields  – the famous Abadan refinery is at its southern tip – but the inhabitants, two and a half million of them, haven’t benefited from that.  The rivers have flowed unused, the fabulously rich soil has lain fallow, and all but a tiny fraction of the people have continued to live in desperate poverty.

D. & R. signed a 5-year agreement with the Iranian government.  Once the project got going, there were 700 people working on it – 100 Americans, 300 Iranians, and 300 others (mostly Europeans).  In addition, 4,700 Iranian-laborers were on the various sites.  The entire project called for 14 dams on 5 different rivers.  After D. & R. completed its first 5-year contract, they signed a year-and-a-half extension including an option for an additional 5 years.

Brooks records:

While the Iranian project was proceeding, D. & R. was also busy lining up and carrying out its programs for Italy, Colombia, Ghana, the Ivory Coast, and Puerto Rico, as well as programs for private business groups in Chile and the Philippines.  A job that D. & R. had just taken on from the United States Army Corps of Engineers excited Lilienthal enormously – an investigation of the economic impact of power from a proposed dam on the Alaskan sector of the Yukon, which he described as ‘the river with the greatest hydroelectric potential remaining on this continent.’  Meanwhile, Lazard Freres maintained its financial interest in the firm and now very happily collected its share of a substantial annual profit, and Lilienthal happily took to teasing Meyer about his former skepticism as to D. & R. financial prospects.

Lilienthal wrote in his journal about the extreme poverty in Ahwaz, Khuzistan:

…visiting villages and going into mud ‘homes’ quite unbelievable – and unforgettable forever and ever.  As the Biblical oath has it:  Let my right hand wither if I ever forget how some of the most attractive of my fellow human beings live – are living tonight, only a few kilometres from here, where we visited them this afternoon…

And yet I am as sure as I am writing these notes that the Ghebli area, of only 45,000 acres, swallowed in the vastness of Khuzistan, will become as well known as, say, the community of Tupelo… became, or New Harmony or Salt Lake City when it was founded by a handful of dedicated men in a pass of the great Rockies.



The owners of public businesses in the United States are the stockholders.  But many stockholders don’t pay much attention to company affairs when things are going well.  Also, many stockholders own small numbers of shares, making it not seem worthwhile to exercise their rights as owners of the corporations.  Furthermore, many stockholders don’t understand or follow business, notes Brooks.

Brooks decided to attend several annual meetings in the spring of 1966.

What particularly commended the 1966 season to me was that it promised to be a particularly lively one.  Various reports of a new “hard-line approach” by company managements to stockholders had appeared in the press.  (I was charmed by the notion of a candidate for office announcing his new hard-line approach to voters right before an election.)

Brooks first attended the A. T. & T. annual meeting in Detroit.  Chairman Kappel came on stage, followed by eighteen directors who sat behind him, and he called the meeting to order.  Brooks:

From my reading and from annual meetings that I’d attended in past years, I knew that the meetings of the biggest companies are usually marked by the presence of so-called professional stockholders… and that the most celebrated members of this breed were Mrs. Wilma Soss, of New York, who heads an organization of women stockholders and votes the proxies of its members as well as her own shares, and Lewis D. Gilbert, also of New York, who represents his own holdings and those of his family – a considerable total.

Brooks learned that, apart from prepared comments by management, many big-company meetings are actually a dialogue between the chairman and a few professional stockholders.  So professional stockholders can come to represent, in a way, many other shareholders who might otherwise not be represented, whether because they own few shares, don’t follow business, or other reasons.

Brooks notes that occasionally some professional stockholders get boorish, silly, on insulting.  But not Mrs. Soss or Mr. Gilbert:

Mrs. Soss, a former public-relations woman who has been a tireless professional stockholder since 1947, is usually a good many cuts above this level.  True, she is not beyond playing to the gallery by wearing bizarre costumes to meetings;  she tries, with occasional success, to taunt recalcitrant chairmen into throwing her out;  she is often scolding and occasionally abusive;  and nobody could accuse her of being unduly concise.  I confess that her customary tone and manner set my teeth on edge, but I can’t help recognizing that, because she does her homework, she usually has a point.  Mr. Gilbert, who has been at it since 1933 and is the dean of them all, almost invariably has a point, and by comparison with his colleagues he is the soul of brevity and punctilio as well as of dedication and diligence.

At the A. T. & T. meeting, after the management-sponsored slate of directors had been duly nominated, Mrs. Soss got up to make a nomination of her own, Dr. Frances Arkin, a psychoanalyst.  Mrs. Soss said A. T. & T. ought to have a woman on its board and, moreover, she thought some of the company’s executives would have benefited from periodic psychiatric examinations.  (Brooks comments that things were put back into balance at another annual meeting when the chairman suggested that some of the firm’s stockholders should see a psychiatrist.)  The nomination of Dr. Arkin was seconded by Mr. Gilbert, but only after Mrs. Soss nudged him forcefully in the ribs.

A professional stockholder named Evelyn Y. Davis complained about the meeting not being in New York, as it usually is.  Brooks observed that Davis was the youngest and perhaps the best-looking, but “not the best-informed or the most temperate, serious-minded, or worldly-wise.”  Davis’ complaint was met with boos from the largely local crowd in Detroit.

After a couple of hours, Mr. Kappel was getting testy.  Soon thereafter, Mrs. Soss was complaining that while the business affiliations of the nominees for director were listed in the pamphlet handed out at the meeting, this information hadn’t been included in the material mailed to stockholders, contrary to custom.  Mrs. Soss wanted to know why.  Mrs. Soss adopted a scolding tone and Mr. Kappel an icy one, says Brooks.  “I can’t hear you,” Mrs. Soss said at one point.  “Well, if you’d just listen instead of talking…”, Mr. Kappel replied.  Then Mrs. Soss said something (Brooks couldn’t hear it precisely) that successfully baited the chairman, who got upset and had the microphone in front of Mrs. Soss turned off.  Mrs. Soss marched towards the platform and was directly facing Mr. Kappel.  Mr. Kappel said he wasn’t going to throw her out of the meeting as she wanted.  Mrs. Soss later returned to her seat and a measure of calm was restored.

Later, Brooks attended the annual meeting of Chas. Pfizer & Co., which was run by the chairman, John E. McKeen.  After the company announced record highs on all of its operational metrics, and predicted more of the same going forward, “the most intransigent professional stockholder would have been hard put to it to mount much of a rebellion at this particular meeting,” observes Brooks.

John Gilbert, brother of Lewis Gilbert, may have been the only professional stockholder present.  (Lewis Gilbert and Mrs. Davis were at the U.S. Steel meeting in Cleveland that day.)

John Gilbert is the sort of professional stockholder the Pfizer management deserves, or would like to think it does.  With an easygoing manner and a habit of punctuating his words with self-deprecating little laughs, he is the most ingratiating gadly imaginable (or was on this occasion; I’m told he isn’t always), and as he ran through what seemed to be the standard Gilbert-family repertoire of questions – on the reliability of the firms’s auditors, the salaries of its officers, the fees of its directors – he seemed almost apologetic that duty called on him to commit the indelicacy of asking such things.

The annual meeting of Communications Satellite Corporation had elements of farce, recounts Brooks.  (Brooks refers to Comsat as a “glamorous space-age communications company.”)  Mrs. Davis, Mrs. Soss, and Lewis Gilbert were in attendance.  The chairman of Comsat, who ran the meeting, was James McCormack, a West Point graduate, former Rhodes Scholar, and retired Air Force General.

Mrs. Soss made a speech which was inaudible because her microphone wasn’t working.  Next, Mrs. Davis rose to complain that there was a special door to the meeting for “distinguished guests.”  Mrs. Davis viewed this as undemocratic.  Mr. McCormack responded, “We apologize, and when you go out, please go by any door you want.”  But Mrs. Davis went on speaking.  Brooks:

And now the mood of farce was heightened when it became clear that the Soss-Gilbert faction had decided to abandon all efforts to keep ranks closed with Mrs. Davis.  Near the height of her oration, Mr. Gilbert, looking as outraged as a boy whose ball game is being spoiled by a player who doesn’t know the rules or care about the game, got up and began shouting, ‘Point of order!  Point of order!’  But Mr. McCormack spurned this offer of parliamentary help;  he ruled Mr. Gilbert’s point of order out of order, and bade Mrs. Davis proceed.  I had no trouble deducing why he did this.  There were unmistakable signs that he, unlike any other corporate chairman I had seen in action, was enjoying every minute of the goings on.  Through most of the meeting, and especially when the professional stockholders had the floor, Mr. McCormack wore the dreamy smile of a wholly bemused spectator.

Mrs. Davis’ speech increased in volume and content, and she started making specific accusations against individual Comsat directors.  Three security guards appeared on the scene and marched to a location near Mrs. Davis, who then suddenly ended her speech and sat down.

Brooks comments:

Once, when Mr. Gilbert said something that Mrs. Davis didn’t like and Mrs. Davis, without waiting to be recognized, began shouting her objection across the room, Mr. McCormack gave a short irrepressible giggle.  That single falsetto syllable, magnificently amplified by the chairman’s microphone, was the motif of the Comsat meeting.



Brooks writes about Donald W. Wohlgemuth, a scientist for B. F. Goodrich Company in Akron, Ohio.

…he was the manager of Goodrich’s department of space-suit engineering, and over the past years, in the process of working his way up to that position, he had had a considerable part in the designing and construction of the suits worn by our Mercury astronauts on their orbital and suborbital flights.

Some time later, the International Latex Corporation, one of Goodrich’s three main competitors in the space-suit field, contacted Wohlgemuth.

…Latex had recently been awarded a subcontract, amounting to some three-quarters of a million dollars, to do research and development on space suits for the Apollo, or man-on-the-moon, project.  As a matter of fact, Latex had won this contract in competition with Goodrich, among others, and was thus for the moment the hottest company in the space-suit field.

Moreover, Wohlgemuth was not particularly happy at Goodrich for a number of reasons.  His salary was below average.  His request for air-conditioning had been turned down.

Latex was located in Dover, Delaware.  Wohlgemuth went there to meet with company representatives.  He was given a tour of the company’s space-suit-development facilities.  Overall, he was given “a real red-carpet treatment,” as he later desribed.  Eventually he was offered the position of manager of engineering for the Industrial Products Division, which included space-suit development, at an annual salary of $13,700 (over $109,000 in 2018 dollars) – solidly above his current salary.  Wohlgemuth accepted the offer.

The next morning, Wohlgemuth informed his boss at Goodrich, Carl Effler, who was not happy.  The morning after that, Wohlgemuth told Wayne Galloway – with whom he had worked closely – of his decision.

Galloway replied that in making the move Wohlgemuth would be taking to Latex certain things that did not belong to him – specifically, knowledge of the processes that Goodrich used in making space suits.

Galloway got upset with Wohlgemuth.  Later Effler called Wohlgemuth to his office and told him he should leave the Goodrich offices as soon as possible.  Then Galloway called him and told him the legal department wanted to see him.

While he was not bound to Goodrich by the kind of contract, common in American industry, in which an employee agrees not to do similar work for any competing company for a stated period of time, he had, on his return from the Army, signed a routine paper agreeing ‘to keep confidential all information, records, and documents of the company of which I may have knowledge because of my employment’ – something Wohlgemuth had entirely forgotten until the Goodrich lawyer reminded him.  Even if he had not made that agreement, the lawyer told him now, he would be prevented from going to work on space suits for Latex by established principles of trade-secrets law.  Moreover, if he persisted in his plan, Goodrich might sue him.

To make matters worse, Effler told Wohlgemuth that if he stayed at Goodrich, this incident could not be forgotten and might well impact his future.  Wohlgemuth then informed Latex that he would be unable to accept their offer.

That evening, Wohlgemuth’s dentist put him in touch with a lawyer.  Wohlgemuth talked with the lawyer, who consulted another lawyer.  They told Wohlgemuth that Goodrich was probably bluffing and wouldn’t sue him if he went to work for Latex.

The next morning – Thursday – officials of Latex called him back to assure him that their firm would bear his legal expenses in the event of a lawsuit, and, furthermore, would indemnify him against any salary losses.

Wohlgemuth decided to work for Latex, after all, and left the offices of Goodrich late that day, taking with him no documents.

The next day, R. G. Jeter, general counsel of Goodrich, called Emerson P. Barrett, director of industrial relations for Latex.  Jeter outlined Goodrich’s concern for its trade secrets.  Barrett replied that Latex was not interested in Goodrich trade secrets, but was only interested in Wohlgemuth’s “general professional abilities.”

That evening, at a farewell dinner given by forty or so friends, Wohlgemuth was called outside.  The deputy sheriff of Summit County handed him two papers.

One was a summons to appear in the Court of Common Pleas on a date a week or so off.  The other was a copy of a petition that had been filed in the same court that day by Goodrich, praying that Wohlgemuth be permanently enjoined from, among other things, disclosing to any unauthorized person any trade secrets belonging to Goodrich, and ‘performing any work for any corporation… other than plaintiff, relating to the design, manufacture and/or sale of high-altitude pressure suits, space suits and/or similar protective garments.’

For a variety of reasons, says Brooks, the trial attracted much attention.

On one side was the danger that discoveries made in the course of corporate research might become unprotectable – a situation that would eventually lead to the drying up of private research funds.  On the other side was the danger that thousands of scientists might, through their very ability and ingenuity, find themselves permanently locked in a deplorable, and possibly unconstitutional, kind of intellectual servitude – they would be barred from changing jobs because they knew too much.

Judge Frank H. Harvey presided over the trial, which took place in Akron from November 26 to December 12.  The seriousness with which Goodrich took this case is illustrated by the fact that Jeter himself, who hadn’t tried a case in 10 years, headed Goodrich’s legal team.  The chief defense counsel was Richard A. Chenoweth, of Buckingham, Doolittle & Burroughs – an Akron law firm retained by Latex.

From the outset, the two sides recognized that if Goodrich was to prevail, it had to prove, first, that it possessed trade secrets;  second, that Wohlgemuth also possessed them, and that a substantial peril of disclosure existed;  and, third, that it would suffer irreparable injury if injunctive relief was not granted.

Goodrich attorneys tried to establish that Goodrich had a good number of space-suit secrets.  Wohlgemuth, upon cross-examination from his counsel, sought to show that none of these processes were secrets at all.  Both companies brought their space suits into the courtroom.  Goodrich wanted to show what it had achieved through research.  The Latex space suit was meant to show that Latex was already far ahead of Goodrich in space-suit development, and so wouldn’t have any interest in Goodrich secrets.

On the second point, that Wohlgemuth possessed Goodrich secrets, there wasn’t much debate.  But Wohlgemuth’s lawyers did argue that he had taken no papers with him and that he was unlikely to remember the details of complex scientific processes, even if he wanted to.

On the third point, seeking injunctive relief to prevent irreparable injury, Jeter argued that Goodrich was the clear pioneer in space suits.  It made the first full-pressure flying suit in 1934.  Since then, it has invested huge amounts in space suit research and development.  Jeter characterized Latex as a newcomer intent on profiting from Goodrich’s years of research by hiring Wohlgemuth.

Furthermore, even if Wohlgemuth and Latex had the best of intentions, Wohlgemuth would inevitably give away trade secrets.  But good intentions hadn’t been demonstrated, since Latex deliberately sought Wohlgemuth, who in turn justified his decision in part on the increase in salary.  The defense disagreed that trade secrets would be revealed or that anyone had bad intentions.  The defense also got a statement in court from Wohlgemuth in which he pledged not to reveal any trade secrets of B. F. Goodrich Company.

Judge Harvey reserved the decision for a later date.  Meanwhile, the lawyers for each side fought one another in briefs intended to sway Judge Harvey.  Brooks:

…it became increasingly clear that the essence of the case was quite simple.  For all practical purposes, there was no controversy over facts.  What remained in controversy was the answer to two questions:  First, should a man be formally restrained from revealing trade secrets when he has not yet committed any such act, and when it is not clear that he intends to?  And, secondly, should a man be prevented from taking a job simply because the job presents him with unique temptations to break the law?

The defense referred to “Trade Secrets,” written by Ridsdale Ellis and published in 1953, which stated that usually it is not until there is evidence that the employee has not lived up to the contract, written or implied, that the former employer can take action.  “Every dog has one free bite.”

On February 20, 1963, Judge Harvey delivered his decision in a 9-page essay.  Goodrich did have trade secrets.  And Wohlgemuth could give these secrets to Latex.  Furthermore, there’s no doubt Latex was seeking to get Wohlgemuth for his specialized knowledge in space suits, which would be valuable for the Apollo contract.  There’s no doubt, wrote the judge, that Wohlgemuth would be able to disclose confidential information.

However, the judge said, in keeping with the one-free-bite principle, an injunction against disclosure of trade secrets cannot be issued before such disclosure has occurred unless there is clear and substantial evidence of evil intent on the part of the defendant.  In the view of the court, Wohlgemuth did not have evil intent in this case, therefore the injunction was denied.

On appeal, Judge Arthur W. Doyle partially reversed the decision.  Judge Doyle granted an injunction against Wohlgemuth from disclosing to Latex any trade secrets of Goodrich.  On the other hand, Wohlgemuth had the right to take a job in a competitive industry, and he could use his knowledge and experience – other than trade secrets – for the benefit of his employer.  Wohlgemuth was therefore free to work on space suits for Latex, provided he didn’t reveal any trade secrets of Goodrich.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


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