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: http://scholar.harvard.edu/files/shleifer/files/contrarianinvestment.pdf

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: http://boolefund.com/buffetts-best-microcap-cigar-butts/

(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: http://boolefund.com/buffetts-best-microcap-cigar-butts/

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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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.

Cheap, Solid Microcaps Far Outperform the S&P 500

(Image: Zen Buddha Silence, by Marilyn Barbone)

May 13, 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: http://boolefund.com/warren-buffett-jack-bogle/

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: http://boolefund.com/buffetts-best-microcap-cigar-butts/

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:  http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html)

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:  http://boolefund.com/joseph-piotroski-value-investing/



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: jb@boolefund.com  (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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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: https://www.walterschloss.com/

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.

Link: https://bit.ly/2jBezdv

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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com


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: http://berkshirehathaway.com/letters/2017ltr.pdf

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:  http://www.barrons.com/articles/bruce-greenwald-channeling-graham-and-dodd-1494649404
  • 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): https://www.gmo.com/docs/default-source/research-and-commentary/strategies/equities/global-equities/an-investment-only-a-mother-could-love-the-case-for-natural-resource-equities.pdf

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: http://boolefund.com/lifelong-learning/

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:  http://berkshirehathaway.com/letters/2016ltr.pdf

(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: http://berkshirehathaway.com/2017ar/2017ar.pdf)


(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:  http://boolefund.com/best-performers-microcap-stocks/
  • 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:  http://berkshirehathaway.com/letters/2016ltr.pdf



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.

www.bridgebase.com 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:  https://en.wikipedia.org/wiki/John_Rawls

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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com


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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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.

See:  https://www.gatesnotes.com/Books/Business-Adventures

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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com


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.

There’s Always Something to Do

(Image:  Zen Buddha Silence by Marilyn Barbone.)

March 18, 2018

There’s Always Something to Do:  The Peter Cundill Investment Approach, by Christopher Risso-Gill (2011), is an excellent book.  Cundill was a highly successful deep value investor whose chosen method was to buy stocks below their liquidation value.

Here is an outline for this blog post:

  • Peter Cundill
  • Getting to First Base
  • Launching a Value Fund
  • Value Investment in Action
  • Going Global
  • A Decade of Success
  • Investments and Stratagems
  • Learning From Mistakes
  • Entering the Big League
  • There’s Always Something Left to Learn
  • Pan Ocean
  • Fragile X
  • What Makes a Great Investor?
  • Glossary of Terms with Cundill’s Comments



It was December in 1973 when Peter Cundill first discovered value investing.  He was 35 years old at the time.  Up until then, despite a great deal of knowledge and experience, Cundill hadn’t yet discovered an investment strategy.  He happened to be reading George Goodman’s Super Money on a plane when he came across chapter 3 on Benjamin Graham and Warren Buffett.  Cundill wrote about his epiphany that night in his journal:

…there before me in plain terms was the method, the solid theoretical back-up to selecting investments based on the principle of realizable underlying value.  My years of apprenticeship were over:  ‘THIS IS WHAT I WANT TO DO FOR THE REST OF MY LIFE!’

What particularly caught Cundill’s attention was Graham’s notion that a stock is cheap if it sells below liquidation value.  The farther below liquidation value the stock is, the higher the margin of safety and the higher the potential returns.  This idea is at odds with modern finance theory, according to which getting higher returns always requires taking more risk.

Peter Cundill became one of the best value investors in the world.  He followed a deep value strategy based entirely on buying companies below their liquidation values.

We do liquidation analysis and liquidation analysis only.



One of Cundill’s first successful investments was in Bethlehem Copper.  Cundill built up a position at $4.50, roughly equal to cash on the balance sheet and far below liquidation value:

Both Bethlehem and mining stocks in general were totally out of favour with the investing public at the time.  However in Peter’s developing judgment this was not just an irrelevance but a positive bonus.  He had inadvertently stumbled upon a classic net-net:  a company whose share price was trading below its working capital, net of all its liabilities.  It was the first such discovery of his career and had the additional merit of proving the efficacy of value theory almost immediately, had he been able to recognize it as such.  Within four months Bethlehem had doubled and in six months he was able to start selling some of the position at $13.00.  The overall impact on portfolio performance had been dramatic.

Riso-Gill describes Cundill as having boundless curiosity.  Cundill would not only visit the worst performing stock market in the world near the end of each year in search of bargains.  But he also made a point of total immersion with respect to the local culture and politics of any country in which he might someday invest.



Early on, Cundill had not yet developed the deep value approach based strictly on buying below liquidation value.  He had, however, concluded that most models used in investment research were useless and that attempting to predict the general stock market was not doable with any sort of reliability.  Eventually Cundill immersed himself in Graham and Dodd’s Security Analysis, especially chapter 41, “The Asset-Value Factor in Common-Stock Valuation,” which he re-read and annotated many times.

When Cundill was about to take over an investment fund, he wrote to the shareholders about his proposed deep value investment strategy:

The essential concept is to buy under-valued, unrecognized, neglected, out of fashion, or misunderstood situations where inherent value, a margin of safety, and the possibility of sharply changing conditions created new and favourable investment opportunities.  Although a large number of holdings might be held, performance was invariably established by concentrating in a few holdings.  In essence, the fund invested in companies that, as a result of detailed fundamental analysis, were trading below their ‘intrinsic value.’  The intrinsic value was defined as the price that a private investor would be prepared to pay for the security if it were not listed on a public stock exchange.  The analysis was based as much on the balance sheet as it was on the statement of profit and loss.

Cundill went on to say that he would only buy companies trading below book value, preferably below net working capital less long term debt (Graham’s net-net method).  Cundill also required that the company be profitable – ideally having increased its earnings for the past five years – and dividend-paying – ideally with a regularly increasing dividend.  The price had to be less than half its former high and preferably near its all time low.  And the P/E had to be less than 10.

Cundill also studied past and future profitability, the ability of management, and factors governing sales volume and costs.  But Cundill made it clear that the criteria were not always to be followed precisely, leaving room for investment judgment, which he eventually described as an art form.

Cundill told shareholders about his own experience with the value approach thus far.  He had started with $600,000, and the portfolio increased 35.2%.  During the same period, the All Canadian Venture Fund was down 49%, the TSE industrials down 20%, and the Dow down 26%.  Cundill also notes that 50% of the portfolio had been invested in two stocks (Bethlehem Copper and Credit Foncier).

About this time, Irving Kahn became a sort of mentor to Cundill.  Kahn had been Graham’s teaching assistant at Columbia University.



Having a clearly defined set of criteria helped Cundill to develop a manageable list of investment candidates in the decade of 1974 to 1984 (which tended to be a good time for value investors).  The criteria also helped him identify a number of highly successful investments.

For example, the American Investment Company (AIC), one of the largest personal loan companies in the United States, saw its stock fall from over $30.00 to $3.00, despite having a tangible book value per share of $12.00.  As often happens with good contrarian value candidates, the fears of the market about AIC were overblown.  Eventually the retail loan market recovered, but not before Cundill was able to buy 200,000 shares at $3.00.  Two years later, AIC was taken over at $13.00 per share by Leucadia.  Cundill wrote:

As I proceed with this specialization into buying cheap securities I have reached two conclusions.  Firstly, very few people really do their homework properly, so now I always check for myself.  Secondly, if you have confidence in your own work, you have to take the initiative without waiting around for someone else to take the first plunge.

…I think that the financial community devotes far too much time and mental resource to its constant efforts to predict the economic future and consequent stock market beaviour using a disparate, and almost certainly incomplete, set of statistical variables.  It makes me wonder what might be accomplished if all this time, energy, and money were to be applied to endeavours with a better chance of proving reliable and practically useful.

Meanwhile, Cundill had served on the board of AIC, which brought some valuable experience and associations.

Cundill found another highly discounted company in Tiffany’s.  The company owned extremely valuable real estate in Manhattan that was carried on its books at a cost much lower than the current market value.  Effectively, the brand was being valued at zero.  Cundill accumulated a block of stock at $8.00 per share.  Within a year, Cundill was able to sell it at $19.00.  This seemed like an excellent result, except that six months later, Avon Products offered to buy Tiffany’s at $50.00.  Cundill would comment:

The ultimate skill in this business is in knowing when to make the judgment call to let profits run.

Sam Belzberg – who asked Cundill to join him as his partner at First City Financial – described Cundill as follows:

He has one of the most important attributes of the master investor because he is supremely capable of running counter to the herd.  He seems to possess the ability to consider a situation in isolation, cutting himself off from the mill of general opinion.  And he has the emotional confidence to remain calm when events appear to be indicating that he’s wrong.



Partly because of his location in Canada, Cundill early on believed in global value investing.  He discovered that just as individual stocks can be neglected and misunderstood, so many overseas markets can be neglected and misunderstood.  Cundill enjoyed traveling to these various markets and learning the legal accounting practices.  In many cases, the difficulty of mastering the local accounting was, in Cundill’s view, a ‘barrier to entry’ to other potential investors.

Cundill also worked hard to develop networks of locally based professionals who understood value investing principles.  Eventually, Cundill developed the policy of exhaustively searching the globe for value, never favoring domestic North American markets.



Cundill summarized the lessons of the first 10 years, during which the fund grew at an annual compound rate of 26%.  He included the following:

  • The value method of investing will tend at least to give compound rates of return in the high teens over longer periods of time.
  • There will be losing years; but if the art of making money is not to lose it, then there should not be substantial losses.
  • The fund will tend to do better in slightly down to indifferent markets and not to do as well as our growth-oriented colleagues in good markets.
  • It is ever more challenging to perform well with a larger fund…
  • We have developed a network of contacts around the world who are like-minded in value orientation.
  • We have gradually modified our approach from a straight valuation basis to one where we try to buy securities selling below liquidation value, taking into consideration off-balance sheet items.



Buying at a discount to liquidation value is simple in concept.  But in practice, it is not at all easy to do consistently well over time.  Peter Cundill explained:

None of the great investments come easily.  There is almost always a major blip for whatever reason and we have learnt to expect it and not to panic.

Although Cundill focused exclusively on discount to liquidation value when analyzing equities, he did develop a few additional areas of expertise, such as distressed debt.  Cundill discovered that, contrary to his expectation of fire-sale prices, an investor in distressed securities could often achieve large profits during the actual process of liquidation.  Success in distressed debt required detailed analysis.



1989 marked the fifteenth year in a row of positive returns for Cundill’s Value Fund.  The compound growth rate was 22%.  But the fund was only up 10% in 1989, which led Cundill to perform his customary analysis of errors:

…How does one reduce the margin of error while recognizing that investments do, of course, go down as well as up?  The answers are not absolutely clear cut but they certainly include refusing to compromise by subtly changing a question so that it shapes the answer one is looking for, and continually reappraising the research approach, constantly revisiting and rechecking the detail.

What were last year’s winners?  Why? – I usually had the file myself, I started with a small position and stayed that way until I was completely satisfied with every detail.

For most value investors, the investment thesis depends on a few key variables, which should be written down in a short paragraph.  It’s important to recheck each variable periodically.  If any part of the thesis has been invalidated, you must reassess.  Usually the stock is no longer a bargain.

It’s important not to invent new reasons for owning the stock if one of the original reasons has been falsified.  Developing new reasons for holding a stock is usually misguided.  However, you need to remain flexible.  Occasionally the stock in question is still a bargain.



In the mid 1990’s, Cundill made a large strategic shift out of Europe and into Japan.  Typical for a value investor, he was out of Europe too early and into Japan too early.  Cundill commented:

We dined out in Europe, we had the biggest positions in Deutsche Bank and Paribas, which both had big investment portfolios, so you got the bank itself for nothing.  You had a huge margin of safety – it was easy money.  We had doubles and triples in those markets and we thought we were pretty smart, so in 1996 and 1997 we took our profits and took flight to Japan, which was just so beaten up and full of values.  But in doing so we missed out on some five baggers, which is when the initial investment has multiplied five times, and we had to wait at least two years before Japan started to come good for us.

This is a recurring problem for most value investors – that tendency to buy and to sell too early.  The virtues of patience are severely tested and you get to thinking it’s never going to work and then finally your ship comes home and you’re so relieved that you sell before it’s time.  What we ought to do is go off to Bali or some such place and sit in the sun to avoid the temptation to sell too early.

As for Japan, Cundill had long ago learned the lesson that cheap stocks can stay cheap for “frustratingly long” periods of time.  Nonetheless, Cundill kept loading up on cheap Japanese stocks in a wide range of sectors.  In 1999, his Value Fund rose 16%, followed by 20% in 2000.



Although Cundill had easily avoided Nortel, his worst investment was nevertheless in telecommunications: Cable & Wireless (C&W).  In the late 1990’s, the company had to give up many of its networks in newly independent former British colonies.  The shares dropped from 15 pounds per share to 6 pounds.

A new CEO, Graham Wallace, was brought in.  He quickly and skillfully negotiated a series of asset sales, which dramatically transformed the balance sheet from net debt of 4 billion pounds to net cash of 2.6 billion pounds.  Given the apparently healthy margin of safety, Cundill began buying shares in March 2000 at just over 4 pounds per share.  (Net asset value was 4.92 pounds per share.)  Moreover:

[Wallace was] generally regarded as a relatively safe pair of hands unlikely to be tempted into the kind of acquisition spree overseen by his predecessor.

Unfortunately, a stream of investment bankers, management consultants, and brokers made a simple but convincing pitch to Wallace:

the market for internet-based services was growing at three times the rate for fixed line telephone communications and the only quick way to dominate that market was by acquisition.

Wallace proceeded to make a series of expensive acquisitions of loss-making companies.  This destroyed C&W’s balance sheet and also led to large operating losses.  Cundill now realized that the stock could go to zero, and he got out, just barely.  As Cundill wrote later:

… So we said, look they’ve got cash, they’ve got a valuable, viable business and let’s assume the fibre optic business is worth zero – it wasn’t, it was worth less than zero, much, much less!

Cundill had invested nearly $100 million in C&W, and they lost nearly $59 million.  This loss was largely responsible for the fund being down 11% in 2002.  Cundill realized that his investment team needed someone to be a sceptic for each potential investment.



In late 2002, oil prices began to rise sharply based on global growth.  Cundill couldn’t find any net-net’s among oil companies, so he avoided these stocks.  Some members of his investment team argued that there were some oil companies that were very undervalued.  Finally, Cundill announced that if anyone could find an oil company trading below net cash, he would buy it.

Cundill’s cousin, Geoffrey Scott, came across a neglected company:  Pan Ocean Energy Corporation Ltd.  The company was run by David Lyons, whose father, Vern Lyons, had founded Ocelot Energy.  Lyons concluded that there was too much competition for a small to medium sized oil company operating in the U.S. and Canada.  The risk/reward was not attractive.

What he did was to merge his own small Pan Ocean Energy with Ocelot and then sell off Ocelot’s entire North American and other peripheral parts of the portfolio, clean up the balance sheet, and bank the cash.  He then looked overseas and determined that he would concentrate on deals in Sub-Saharan Africa, where licenses could be secured for a fraction of the price tag that would apply in his domestic market.

Lyons was very thorough and extremely focused… He narrowed his field down to Gabon and Tanzania and did a development deal with some current onshore oil production in Gabon and a similar offshore gas deal in Tanzania.  Neither was expensive.

Geoffrey Scott examined Pan Ocean, and found that its share price was almost equal to net cash and the company had no debt.  He immediately let Cundill know about it.  Cundill met with David Lyons and was impressed:

This was a cautious and disciplined entrepreneur, who was dealing with a pool of cash that in large measure was his own.

Lyons invited Cundill to see the Gabon project for himself.  Eventually, Cundill saw both the Gabon project and the Tanzania project.  He liked what he saw.  Cundill’s fund bought 6% of Pan Ocean.  They made six times their money in two and a half years.



As early as 1998, Cundill had noticed a slight tremor in his right arm.  The condition worsened and affected his balance.  Cundill continued to lead a very active life, still reading and traveling all the time, and still a fitness nut.  He was as sharp as ever in 2005.  Risso-Gill writes:

Ironically, just as Peter’s health began to decline an increasing number of industry awards for his achievements started to come his way.

For instance, he received the Analyst’s Choice award as “The Greatest Mutual Fund Manager of All Time.”

In 2009, Cundill decided that it was time to step down, as his condition had progressively worsened.  He continued to be a voracious reader.



Risso-Gill tries to distill from Cundill’s voluminous journal writings what Cundill himself believed it took to be a great value investor.


Curiosity is the engine of civilization.  If I were to elaborate it would be to say read, read, read, and don’t forget to talk to people, really talk, listening with attention and having conversations, on whatever topic, that are an exchange of thoughts.  Keep the reading broad, beyond just the professional.  This helps to develop one’s sense of perspective in all matters.


Patience, patience, and more patience…


You must have the ability to focus and to block out distractions.  I am talking about not getting carried away by events or outside influences – you can take them into account, but you must stick to your framework.


Never make the mistake of not reading the small print, no matter how rushed you are.  Always read the notes to a set of accounts very carefully – they are your barometer… They will give you the ability to spot patterns without a calculator or spreadsheet.  Seeing the patterns will develop your investment insights, your instincts – your sense of smell.  Eventually it will give you the agility to stay ahead of the game, making quick, reasoned decisions, especially in a crisis.


… Either [value or growth investing] could be regarded as gambling, or calculated risk.  Which side of that scale they fall on is a function of whether the homework has been good enough and has not neglected the fieldwork.


I think it is very useful to develop a contrarian cast of mind combined with a keen sense of what I would call ‘the natural order of things.’  If you can cultivate these two attributes you are unlikely to become infected by dogma and you will begin to have a predisposition toward lateral thinking – making important connections intuitively.


I have no doubt that a strong sense of self belief is important – even a sense of mission – and this is fine as long as it is tempered by a sense of humour, especially an ability to laugh at oneself.  One of the greatest dangers that confront those who have been through a period of successful investment is hubris – the conviction that one can never be wrong again.  An ability to see the funny side of oneself as it is seen by others is a strong antidote to hubris.


Routines and discipline go hand in hand.  They are the roadmap that guides the pursuit of excellence for its own sake.  They support proper professional ambition and the commercial integrity that goes with it.


Scepticism is good, but be a sceptic, not an iconoclast.  Have rigour and flexibility, which might be considered an oxymoron but is exactly what I meant when I quoted Peter Robertson’s dictum ‘always change a winning game.’  An investment framework ought to include a liberal dose of scepticism both in terms of markets and of company accounts.


The ability to shoulder personal responsibility for one’s investment results is pretty fundamental… Coming to terms with this reality sets you free to learn from your mistakes.



Here are some of the terms.


There’s almost too much information now.  It boggles most shareholders and a lot of analysts.  All I really need is a company’s published reports and records, that plus a sharp pencil, a pocket calculator, and patience.

Doing the analysis yourself gives you confidence buying securities when a lot of the external factors are negative.  It gives you something to hang your hat on.


I’d prefer not to know what the analysts think or to hear any inside information.  It clouds one’s judgment – I’d rather be dispassionate.


I go cold when someone tips me on a company.  I like to start with a clean sheet: no one’s word.  No givens.  I’m more comfortable when there are no brokers looking over my shoulder.

They really can’t afford to be contrarians.  A major investment house can’t afford to do research for five customers who won’t generate a lot of commissions.


This started for me when Mutual Shares chieftain Mike Price, who used to be a pure net-net investor, began talking about something called the ‘extra asset syndrome’ or at least that is what I call it.  It’s taking, you might say, net-net one step farther, to look at all of a company’s assets, figure the true value.


We don’t do a lot of forecasting per se about where markets are going.  I have been burned often enough trying.


Peter Cundill has never been afraid to make his own decisions and by setting up his own fund management company he has been relatively free from external control and constraint.  He doesn’t follow investment trends or listen to the popular press about what is happening on ‘the street.’  He has travelled a lonely but profitable road.

Being willing to be the only one in the parade that’s out of step.  It’s awfully hard to do, but Peter is disciplined.  You have to be willing to wear bellbottoms when everyone else is wearing stovepipes.’ – Ross Southam


Mostly Graham, a little Buffett, and a bit of Cundill.

I like to think that if I stick to my formula, my shareholders and I can make a lot of money without much risk.

When I stray out of my comfort zone I usually get my head handed to me on a platter.

I suspect that my thinking is an eclectic mix, not pure net-net because I couldn’t do it anyway so you have to have a new something to hang your hat on.  But the framework stays the same.


I used to try and pick the best stocks in the fund portfolios, but I always picked the wrong ones.  Now I take my own money and invest it with that odd guy Peter Cundill.  I can be more detached when I treat myself as a normal client.

If it is cheap enough, we don’t care what it is.

Why will someone sell you a dollar for 50 cents?  Because in the short run, people are irrational on both the optimistic and pessimistic side.


All we try to do is buy a dollar for 40 cents.

In our style of doing things, patience is patience is patience.

One of the dangers about net-net investing is that if you buy a net-net that begins to lose money your net-net goes down and your capacity to be able to make a profit becomes less secure.  So the trick is not necessarily to predict what the earnings are going to be but to have a clear conviction that the company isn’t going bust and that your margin of safety will remain intact over time.


The difference between the price we pay for a stock and its liquidation value gives us a margin of safety.  This kind of investing is one of the most effective ways of achieving good long-term results.


If there’s a bad stock market, I’ll inevitably go back in too early.  Good times last longer than we think but so do bad times.

Markets can be overvalued and keep getting expensive, or undervalued and keep getting cheap.  That’s why investing is an art form, not a science.

I’m agnostic on where the markets will go.  I don’t have a view.  Our task is to find undervalued global securities that are trading well below their intrinsic value.  In other words, we follow the strict Benjamin Graham approach to investing.


Search out the new lows, not the new highs.  Read the Outstanding Investor Digest to find out what Mason Hawkins or Mike Price is doing.  You know good poets borrow and great poets steal.  So see what you can find.  General reading – keep looking at the news to see what’s troubled.  Experience and curiosity is a really winning combination.

What differentiates us from other money managers with a similar style is that we’re comfortable with new lows.


Many people consider value investing dull and as boring as watching paint dry.  As a consequence value investors are not always listened to, especially in a stock market bubble.  Investors are often in too much of a hurry to latch on to growth stocks to stop and listen because they’re afraid of being left out…


I don’t just calculate value using net-net.  Actually there are many different ways but you have to use what I call osmosis – you have got to feel your way.  That is the art form, because you are never going to be right completely; there is no formula that will ever get you there on its own.  Osmosis is about intuition and about discipline and about all the other things that are not quantifiable.  So can you learn it?  Yes, you can learn it, but it’s not a science, it’s an art form.  The portfolio is a canvas to be painted and filled in.


When times aren’t good I’m still there.  You find bargains among the unpopular things, the things that everybody hates.  The key is that you must have patience.


We try not to lose.  But we don’t want to try too hard.  The losses, of course, work against you in establishing decent compound rates of return.  And I hope we won’t have them.  But I don’t want to be so risk-averse that we are always trying too hard not to lose.


All I know is that if you can end up with a 20% track record over a longer period of time, the compound rates of return are such that the amounts are staggering.  But a lot of investors want excitement, not steady returns.  Most people don’t see making money as grinding it out, doing it as efficiently as possible.  If we have a strong market over the next six months and the fund begins to drop behind and there isn’t enough to do, people will say Cundill’s lost his touch, he’s boring.


…Irving Kahn gave me some advice many years ago when I was bemoaning the fact that according to my criteria there was nothing to do.  He said, ‘there is always something to do.  You just need to look harder, be creative and a little flexible.’


I don’t think I want to become too fashionable.  In some ways, value investing is boring and most investors don’t want a boring life – they want some action: win, lose, or draw.

I think the best decisions are made on the basis of what your tummy tells you.  The Jesuits argue reason before passion.  I argue reason and passion.  Intellect and intuition.  It’s a balance.

We do liquidation analysis and liquidation analysis only.

Ninety to 95% of all my investing meets the Graham tests.  The times I strayed from a rigorous application of this philosophy I got myself into trouble.

But what do you do when none of these companies is available?  The trick is to wait through the crisis stage and into the boredom stage.  Things will have settled down by then and values will be very cheap again.

We customarily do three tests: one of them asset-based – the NAV, using the company’s balance sheet.  The second is the sum of the parts, which I think is probably the most important part that goes into the balance sheet I’m creating.  And then a future NAV, which is making a stab (which I am always suspicious about) at what you think the business might be doing in three years from now.


I’ve been doing this for thirty years.  And I love it.  I’m lucky to have the kind of life where the differentiation between work and play is absolutely zilch.  I have no idea whether I’m working or whether I’m playing.

My wife says I’m a workaholic, but my colleagues say I haven’t worked for twenty years.  My work is my play.



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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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 Art of Value Investing

(Image:  Zen Buddha Silence by Marilyn Barbone.)

March 11, 2018

The Art of Value Investing (Wiley, 2013) is an excellent book by John Heins and Whitney Tilson.  Heins and Tilson have been running the monthly newsletter, Value Investor Insight, for a decade now.  Over that time, they have interviewed many of the best value investors in the world.  The Art of Value Investing is a collection of quotations carefully culled from those interviews.

I’ve selected and discussed the best quotes from the following areas:

  • Margin of Safety
  • Humility, Flexibility, and Patience
  • “Can’t Lose”: Shorting the U.S. Stock Market
  • “Can’t Lose”: Shorting the Japanese Yen
  • Courage
  • Cigar-Butt’s
  • Opportunities in Micro Caps
  • Predictable Human Irrationality
  • Long-Term Time Horizon
  • Screening and Quantitative Models



(Ben Graham, by Equim43)

Ben Graham, the father of value investing, stressed having a margin of safety by buying well below the probable intrinsic value of a stock.  This is essential because the future is uncertain.  Also, mistakes are inevitable.  (Good value investors tend to be right 60 percent of the time and wrong 40 percent of the time.)  Jean-Marie Eveillard:

Whenever Ben Graham was asked what he thought would happen to the economy or to company X’s or Y’s profits, he always used to deadpan, ‘The future is uncertain.’  That’s precisely why there’s a need for a margin of safety in investing, which is more relevant today than ever.

Value investing legend Seth Klarman:

People should be highly skeptical of anyone’s, including their own, ability to predict the future, and instead pursue strategies that can survive whatever may occur.  

The central idea in value investing is to figure out what a business is worth (approximately), and then pay a lot less to acquire part ownership of that business via stock.  Howard Marks:

If I had to identify a single key to consistently successful investing, I’d say it’s ‘cheapness.’  Buying at low prices relative to intrinsic value (rigorously and conservatively derived) holds the key to earning dependably high returns, limiting risk and minimizing losses.  It’s not the only thing that matters—obviously—but it’s something for which there is no substitute.



(Image by Wilma64)

Successful value investing, to a large extent, is about having the right mindset.  Matthew McLennan identifies humility, flexibility, and patience as key traits:

Starting with the first recorded and reliable history that we can find—a history of the Peloponnesian war by a Greek author named Thucydides—and following through a broad array of key historical global crises, you see recurring aspects of human nature that have gotten people into trouble:  hubris, dogma, and haste.  The keys to our investing approach are the symmetrical opposite of that:  humility, flexibility, and patience.

On the humility side, one of the things that Jean-Marie Eveillard firmly ingrained in the culture here is that the future is uncertain.  That results in investing with not only a price margin of safety, but in companies with conservative balance sheets and prudent and proven management teams….

In terms of flexibility, we’ve been willing to be out of the biggest sectors of the market…

The third thing in terms of temperament we think we value more than most other investors is patience.  We have a five-year average holding period….We like to plant seeds and then watch the trees grow, and our portfolio is often kind of a portrait of inactivity.

It’s hard to overstate the importance of humility in investing.  Many of the biggest investing mistakes have occurred when intelligent investors who have succeeded in the past have developed high conviction in an idea that happens to be wrong.  Kyle Bass explains this point clearly:

You obviously need to develop strong opinions and to have the conviction to stick with them when you believe you’re right, even when everybody else may think you’re an idiot.  But where I’ve seen ego get in the way is by not always being open to questions and to input that could change your mind.  If you can’t ever admit you’re wrong, you’re more likely to hang on to your losers and sell your winners, which is not a recipe for success.

It often happens in investing that ideas that seem obvious or even irrefutable turn out to be wrong.  The very best investors—such as Warren Buffett, Charlie Munger, Seth Klarman, Howard Marks, Jeremy Grantham, George Soros, and Ray Dalio—have developed enough humility to admit when they’re wrong, even when all the evidence seems to indicate that they’re right.

Here are two great examples of how seemingly irrefutable ideas can turn out to be wrong:

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



(Illustration by Eti Swinford)

Professor Russell Napier is the author of Anatomy of the Bear (Harriman House, 4th edition, 2016).  Napier was a top-rated analyst for many years and has been studying and writing about global macro strategy for institutional investors since 1995.

Napier has maintained (at least since 2012) that the U.S. stock market is significantly overvalued based on the Q-ratio and also the CAPE (cyclically adjusted P/E).  Moreover, Napier points out that every major U.S. secular bear market bottom in the last 100 years or so has seen the CAPE approach single digits.  The catalyst for the major drop has always been either inflation or deflation, states Napier.

Napier continues to argue that U.S. stocks are overvalued and that deflation will cause the U.S. stock market to drop significantly, similar to previous secular bear markets.

Many highly intelligent value investors—at least since 2012 or 2013—have maintained high cash balances and/or short positions because they essentially agree with Napier’s argument.

However, no one has ever been able to predict the stock market.  But if you follow the advice of most great value investors, you just focus on investing in individual businesses that you can understand.  There’s no need to try to predict the unpredictable.

That’s not to say there won’t be a large drop in the S&P 500 Index at some point.  But Napier was arguing—starting even before 2012—that the S&P 500 Index was overvalued at levels around 1200-1500 and that it would fall possibly as low as 400.  It’s now roughly six years later and the S&P 500 Index has recently exceeded 2700-2800.  Moreover, Jeremy Grantham, an expert on bubbles and fully aware of arguments by bears like Napier, has recently suggested the S&P 500 Index could exceed 3400-3700 before any serious break.

If the market exceeds 3400 or 3700 and then falls to 1700-2000, Napier still wouldn’t be right because he originally suggested a fall from 1200-1500 towards levels near 400.  Napier is one of the smartest market historians in the world.  This demonstrates that no one has ever been able to predict the stock market.  That’s what great value investors—including Ben Graham, Henry Singleton, Warren Buffett, Charlie Munger, Peter Lynch, and Seth Klarman—have always maintained.

The basic reason the stock market can’t be predicted is that the economy changes and evolves over time.

  • For example, Fed policy in recent decades has been to keep interest rates quite low for years in order to prevent deflation.  Very low rates cause stocks to be much higher than otherwise.
  • Profit margins are arguably higher to the extent that software (and related technologies) has become much more important in the U.S. and global economy.  The five largest U.S. companies are Google, Apple, Microsoft, Facebook, and Amazon, all technology companies.  Lower corporate taxes are likely giving a further boost to profit margins.

Jeremy Grantham, co-founder of GMO, is one of the most astute value investors who tracks fair value of the S&P 500 Index.  Grantham used to think, back in 2012-2013, that the U.S. secular bear market was not over.  Then he partially revised his view and predicted that the S&P 500 Index was likely to exceed 2250-2300.  This level would have made the S&P 500’s value two standard deviations above the historical mean, indicating that it was back in bubble territory according to GMO’s definition.

Recently, in June 2017, Grantham has revised his view again.  See: https://www.gmo.com/docs/default-source/research-and-commentary/strategies/asset-allocation/viewpoints—i-do-indeed-believe-the-us-market-will-revert-toward-its-old-means-just-very-slowly

Grantham says mean reversion for profit margins and for the CAPE (cyclically adjusted P/E) is likely, but will probably take 20 years rather than 7 years (which previously was sufficient for mean reversion).  That’s because the factors that support margins and the CAPE are themselves changing very slowly.  Those factors include Fed policy including moral hazard, lower interest rates, an aging population, slower growth, productivity, and increased political and monopoly power for corporations.

In January 2018, Grantham updated his view yet again: https://www.gmo.com/docs/default-source/research-and-commentary/strategies/asset-allocation/viewpoints—bracing-yourself-for-a-possible-near-term-melt-up.pdf?sfvrsn=4

Grantham now asserts that a market melt-up is likely over the next 6 months to 2 years.  Grantham suggests that the S&P 500 Index will exceed 3400 or 3700.  Prices are already high, but few of the usual signs of euphoria are present, which is why Grantham thinks the S&P 500 Index is not quite back to bubble territory.

The historian has to emphasize the big picture: In general are investors getting clearly carried away?  Are prices accelerating?  Is the market narrowing?  And, are at least some of the other early warnings from the previous great bubbles falling into place?

(Image by joshandandreaphotography)

As John Maynard Keynes is (probably incorrectly) reported to have said:

When the information changes, I alter my conclusions.  What do you do, sir?

There are some very smart value investors—such as Frank Martin and John Hussman—who still basically agree with Russell Napier’s views.  They may eventually be right.

But no one has ever been able to predict the stock market.  Ben Graham—with a 200 IQ—was as smart or smarter than any value investor who’s ever lived.  And here’s what Graham said near the end of his career:

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.

In 1963, Graham gave a lecture, “Securities in an Insecure World.”  Link: https://www8.gsb.columbia.edu/rtfiles/Heilbrunn/Schloss%20Archives%20for%20Value%20Investing/Articles%20by%20Benjamin%20Graham/DOC005.PDF

In the lecture, Graham admits that the Graham P/E—based on ten-year average earnings of the Dow components—was much too conservative.  Graham:

The action of the stock market since then would appear to demonstrate that these methods of valuations are ultra-conservative and much too low, although they did work out extremely well through the stock market fluctuations from 1871 to about 1954, which is an exceptionally long period of time for a test.  Unfortunately in this kind of work, where you are trying to determine relationships based upon past behavior, the almost invariable experience is that by the time you have had a long enough period to give you sufficient confidence in your form of measurement just then new conditions supersede and the measurement is no longer dependable for the future.

Graham goes on to note that, in the 1962 edition of Security Analysis, Graham and Dodd addressed this issue.  Because of the U.S. government’s more aggressive policy with respect to preventing a depression, Graham and Dodd concluded that the U.S. stock market should have a fair value 50 percent higher.

Similar logic can be applied to the S&P 500 Index today—at just over 2783.  Fed policy including moral hazard, lower interest rates, an aging population, slower growth, productivity, and increased political and monopoly power for corporations are all factors in the S&P 500 being quite high.  But Grantham is most likely right that there won’t be a true bubble until there are more signs of investors getting carried away.  Grantham reminds readers that a bubble is “Excellent Fundamentals Euphorically Extrapolated.”  Now that the global economy is doing nicely, this condition for a true bubble is now in place.

None of this suggests that an investor should attempt market timing.  Value investors can still find individual stock that are undervalued, even though there are fewer today than a few years ago.  But trying to time the market itself has almost never worked except by luck.  This has not only been observed by Graham.  But it’s also been pointed out by Peter Lynch, Seth Klarman, Henry Singleton, and Warren Buffett.  Peter Lynch is one of the best investors.  Klarman is even better.  Buffett is arguably the best.  And Singleton was even smarter than Buffett.

(Illustration by Maxim Popov)

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.

Seth Klarman:

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.

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.

Howard Marks has asked: of those who correctly predicted the bear market in 2008, how many of them predicted the recovery in 2009 and since then?  The answer: very few.  Marks points out that most of those who got 2008 right were already disposed to bearish views in general.  So when a bear market finally came, they were “right,” but the vast majority missed the recovery starting in 2009.

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.

Buffett himself made a 10-year wager against a group of talented hedge fund (and fund of hedge fund) managers.  The S&P 50 Index fund trounced the super-smart hedge funds.  See: http://berkshirehathaway.com/letters/2017ltr.pdf

Some very able investors have stayed largely in cash since 2011-2012.  The S&P 500 Index has more than doubled since then.  Moreover, many have tried to short the U.S. stock market since 2011-2012.  Some are down 50 percent or more, while the S&P 500 Index has more than doubled.  The net result of that combination is to be at only 15-25% of the S&P 500’s current value.

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, never relied on financial forecasts—despite operating in a secular bear market from 1968 to 1982:

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.

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.



Another good example of a “can’t lose” investment idea that has turned out not to be right:  shorting the Japanese yen.  Many macro experts have been quite certain that the Japanese yen versus the U.S. dollar would eventually exceed 200.  They thought this would have happened years ago.  Some called it the “trade of the decade.”  But the yen versus U.S. dollar is still around 110.  A simple S&P 500 index fund appears to be doing far better than the “trade of the decade.”

(Illustration by Shalom3)

Some have tried to short Japanese government bonds (JGB’s), rather than shorting the yen currency.  But that hasn’t worked for decades.  In fact, shorting JGB’s has become known as the widowmaker trade.

Seth Klarman on humility:

In investing, certainty can be a serious problem, because it causes one not to reassess flawed conclusions.  Nobody can know all the facts.  Instead, one must rely on shreds of evidence, kernels of truth, and what one suspects to be true but cannot prove.

Klarman on the vital importance of doubt:

It is much harder psychologically to be unsure than to be sure;  certainty builds confidence, and confidence reinforces certainty.  Yet being overly certain in an uncertain, protean, and ultimately unknowable world is hazardous for investors.  To be sure, uncertainty breeds doubt, which can be paralyzing.  But uncertainty also motivates diligence, as one pursues the unattainable goal of eliminating all doubt.  Unlike premature or false certainty, which induces flawed analysis and failed judgments, a healthy uncertainty drives the quest for justifiable conviction.

My own painful experiences:  shorting the U.S. stock market and shorting the Japanese yen.  In each case, I believed that the evidence was overwhelming.  By far the biggest mistake I’ve ever made was shorting the U.S. stock market in 2011-2013.  At the time, I agreed with Russell Napier’s arguments.  I was completely wrong.

After that, I shorted the Japanese yen because I was convinced the argument was virtually irrefutable.  Wrong.  Perhaps the yen will collapse some day, but if it’s 10-20 years in the future—or even later—then an index fund or a quantitative value fund would be a far better and safer investment.

Spencer Davidson:

Over a long career you learn a certain humility and are quicker to attribute success to luck rather than your own brilliance.  I think that makes you a better investor, because you’re less apt to make the big mistake and you’re probably quicker to capitalize on good fortune when it shines upon you.

Jeffrey Bronchick:

It’s important not to get carried away with yourself when times are good, and to be able to admit your mistakes and move on when they’re not so good.  If you are intellectually honest—and not afraid to be visibly and sometimes painfully judged by your peers—investing is not work, it’s fun.

Patiently waiting for pessimism or temporary bad news to create low stock prices (some place), and then buying stocks well below probable intrinsic value, does not require genius in general.  But it does require the humility to focus only on areas where you can do well.  As Warren Buffett has remarked:

What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know.



(Courage concept by Travelling-light)

Humility is essential for success in investing.  But you also need the courage to think and act independently.  You have to be able to develop an investment thesis based on the facts and good reasoning without worrying if many others disagree.  Most of the best value investments are contrarian, meaning that your view differs from the consensus.  Ben Graham:

In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand.

Graham again:

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

Or as Carlo Cannell says:

Going against the grain is clearly not for everyone—and it doesn’t tend to help you in your social life—but to make the really large money in investing, you have to have the guts to make the bets that everyone else is afraid to make.

Joel Greenblatt identifies two chief reasons why contrarian value investing is hard:

Value investing strategies have worked for years and everyone’s known about them.  They continue to work because it’s hard for people to do, for two main reasons.  First, the companies that show up on the screens can be scary and not doing so well, so people find them difficult to buy.  Second, there can be one-, two- or three-year periods when a strategy like this doesn’t work.  Most people aren’t capable of sticking it out through that.

Contrarian value investing requires buying what is out-of-favor, neglected, or hated.  It also requires the ability to endure multi-year periods of trailing the market, which most investors just can’t do.  Furthermore, while you’re buying what everyone hates and while you’re trailing the market, you also have to put up with people calling you an idiot.  In a word, you must have the ability to suffer.  Eveillard:

If you are a value investor, you’re a long-term investor.  If you are a long-term investor, you’re not trying to keep up with a benchmark on a short-term basis.  To do that, you accept in advance that every now and then you will lag behind, which is another way of saying you will suffer.  That’s very hard to accept in advance because, the truth is, human nature shrinks from pain.  That’s why not so many people invest this way.  But if you believe as strongly as I do that value investing not only makes sense, but that it works, there’s really no credible alternative.



(Photo by Leung Cho Pan)

Warren Buffett has remarked that buying baskets of statistically cheap cigar-butt’s—50-cent dollars—is a more dependable way to generate good returns than buying high-quality businesses.  Rich Pzena perhaps expressed it best:

When I talk about the companies I invest in, you’ll be able to rattle off hundreds of bad things about them—but that’s why they’re cheap!  The most common comment I get is ‘Don’t you read the paper?’  Because if you read the paper, there’s no way you’d buy these stocks.

They’re priced where they are for good reason, but I invest when I believe the conditions that are causing them to be priced that way are probably not permanent.  By nature, you can’t be short-term oriented with this investment philosophy.  If you’re going to worry about short-term volatility, you’re just not going to be able to buy the cheapest stocks.  With the cheapest stocks, the outlooks are uncertain.

Many investors incorrectly assume that high growth in the past will continue into the future, or that a high-quality company is automatically a good investment.  Behavioral finance expert and value investor James Montier:

There’s a great chapter [in Dan Ariely’s Predictably Irrational] about the ways in which we tend to misjudge price and use it as an indicator of something or other.  That links back to my whole thesis that the most common error we as investors make is overpaying for the hope of growth.  Dan did an experiment involving wine, in which he told people, ‘Here’s a $10 bottle of wine and here’s a $90 bottle of wine.  Please rate them and tell me which tastes better.’  Not surprisingly, nearly everyone thought the $90 wine tasted much better than the $10 wine.  The only snag was that the $90 wine and the $10 wine were actually the same $10 wine.



(Illustration by Mopic)

Micro-cap stocks are the most inefficiently priced.  That’s because, for most professional investors, assets under management are too large.  These investors cannot even consider micro caps.  The Boole Microcap Fund is designed to take advantage of this inefficiency: http://boolefund.com/best-performers-microcap-stocks/

James Vanasek on the opportunity in micro caps:

We’ll invest in companies with up to $1 billion or so in market cap, but have been most successful in ideas that start out in the $50 million to $300 million range.  Fewer people are looking at them and the industries the companies are in can be quite stable.  Given that, if you find a company doing well, it’s more likely it can sustain that advantage over time.

Because very few professional investors can even contemplate investing in micro caps, there’s far less competition.  Carlo Cannell:

My basic premise is that the efficient markets hypothesis breaks down when there is inconsistent, imperfect dissemination of information.  Therefore it makes sense to direct our attention to the 14,000 or so publicly traded companies in the U.S. for which there is little or no investment sponsorship by Wall Street, meaning three or fewer sell-side analysts who publish research…

You’d be amazed how little competition we have in this neglected universe.  It is just not in the best interest of the vast majority of the investing ecosphere to spend 10 minutes on the companies we spend our lives looking at.

Robert Robotti adds:

We focus on smaller-cap companies that are largely ignored by Wall Street and face some sort of distress, of their own making or due to an industry cycle.  These companies are more likely to be inefficiently priced and if you have conviction and a long-term view they can produce not 20 to 30 percent returns, but multiples of that.



Value investors recognize that the stock market is not always efficient, largely because humans are often less than fully rational.  As Seth Klarman explains:

Markets are inefficient because of human nature—innate, deep-rooted, permanent.  People don’t consciously choose to invest with emotion—they simply can’t help it.

Quantitative value investor James O’Shaugnessy:

Because of all the foibles of human nature that are well documented by behavioral research—people are always going to overshoot and undershoot when pricing securities.  A review of financial markets all the way back to the South Sea Company nearly 300 years ago proves this out.

Bryan Jacoboski:

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.

Overconfidence is extremely deep-rooted in human psychology.  When asked, the vast majority of us rate ourselves as above average across a wide variety of dimensions such as looks, smarts, driving skill, academic ability, future well-being, and even luck (!).

In a field such as investing, it’s vital to become aware of our natural overconfidence.  Charlie Munger likes this quote from Demosthenes:

Nothing is easier than self-deceit.  For what each man wishes, that also he believes to be true.

But becoming aware of our overconfidence is usually not enough.  We also have to develop systems—such as checklists – that can automatically reduce both the frequency and the severity of mistakes.

(Image by Aleksey Vanin)

Charlie Munger reminds value investors not only to develop and use a checklist, but also to follow the advice of mathematician Carl Jacobi:

Invert, always invert.

In other words, instead of thinking about how to succeed, Munger advises value investors to figure out all the ways you can fail.  This is a powerful concept in a field like investing, where overconfidence frequently causes failure.  Munger:

It is occasionally possible for a tortoise, content to assimilate proven insights of his best predecessors, to outrun hares which seek originality or don’t wish to be left out of some crowd folly which ignores the best work of the past.  This happens as the tortoise stumbles on some particularly effective way to apply the best previous work, or simply avoids the standard calamities.  We try more to profit by always remembering the obvious than from grasping the esoteric.  It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.

When it comes to checklists, it’s helpful to have a list of cognitive biases.  Here’s my list: http://boolefund.com/cognitive-biases/

Munger’s list is more comprehensive: http://boolefund.com/the-psychology-of-misjudgment/

Recency bias is one of the most important biases to be aware of as an investor.  Jed Nussdorf:

It is very hard to avoid recency bias, when what just happened inordinately informs your expectation of what will happen next.  One of the best things I’ve read on that is The Icarus Syndrome, by Peter Beinart.  It’s not about investing, but describes American hubris in foreign policy, in many cases resulting from doing what seemed to work in the previous 10 years even if the setting was materially different or conditions had changed.  One big problem is that all the people who succeed in the recent past become the ones in charge going forward, and they think they have it all figured out based on what they did before.  It’s all quite natural, but can result in some really bad decisions if you don’t constantly challenge your core beliefs.

Availability bias is closely related to recency bias and vividness bias.  You’re at least 15-20 times more likely to be hit by lightning in the United States than to be bitten by shark.  But often people don’t realize this because shark attacks tend to be much more vivid in people’s minds.  Similarly, your odds of dying in a car accident are 1 in 5,000, while your odds of dying in a plane crash are 1 in 11 million.  Nonetheless, many people view flying as more dangerous.

John Dorfman on investors overreacting to recent news:

Investors overreact to the latest news, which has always been the case, but I think it’s especially true today with the Internet.  Information spreads so quickly that decisions get made without particularly deep knowledge about the companies involved.  People also overemphasize dramatic events, often without checking the facts.



(Illustration by Marek)

Because so many investors worry and think about the shorter term, value investors continue to gain a large advantage by focusing on the longer term (especially three to five years).  In a year or less, a given stock can do almost anything.  But over a five-year period, a stock tracks intrinsic business value to a large extent.  Jeffrey Ubben:

It’s still true that the biggest players in the public markets—particularly mutual funds and hedge funds—are not good at taking short-term pain for long-term gain.  The money’s very quick to move if performance falls off over short periods of time.  We don’t worry about headline risk—once we believe in an asset, we’re buying more on any dips because we’re focused on the end game three or four years out.

Mario Cibelli:

One of the last great arbitrages left is to be long-term-oriented when there is a large class of shareholders who have no tolerance for short-term setbacks.  So it’s interesting when stocks get beaten-up because a company misses earnings or the market reacts to a short-term business development.  It’s crazy to me when someone says something is cheap but doesn’t buy it because they think it won’t go anywhere for the next 6 to 12 months.  We have a pretty high tolerance for taking that pain if we see glory longer term.

Whitney Tilson wrote about a great story that value investor Bill Miller told.  Miller recalled that, early in his career, he was visiting an institutional money manager, to whom he was pitching R.J. Reynolds, then trading at four times earnings.  Miller:

“When I finished, the chief investment officer said: ‘That’s a really compelling case but we can’t own that.  You didn’t tell me why it’s going to outperform the market in the next nine months.’  I said I didn’t know if it was going to do that or not but that there was a very high probability it would do well over the next three to five years.

“He said: ‘How long have you been in this business?  There’s a lot of performance pressure, and performing three to five years down the road doesn’t cut it.  You won’t be in business then.  Clients expect you to perform right now.’

“So I said: ‘Let me ask you, how’s your performance?’

“He said: ‘It’s terrible, that’s why we’re under a lot of performance pressure.’

“I said: ‘If you bought stocks like this three years ago, your performance would be good right now and you’d be buying RJR to help your performance over the next three years.’”

Link: http://www.tilsonfunds.com/Patience%20can%20find%20a%20virtue%20in%20market%20inefficiency-FT-6-9-06.pdf

Many investors are so focused on shorter periods of time (a year or less).  They forget that the value of any business is ALL of its (discounted) future free cash flow, which often means 10-20 years or more.  David Herro:

I would assert the biggest reason quality companies sell at discounts to intrinsic value is time horizon.  Without short-term visibility, most investors don’t have the conviction or courage to hold a stock that’s facing some sort of challenge, either internally or externally generated.  It seems kind of ridiculous, but what most people in the market miss is that intrinsic value is the sum of ALL future cash flows discounted back to the present.  It’s not just the next six months’ earnings or the next year’s earnings.  To truly invest for the long term, you have to be able to withstand underperformance in the short term, and the fact of the matter is that most people can’t.

As Mason Hawkins observes, a company may be lagging now precisely because it’s making longer-term investments that will probably increase business value in the future:

Classic opportunities for us get back to time horizon.  A company reports a bad quarter, which disappoints Wall Street with its 90-day focus, but that might be for explainable temporary reasons or even because the company is making very positive long-term investments in the business.  Many times that investment increases the likely value of the company five years from now, but disappoints people who want the stock up tomorrow.

Whitney George:

We evaluate businesses over a full business cycle and probably our biggest advantage is an ability to buy things when most people can’t because the short-term outlook is lousy or very hard to judge.  It’s a good deal easier to know what’s likely to happen than to know precisely when it’s going to happen.

In general, humans are impatient and often discount multi-year investment gains far too much.  John Maynard Keynes: 

Human nature desires quick results, there is a particular zest in making money quickly, and remoter gains are discounted by the average man at a very high rate.



(Word cloud by Arloofs)

Automating of the investment process, including screening, is often more straightforward now than it has been, thanks to enormous advances in computing in the past two decades.

Will Browne:

We often start with screens on all aspects of valuation.  There are characteristics that have been proven over long periods to be associated with above-average rates of return:  low P/Es, discounts to book value, low debt/equity ratios, stocks with recent significant price declines, companies with patterns of insider buying and—something we’re paying a lot more attention to—stocks with high dividend yields.

Stephen Goddard:

Our basic screening process weights three factors equally:  return on tangible capital, the multiple of EBIT to enterprise value, and free cash flow yield.  We rank the universe we’ve defined on each factor individually from most attractive to least, and then combine the rankings and focus on the top 10%.

Carlo Cannell:

[We] basically spend our time trying to uncover the assorted investment misfits in the market’s underbrush that are largely neglected by the investment community.  One of the key metrics we assign to our companies is an analyst ratio, which is simply the number of analysts who follow the company.  The lower the better—as of the end of last year, about 65 percent of the companies in our portfolio had virtually no analyst coverage.

For some time now, it has been clear that simple quant models outperform experts in a wide variety of areas: http://boolefund.com/simple-quant-models-beat-experts-in-a-wide-variety-of-areas/

Quantitative value investor James O’Shaugnessy:

Models beat human forecasters because they reliably and consistently apply the same criteria time after time.  Models never vary.  They are never moody, never fight with their spouse, are never hung over from a night on the town, and never get bored.  They don’t favor vivid, interesting stories over reams of statistical data.  They never take anything personally.  They don’t have egos.  They’re not out to prove anything.  If they were people, they’d be the death of any party.

People on the other hand, are far more interesting.  It’s far more natural to react emotionally or to personalize a problem than it is to dispassionately review broad statistical occurrences—and so much more fun!  It’s much more natural for us to look at the limited set of our personal experiences and then generalize from this small sample to create a rule-of-thumb heuristic.  We are a bundle of inconsistencies, and although this tends to make us interesting, it plays havoc with our ability to successfully invest.

Buffett maintains (correctly) that the vast majority of investors, large or small, should invest in low-cost broad market index funds: http://boolefund.com/quantitative-microcap-value/

If you invest in a quantitative value fund focused on cheap micro caps with improving fundamentals, then you can reasonably expect to do about 7% (+/- 3%) better than the S&P 500 Index over time: http://boolefund.com/best-performers-microcap-stocks/

Will Browne:

When you have a model you believe in, that you’ve used for a long time and which is more empirical than intuitive, sticking with it takes the emotion away when markets are good or bad.  That’s been a central element of our success.  It’s the emotional dimension that drives people to make lousy, irrational decisions.



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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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 Innovator’s Solution

(Image: Zen Buddha Silence, by Marilyn Barbone)

February 25, 2018

The Innovator’s Dilemma is a business classic by Clayten M. Christensen.  Good companies frequently fail precisely because they are good.  Good companies invest in sustaining technologies, which are generally high-functioning, high-margin, and demanded by customers, instead of disrupting technologies, which start out relatively low-functioning, low-margin, and not demanded by customers.

The Innovator’s Solution, by Clayton Christensen and Michael Raynor, aims at presenting solutions to the innovator’s dilemma.

(Illustration by Rapeepon Boonsongsuwan)


  • The Growth Imperative
  • How Can We Beat Our Most Powerful Competitors?
  • What Products Will Customers Want to Buy?
  • Who Are the Best Customers For Our Products?
  • Getting the Scope of the Business Right
  • How to Avoid Commoditization
  • Is Your Organization Capable of Disruptive Growth?
  • Managing the Strategy Development Process
  • There is Good Money and There is Bad Money
  • The Role of Senior Executives in Leading New Growth



As companies grow larger, it becomes more difficult to grow.  But shareholders demand growth.  Many companies invest aggressively to try to create growth, but most fail to do so.  Why is creating growth so hard for larger companies?

(Image by Bearsky23)

Christensen and Raynor note three explanations that seem plausible but are wrong:

  • Smarter managers could have succeeded.  But when it comes to sustaining growth that creates shareholder value, 90 percent of all publicly traded companies have failed to create it for more than a few years.  Are 90 percent of all managers are below average?
  • Managers become risk-averse.  But here again, the facts don’t support the explanation.  Managers frequently bet billion-dollar companies on one innovation.
  • Creating new-growth businesses is inherently unpredictable.  The odds of success are low, as reflected by how venture capitalists invest.  But there’s far more to the process of creating growth than just luck.

The innovator’s dilemma causes good companies to invest in high-functioning, high-margin products that their current customers want.  This can be seen in the process companies follow to fund ideas:

The process of sorting through and packaging ideas into plans that can win funding… shapes those ideas to resemble the ideas that were approved and became successful in the past.  The processes have in fact evolved to weed out business proposals that target markets where demand might be small.  The problem for growth-seeking managers, of course, is that the exciting growth markets of tomorrow are small today.

A dearth of good ideas is rarely the core problem in a company that struggles to launch exciting new-growth businesses.  The problem is in the shaping process.  Potentially innovative new ideas seem inexorably to be recast into attempts to make existing customers still happier.

It’s possible to gain greater understanding of how companies create profitable growth.  If we can develop a better theory, then we can make better predictions.  There are three stages in theory-building, say Christensen and Raynor:

  • Describe the phenomena in question.
  • Classify the phenomena into categories.
  • Explain what causes the phenomena, and under what circumstances.

Building a theory is iterative.  Scientists keep improving their descriptions, classifications, and causal explanations.

Frequently there is not enough understanding of the circumstances under which businesses succeed.

To know for certain what circumstances they are in, managers also must know what circumstances they are not in.  When collectively exhaustive and mutually exclusive categories of circumstances are defined, things get predictable: We can state what will cause what and why, and can predict how that statement of causality might vary by circumstance.



(Illustration by T. L. Furrer)

Compared to existing products, disruptive innovations start out simpler, more convenient, and less expensive.

Once the disruptive product gains a foothold in new or low-end markets, the improvement cycle begins.  And because the pace of technological progress outstrips customers’ ability to use it, the previously not-good-enough technology eventually improves enough to intersect with the needs of more demanding customers.  When that happens, the disruptors are on a path that will ultimately crush the incumbents.

Most disruptive innovations are launched by entrants.  A good example is minimills disrupting integrated steel companies.

Minimills discovered that by melting scrap metal, they could make steel at 20 percent lower cost than the integrated steel mills.  But the quality of steel the minimills initially produced was low due to the use of scrap metal.  Their steel could only be used for concrete reinforcing bar (rebar).

The rebar market was naturally more profitable for the minimills, due to their lower cost structure.  The integrated steel mills were happy to give up what for them was a lower-margin business.  The minimills were profitable as long as they were competing against integrated steel mills that were still supplying the rebar market.  Once there were no integrated steel mills left, the price of the rebar dropped 20 percent to reflect the lower cost structure of minimills.

This pattern kept repeating.  The minimills looked up-market again.  The minimills expanded their capacity to make angle iron, and thicker bars and rods.  The minimills reaped significant profits as long as they were competing against integrated steel mills still left in the market for bar and rod.  Meanwhile, integrated steel mills gradually abandoned this market because it was lower-margin for them.  After the last integrated steel mill dropped out, the price of bar and rod dropped 20 percent to reflect the costs of minimills.

So the mimimills looked up-market again to structural beams.  Most experts thought minimills wouldn’t be able to roll structural beams.  But the minimills were highly motivated and came up with very clever innovations.  Once again, the minimills experienced nice profits as long as they were competing against integrated steels mills.  But when the last integrated steel mill dropped out of the structural beam market, the price dropped 20 percent.

(Image by Megapixie, via Wikimedia Commons)

Christensen and Raynor add:

The sequence repeated itself when the leading minimill, Nucor, attacked the steel sheet business.  Its market capitalization now dwarfs that of the largest integrated steel company, U.S. Steel.  Bethlehem Steel is bankrupt as of the time of this writing.

This is not a history of bungled steel company management.  It is a story of rational managers facing the innovator’s dilemma: Should we invest to protect the least profitable end of our business, so that we can retain our least loyal, most price-sensitive customers?  Or should we invest to strengthen our position in the most profitable tiers of our business, with customers who reward us with premium prices for better products?

The authors note that these patterns hold for all companies, not just technology companies.  Also, they define “technology” as “the process that any company uses to convert inputs of labor, materials, capital, energy, and information into outputs of greater value.”  Christensen and Raynor:

Disruption does not guarantee success, but it sure helps: The Innovator’s Dilemma showed that following a strategy of disruption increased the odds of creating a successful growth business from 6 percent to 37 percent.

New-market disruptions relate to consumers who previously lacked the money or skills to buy and use the product, or they relate to different situations in which the product can be used.  New-market disruptions compete with “nonconsumption.”

Low-end disruptions attack the least profitable and most overserved customers in the original market.

Examples of new-market disruptions:

The personal computer and Sony’s first battery-powered transistor pocket radio were new-market disruptions, in that their initial customers were new consumers — they had not owned or used the prior generation of products and services.  Canon’s desktop photocopiers were also a new-market disruption, in that they enabled people to begin conveniently making their own photocopies around the corner from their offices, rather than taking their originals to the corporate high-speed photocopy center where a technician had to run the job for them.

The authors then explain low-end disruptions:

…Disruptions such as steel minimills, discount retailing, and the Korean automakers’ entry into the North American market have been pure low-end disruptions in that they did not create new markets — they were simply low-cost business models that grew by picking off the least attractive of the established firms’ customers.

Many disruptions are a hybrid of new-market and low-end.

Christensen and Raynor suggest three sets of questions to determine if an idea has disruptive potential.  The first set of questions relates to new-market potential:

  • Is there a large population of people who historically have not had the money, equipment, or skill to do this thing for themselves, and as a result have gone without it altogether or have needed to pay someone with more expertise to do it for them?
  • To use the product or service, do customers need to go to an inconvenient, centralized location?

The second set of questions concerns low-end disruptions:

  • Are there customers at the low-end of the market who would be happy to purchase a product with less (but good enough) performance if they could get it at a lower price?
  • Can we create a business model that enables us to earn attractive profits at the discount prices required to win the business of these overserved customers at the low end?

A final question is a litmus test:

  • Is the innovation disruptive to all of the significant incumbent firms in the industry?  If it appears to be sustaining to one or more significant players in the industry, then the odds will be stacked in that firm’s favor, and the entrant is unlikely to win.



Christensen and Raynor:

All companies face the continual challenge of defining and developing products that customers will scramble to buy.  But despite the best efforts of remarkably talented people, most attempts to create successful new products fail.  Over 60 percent of all new-product development efforts are scuttled before they ever reach the market.  Of the 40 percent that do see the light of day, 40 percent fail to become profitable and are withdrawn from the market.

(Photo by Kirill Ivanov)

The authors stress that customers “hire” products to do “jobs.”  We need to think about what customers are trying to do and the circumstances involved.

…This is how customers experience life.  Their thought processes originate with an awareness of needing to get something done, and then they set out to hire something or someone to do the job as effectively, conveniently, and inexpensively possible… In other words, the jobs that customers are trying to get done or the outcomes that they are trying to achieve constitute a circumstance-based categorization of markets.

The authors give the example of milkshakes.  What are the jobs that people “hire” milkshakes for?  Nearly half of all milkshakes are bought early the morning.  Often these customers want to have a less boring commute.  Also, a morning milkshake helps to avoid feeling hungry at 10:00.  At other times of day, parents were observed buying milkshakes for their children as a way to calm them down.  Armed with this knowledge, milkshake sellers can improve the milkshakes they sell at specific times of day.

The key here is observing what people are trying to accomplish.  Develop and test hypotheses accordingly.  Then develop products rapidly and get fast feedback.

It’s often much easier to figure out how to develop a low-end disruption.  That’s because the market already exists.  The goal is to move gradually up-market.

Why do many executives, instead of following jobs-to-be-done segmentation, focus on market segments not aligned with how customers live their lives?  Christensen and Raynor say there are at least four reasons:

  • Fear of focus.
  • Senior executives’ demand for quantification of opportunities.
  • The structure of channels.
  • Advertising economics and brand strategies.

The first two reasons relate to resource allocation.  The second two reasons concern the targeting of customers rather than circumstances.

Focus is scary — until you realize that it only means turning your back on markets you could never have anyway.  Sharp focus on jobs that customers are trying to get done holds the promise of greatly improving the odds of success in new-product development.

(Photo by Creativefire)

Rather than understand how customers and markets work, most market research is focused on defining the size of the opportunity.  This is the mistake of basing research on the available data instead of finding out about the jobs customers are trying to do.

When they frame the customer’s world in terms of products, innovators start racing against competitors by proliferating features, functions, and flavors of products that mean little to customers.  Framing markets in terms of customer demographics, they average across several different jobs that arise in customers’ lives and develop one-size-fits-all products that rarely leave most customers fully satisfied.  And framing markets in terms of an organization’s boundaries further restricts innovators’ abilities to develop products that will truly help their customers get the job done perfectly.

Regarding the structure of channels:

Many retail and distribution channels are organized by product categories rather than according to the jobs that customers need to get done.  This channel structure limits innovators’ flexibility in focusing their products on jobs that need to be done, because products need to be slotted into the product categories to which shelf space has been allocated.

Christensen and Raynor give the example of a manufacturer of power tools.  It learned that when workers were hanging a door, they used seven different tools, none of which was specific to the task.  The manufacturer invented a new tool that noticeably simplified the job.  But retail chains refused to sell the new tool because they didn’t have pre-existing shelf space for it.

Brands should be based on jobs to be done.

If a brand’s meaning is positioned on a job to be done, then when the job arises in a customer’s life, he or she will remember the brand and hire the product.  Customers pay significant premiums for brands that do a job well.

Some executives worry that a low-end disruption might harm their established brand.  But they can avoid this issue by properly naming each product.



As long as a business can profit using discount prices, the business can do well selling a low-end innovation.  It’s much harder to find new-market customers.  How do you determine if nonconsumers will become consumers of a given product?  Once again, the job-to-be-done perspective is crucial.

(Illustration by Alexmillos)

The authors continue:

A new-market disruption is an innovation that enables a larger population of people who previously lacked the money or skill now to begin buying and using a product and doing the job for themselves.  From this point forward, we will use the terms nonconsumers and nonconsumption to refer to this type of situation, where the job needs to get done but a good solution historically has been beyond reach.

Christensen and Raynor identify four elements in new-market disruption:

  • The target customers are trying to get a job done, but because they lack the money or skill, a simple, inexpensive solution has been beyond reach.
  • These customers will compare the disruptive product to having nothing at all.  As a result, they are delighted to buy it even though it may not be as good as other products available at high prices to current users with deeper expertise in the original value network.  The performance hurdle required to delight such new-market customers is quite modest.
  • The technology that enables the disruption might be quite sophisticated, but disruptors deploy it to make the purchase and use of the product simple, convenient, and foolproof.  It is the “foolproofedness” that creates new growth by enabling people with less money and training to begin consuming.
  • The disruptive innovation creates a whole new value network.  The new consumers typically purchase the product through new channels and use the product in new venues.

When disruptions come, established firms must take two key steps: First, when it comes to resource allocation, identify the disruption as a threat.  Second, those charged with building a new technology as a response should view their task as an opportunity.  This group should be an independent entity within the overall company.

Disruptive channels are often required to reach new-market customers:

…A company’s channel includes not just wholesale distributors and retail stores, but any entity that adds value to or creates value around the company’s product as it wends its way toward the hands of the end user…

We use this broader definition of channel because there needs to be symmetry of motivation across the entire chain of entities that add value to the product on its way to the end user.  If your product does not help all of these entities do their fundamental job better — which is to move up-market along their own sustaining trajectory toward higher-margin business — then you will struggle to succeed.  If your product provides the fuel that entities in the channel need to move toward improved margins, however, then the energy of the channel will help your new venture succeed.



It’s often advised to stick to your core competence.  The trouble is that something that doesn’t seem core today may turn out to be critical tomorrow.

Consider, for example, IBM’s decision to outsource the microprocessor for its PC business to Intel, and its operating system to Microsoft.  IBM made these decisions in the early 1980s in order to focus on what it did best — designing, assembling, and marketing computer systems… And yet in the process of outsourcing what it did not perceive to be core to the new business, IBM put into business the two companies that subsequently captured most of the profit in the industry.

The solution starts again with the jobs-to-be-done approach.  If the current products are not good enough, integration is best.  If the current products are more than good enough, outsourcing makes sense.

(Photo by Marek Uliasz)

Christensen and Raynor explain product architecture and interfaces:

An architecture is interdependent at an interface if one part cannot be created independently of the other part — if the way one is designed and made depends on the way the other is being designed and made.  When there is an interface across which there are unpredictable interdependencies, then the same organization must simultaneously develop both of the components if it hopes to develop either component.

Interdependent architectures optimize performance, in terms of functionality and reliability.  By definition, these architectures are proprietary because each company will develop its own interdependent design to optimize performance in a different way…

In contrast, a modular interface is a clean one, in which there are no unpredictable interdependencies across components or stages of the value chain.  Modular components fit and work together in well-understood and highly defined ways.  A modular architecture specifies the fit and function of all elements so completely that it doesn’t matter who makes the components or subsystems, as long as they meet the specifications…

Modular architectures optimize flexibility, but because they require tight specification, they give engineers fewer degrees of freedom in design.  As a result, modular flexibility comes at the sacrifice of performance.

The authors point out that most products fall between the two extremes of interdependence and pure modularity.

When product functionality and reliability are not yet good enough, firms that build their products around proprietary, interdependent architectures have a competitive advantage.  That’s because competitors with product architectures that are modular have less freedom and so cannot optimize performance.

The authors mention RCA, Xerox, AT&T, Standard Oil, and U.S. Steel:

These firms enjoyed near-monopoly power.  Their market dominance was the result of the not-good-enough circumstance, which mandated interdependent product or value chain architectures and vertical integration.  But their hegemony proved only temporary, because ultimately, companies that have excelled in the race to make the best possible products find themselves making products that are too good.

Eventually customers evolve in what they want.  They become willing to pay for speed, convenience, and customization.  Product architecture evolves towards more modular design.  This deeply impacts industry structure.  Independent, nonintegrated organizations become able to sell components and subsystems.  Industry standards develop that specify modular interfaces.



Many think commoditization is inevitable, no matter how good the innovation.  Christensen and Raynor reached a different conclusion:

One of the most exciting insights from our research about commoditization is that whenever it is at work somewhere in a value chain, a reciprocal process of de-commoditization is at work somewhere else in the value chain.  And whereas commoditization destroys a company’s ability to capture profits by undermining differentiability, de-commoditization affords opportunities to create and capture potentially enormous wealth.

Companies that position themselves at a place in the value chain where performance is not yet good enough will earn the profits when a disruption is occurring.  Just as Wayne Gretsky sought to skate to where the puck would be (not where it is), companies should position themselves where the money will be (not where it is).

(Photo of Wayne Gretzky by Rick Dikeman, via Wikimedia Commons)

When products are not yet good enough, companies with interdependent, proprietary architecture have strong advantages in differentiation and in cost structures.

This is why, for example, IBM, as the most integrated competitor in the mainframe computer industry, held a 70 percent market share but made 95 percent of the industry’s profits: It had proprietary products, strong cost advantages, and high entry barriers… Making highly differentiable products with strong cost advantages is a license to print money, and lots of it.

Of course, as a company seeks to outdo competitors, eventually it overshoots on the reliability and functionality that customers can use.  This leads to a change in the basis of competition.  There’s evolution towards modular architectures.  This process starts at the bottom of the market, where functionality overshoots first, and then moves gradually up-market.

Christensen and Raynor comment that “industry” itself is usually a faulty categorization.  Value chains evolve as the processes of commoditization and de-commoditization gradually repeat over time.

What’s fascinating — it’s the innovator’s dilemma — is that as innovators are moving up the value chain, established firms gradually abandon their lower-margin products and focus on their higher-margin products.  Established firms repeatedly focus on areas that increase their ROIC (return on invested capital) in the short term.  But these same decisions move established firms away from where the profits will be in the future.

Brands are most valuable when products aren’t yet good enough.  A brand can signal to potential customers that the products they seek will meet their standards.  When the performance of the products becomes more than good enough, the power of brands diminishes.  Christensen and Raynor:

The migration of branding power in a market that is composed of multiple tiers is a process, not an event.  Accordingly, the brands of companies with proprietary products typically create value mapping upward from their position on the improvement trajectory — toward those customers who still are not satisfied with the functionality and reliability of the best that is available.  But mapping downward from the same point — toward the world of modular products where speed, convenience, and responsiveness drive competitive success — the power to create powerful brands migrates away from the end-use product, toward the subsystems and the channel.

This has happened in heavy trucks.  There was a time when the valuable brand, Mack, was on the truck itself.  Truckers paid a significant premium for Mack the bulldog on the hood.  Mack achieved its preeminent reliability through its interdependent architecture and extensive vertical integration.  As the architectures of large trucks have become more modular, however, purchasers have come to care far more whether there is a Cummins or Caterpillar engine inside than whether the truck is assembled by Paccar, Navistar, or Freightliner.



Many innovations fail because the managers or corporations lack the capabilities to create a successful disruption.  Often the very skills that cause a leading company to succeed — through sustaining innovations — cause the same company to fail when it comes to disruptive growth.

The authors define capability by what they call the RPV framework — resources, processes, and values.

Resources are usually people, or things such as technology and cash.  What most often causes failure in disruptive growth is the wrong choice of managers.  It’s often thought that right-stuff attributes, plus a string of uninterrupted successes, is the best way to choose leaders of a disruptive venture.

But the skills needed to run an established firm are quite different from the skills needed to manage a disruptive venture.

In order to be confident that managers have developed the skills required to succeed at a new assignment, one should examine the sorts of problems they have wrestled with in the past.  It is not as important that managers have succeeded with the problem as it is for them to have wrestled with it and developed the skills and intuition for how to meet the challenge successfully the next time around.  One problem with predicting future success from past success is that managers can succeed for reasons not of their own making — and we often learn far more from our failures than our successes.  Failure and bouncing back from failure can be critical courses in the school of experience.  As long as they are willing and able to learn, doing things wrong and recovering from mistakes can give managers an instinct for better navigating through the minefield the next time around.

(Photo by Yuryz)

Successful companies have good processes in place: “Processes include the ways that products are developed and made and the methods by which procurement, market research, budgeting, employee development and compensation, and resource allocation are accomplished.”

Processes evolve as ways to complete specific tasks.  Effective organizations tend to have processes that are aligned with tasks.  But processes are not flexible and they’re not meant to be.  You can’t take processes that work for an established firm and expect them to work in a new-growth venture.

The most important processes usually relate to market research, financial projections, and budgeting and reporting.  Some processes are hard to observe.  But it makes sense to look at whether the organization has faced similar issues in the past.


An organization’s values are the standards by which employees make prioritization decisions — those by which they judge whether an order is attractive or unattractive, whether a particular customer is more important or less important than another, whether an idea for a new product is attractive or marginal, and so on.

Employees at every level make prioritization decisions.  At the executive tiers, these decisions often take the form of whether or not to invest in new products, services, and processes.  Among salespeople, they consist of on-the-spot, day-to-day decisions about which customers they will call on, what products to push with those customers, and which products not to emphasize.  When an engineer makes a design choice or a production scheduler puts one order ahead of another, it is a prioritization decision.

This brings up a crucial point:

Whereas resources and processes are often enablers that define what an organization can do, values often represent constraints — they define what the organization cannot do.  If, for example, the structure of a company’s overhead costs requires it to achieve gross profit margins of 40 percent, a powerful value or decision rule will have evolved that encourages employees not to propose, and senior managers to kill, ideas that promise gross margins below 40 percent.  Such an organization would be incapable of succeeding in low-margin businesses — because you can’t succeed with an endeavor that cannot be prioritized.  At the same time, a different organization’s values, shaped around a very different cost structure, might enable it to accord high priority to the very same project.  These differences create the asymmetries of motivation that exist between disruptors and disruptees.

Acceptable gross margins and cost structures co-evolve.  Another issue is how big a business opportunity has to be.  A huge company may not consider interesting opportunities if they’re too small to move the needle.  However, a wisely run large company will set up small business units for which smaller opportunities are still meaningful.

In the start-up stage, resources are important, especially people.  A few key people can make all the difference.

(Photo by Golloween)

But over time, processes and values become more important.  Many hot, young companies fail because the founders don’t create the processes and values needed to continue to create successful innovations.

As processes and values become almost subconscious, they come to represent the culture of the organization.  When a few people are still important, it’s far easier for the company to change in response to new problems.  But it becomes much more difficult when processes and values are established, and more difficult still when the culture is widespread.

Executives who are building new-growth businesses therefore need to do more than assign managers who have been to the right schools of experience to the problem.  They must ensure that responsibility for making the venture successful is given to an organization whose processes will facilitate what needs to be done and whose values can prioritize those activities.



In every company, there are two strategy-making processes — deliberate and emergent.  Deliberate strategies are conscious and analytical.

Emergent strategy… is the cumulative effect of day-to-day prioritization and investment decisions made by middle managers, engineers, salespeople, and financial staff.  These tend to be tactical, day-to-day operating decisions that are made by people who are not in a visionary, futuristic, or strategic state of mind.  For example, Sam Walton’s decision to build his second store in another small town near his first one in Arkansas for purposes of logistical and managerial efficiency, rather than building it in a large city, led to what became Wal-Mart’s brilliant strategy of building in small towns discount stores that were large enough to preempt competitors’ ability to enter.  Emergent strategies result from managers’ responses to problems or opportunities that were unforeseen in the analysis and planning stages of the deliberate strategy-making process.

(Photo by Alain Lacroix)

If an emergent strategy proves effective, it can be transformed into a deliberate strategy.

Emergent processes should dominate in circumstances in which the future is hard to read and in which it is not clear what the right strategy should be.  This is almost always the case during the early phases of a company’s life.  However, the need for emergent strategy arises whenever a change in circumstances portends that the formula that worked in the past may not be as effective in the future.  On the other hand, the deliberate strategy process should be dominant once a winning strategy has become clear, because in those circumstances effective execution often spells the difference between success and failure.

Initiatives that receive resources are strategic actions, and strategies evolve based on the results of strategic actions.  Resource allocation decisions are especially influenced by a company’s cost structure — which determines gross profit margins — and by the size of a given opportunity.  A great opportunity for a small company — or a small unit — might not move the needle for a large company.

Additional influences on resource allocation include the sales force’s incentive compensation system.  Salespeople decide which customers to focus on and what products to emphasize.  Customers, by their preferences, have significant influence on the resource allocation process.  Competitors’ actions are also important.

The resource allocation process, in other words, is a diffused, unruly, and often invisible process.  Executives who hope to manage the strategy process effectively need to cultivate a subtle understanding of its workings, because strategy is determined by what comes out of the resource allocation process, not by the intentions and proposals that go into it.

(Illustration by Amir Zukanovic)

In 1971, by chance Intel invented the microprocessor during a funded development project for a Japanese calculator company, Busicom.  But DRAMs, not microprocessors, continued to represent the bulk of the company’s sales through the 1970s.  By the early 1980s, DRAMs had the lowest profit margins of Intel’s products.

Microprocessors, by contrast, because they didn’t have much competition, earned among the highest gross profit margins.  The resource allocation process systematically diverted manufacturing resources away from DRAMs and into microprocessors.  This happened automatically, without any explicit management decisions.  Senior management continued putting two-thirds of the R&D budget into DRAM research.  By 1984, senior management realized that Intel had become a microprocessor company.

Intel needed both emergent and deliberate strategies:

A viable strategic direction had to coalesce from the emergent side of the process, because nobody could foresee clearly enough the future of microprocessor-based desktop computers.  But once the winning strategy became apparent, it was just as critical to Intel’s ultimate success that the senior management then seized control of the resource allocation process and deliberately drove the strategy from the top.

It’s essential for start-ups to be flexible and adaptive:

Research suggests that in over 90 percent of all successful new businesses, historically, the strategy that the founders had deliberately decided to pursue was not the strategy that ultimately led to the business’s success.  Entrepreneurs rarely get their strategies exactly right the first time… One of the most important roles of senior management during a venture’s early years is to learn from emergent sources what is working and what is not, and then to cycle that learning back into the process through the deliberate channel.

Once managers hit upon a strategy that works, then they must focus on executing that strategy aggressively.

The authors highlight three points of executive leverage on the strategy process.  Managers must:

  • Carefully control the initial cost structure of a new-growth business, because this quickly will determine the values that will drive the critical resource allocation decisions in that business.
  • Actively accelerate the process by which a viable strategy emerges by insuring that business plans are designed to test and confirm critical assumptions using tools such as discovery-driven planning.
  • Personally and repeatedly intervene, business by business, excercising judgment about whether the circumstance is such that the business needs to follow an emergent or deliberate strategy-making process.  CEOs must not leave the choice about strategy process to policy, habit, or culture.

Managers have to pay particular attention to the initial cost structure of the business:

The only way that a new venture’s managers can compete against nonconsumption with a simple product is to put in place a cost structure that makes such customers and products financially attractive.  Minimizing major cost commitments enables a venture to enthusiastically pursue the small orders that are the initial lifeblood of disruptive businesses in their emergent years.



The type and amount of money determines investor expectations, which in turn heavily influence the markets and channels the venture can and cannot target.  Many potentially disruptive ideas get turned into sustaining innovations, which generally leads to failure.

Christensen and Raynor hold that the best money in early years is patient for growth but impatient for profit.  Disruptive markets start out small, which is why patience for growth is important.  Once a viable strategy has been identified, then impatience for growth makes sense.

Impatience for profit is important so that managers will test ideas as quickly as possible.

(Image by Vpublic)

It’s crucial to keep costs low for both low-end and new-market disruptive strategies.  This determines the type of customers that are attractive.

Financial results do not signal potential stall points well.  Financial results are the fruit of investments made years ago.  Financial results tell you how healthy the business was, not how healthy the business is.  Reliable data generally are about the past.  They only help with planning if the future resembles the past, which is often only true to a limited extent.

Christensen and Raynor suggest three policies for keeping the growth engine running:

  • Launch new growth businesses regularly when the core is still healthy — when it can still be patient for growth — not when financial results signal the need.
  • Keep dividing business units so that as the corporation becomes increasingly large, decisions to launch growth ventures continue to be made within organizational units that can be patient for growth because they are small enough to benefit from investing in small opportunities.
  • Minimize the use of profit from established businesses to subsidize losses in new-growth businesses.  Be impatient for profit: There is nothing like profitability to ensure that a high potential business can continue to garner the funding it needs, even when the corporation’s core business turns sour.



Christensen and Raynor:

The senior executives of a company that seeks repeatedly to create new waves of disruptive growth have three jobs.  The first is a near-term assignment: personally to stand astride the interface between disruptive growth businesses and the mainstream businesses to determine through judgment which of the corporation’s resources and processes should be imposed on the new business, and which should not.  The second is a longer-term responsibility: to shephard the creation of a process that we call a “disruptive growth engine,” which capably and repeatedly launches successful growth businesses.  The third responsibility is perpetual: to sense when the circumstances are changing, and to keep teaching others to recognize these signals.  Because the effectiveness of any strategy is contingent on the circumstance, senior executives need to look to the horizon (which often is at the low end of the market or in nonconsumption) for evidence that the basis of competition is changing, and then initiate projects and acquisitions to ensure that the corporation responds to the changing circumstance as an opportunity for growth and not as a threat to be defended against.

The personal involvement of a senior executive is one of the most crucial things for a disruptive business.  Often the most important improvements for the entire corporation begin as disruptions.

The vast majority of companies that successfully caught a disruptive innovation are companies still run by founders.

We suspect that founders have an advantage in tackling disruption because they not only wield the requisite political clout but also have the self-confidence to override established processes in the interests of pursuing disruptive opportunities.  Professional managers, on the other hand, often seem to find it difficult to push in disruptive directions that seem counterintuitive to most other people in the organization.




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:  http://boolefund.com/best-performers-microcap-stocks/

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: jb@boolefund.com




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.