Quality Without Compromise
September 12, 2007–See’s Candies, Warren Buffett and the perfect investment.

Warren Buffett & The Washington Post
December 12, 2006

“The Restaurant Investor” by Max Olson

In March, 2008, Sardar Biglari won the most important victory of his life. In an activist campaign to gain control of the board of directors of The Steak n Shake Company, Biglari and his partner received nearly triple the number of votes of the directors they were replacing.

It hadn’t been easy—their proxy fight with incumbent management had been going on for more than six months. Biglari and the entities he controlled first purchased seven percent of Steak n Shake during the summer of 2007. In August, the initial filing was made with the S.E.C. stating that Biglari had been in discussions with management. At this point, as with many activist investors, Biglari hoped that management would be open to his suggestions and criticisms of the company. He was the third largest owner of Steak n Shake at the time, holding more shares than all executive officers and directors combined. Only days earlier, C.E.O. Peter Dunn had unexpectedly resigned, stating his intent to “pursue other interests.” It seemed like the perfect time to reform the faltering restaurant chain.

Yet, after Biglari’s initial meeting with the Board and interim C.E.O., he was denied representation and otherwise rebuffed from any involvement with the company. To management, he was as a nuisance—one that if ignored, would go away. But Biglari was not the kind of investor to be ignored. While continuing to accumulate shares, he launched the first blow in the proxy fight on October 1. Along with an official solicitation to shareholders, Biglari wrote a brief letter outlining his intentions and frustration with the performance of Steak n Shake.

During the proxy fight, Biglari’s demands were relatively mild. His initial goal was to obtain two Board seats—one for himself, and one for Philip Cooley (Biglari’s mentor and business partner). But as the Board continued to fight, and Steak n Shake’s performance continued to decline, he determined that simple representation wasn’t enough. The current Chairman and interim C.E.O., along with the Lead Director, had to go. Biglari launched a website titled “Enhance Steak n Shake” and went as far as buying billboard space in the company’s hometown of Indianapolis.

After months of back-and-forth between Biglari and incumbent management, the minority share owners of Steak n Shake made the overwhelming choice to replace current leadership with Sardar Biglari and Phil Cooley. During the contest, some claimed that Biglari was nothing but a corporate raider, only interested in Steak n Shake to pursue short-term profits at the expense of the company. Now, he would have the chance to prove them wrong.

Of course, this wasn’t the first time Biglari had successfully launched a hostile Board takeover of a public company. Despite his relatively young age of thirty-years, this wasn’t even the first restaurant he had pursued.

Continue Reading “The Restaurant Investor”

The talk applies to everything we do but (staying on subject) I’m going to talk about its relation to business.

In my post The Real Causes of the Financial Crisis, I talked about how misaligned incentives led the system astray. But even if you properly incentivize people to do the right thing, that doesn’t mean everything is going to work out. In my previous post, I left it at “However, there’s no perfect solution.” But now I’d like to elaborate.

Dick Fuld, Jimmy Cayne and other financial execs had significant share ownership relative to their personal net worth. In other words, their interests were strongly aligned with shareholders. But that didn’t stop them from making bad decisions that were not only harmful to their company, but bad for society as a whole.

Optimally, you want management that doesn’t need incentives to do the right thing. Good incentives can help, but they aren’t going to cut it. Financial managers in particular need risk aversion ingrained in their personality. They need to be willing to stray from the herd and not follow the crowd. They need to have the wisdom, as Barry Schwartz described it, to do the right thing.

In looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if they don’t have the first, the other two will kill you. … If you hire somebody without the first, you really want them to be dumb and lazy.
— Warren Buffett

In terms of business and finance, you can’t find a better example of a wise person than Warren Buffett.

As an investor or an employee, you want a business leader who is passionate about their company and the product they are selling—not about the money.* Qualities like this can be very difficult to determine. Buffett not only shares them, but he’s good at seeing them in others (one of the major reasons he is so successful).

In business school, you’re not taught to have character. You’re given the numbers, the statistics, the “how to” in a step-by-step fashion. But sometimes, its better to focus on common sense instead of what the figures say. Wisdom, virtue and common sense: all things that can’t be taught, no matter how prestigious the school.

* One last note – if I were the shareholder of a company that has received TARP funds, and will now have salary/bonus caps at $500k, here’s what I’d think: 1) if management gets paid a little less while we’re receiving a safety net from our government, that’s fine. 2) If one of my managers wants to jump ship so he can get paid more somewhere else, then great. It turns out I didn’t want him at the company in the first place.

In October of 1907, financial markets in the United States came to a complete halt. Credit markets froze, major banks collapsed, and the stock market plunged. Heads of industry, like J. P. Morgan, were forced to inject massive amounts of capital to prevent a complete collapse.

The circumstances of the Panic of 1907 are very similar to our current crisis. In both, the economy had experienced huge growth over the preceding decade. Banks lowered lending standards, which led people to take on more and more debt. When bank assets began to decline, depositors panicked, and there was a run on the financial system.

But for the rest of this post, I’d like to focus on the period that follows a financial crisis—not on the crisis itself. (Keep in mind that although I speak in terms of American progress, my point applies to any country around the world.)

* * *

The period following 1907 was monumental in American history.

Influential figures of the era would forever change the world: Thomas Edison, John D. Rockefeller, Mark Twain, Rudyard Kipling, J. P. Morgan, Henry Ford, the Wright brothers, Nikola Tesla, Andrew Carnegie, Pablo Picasso (Spain), and Albert Einstein (Germany).

In 1908, the Wright brothers performed their first public flights. Henry Ford introduced the Model T, changing automobile industry forever and giving the world it’s first modern assembly line. Frederick Cook became the first person to reach the North Pole. The United States in particular was at the dawn of one of the greatest technological and economic expansions in history.

New York City skyline, 1908

In the past century, the United States has grown at astounding rates: 6.5% annual GDP growth, 1.2% annual population increase, 2.7% real GDP growth per capita (inflation-adjusted GDP growth per person). These figures don’t do justice to the profound change that has occurred during that period. To paraphrase Warren Buffett, the average person today lives much better than John D. Rockefeller did at his height (and he was worth over $300 billion).

Will the next hundred years hold a similar fate? In terms of expansion, probably not. But what we lack in growth, we can make up for in accomplishments.

Over the past few decades, manufacturing skill and productivity have moved to other countries. Going forward, the US will still be a manufacturer, but on a much smaller scale. Hopefully we will continue to work with faster growing economies like China, India and Brazil for the mutual benefit of everyone involved.

Looking Forward

So the US won’t be the world’s manufacturer anymore. And at the moment, we don’t have much capital to spare. But the one thing that we will continue to export is our ideas.

Much ingenuity with a little money is vastly more profitable and amusing than much money without ingenuity — Arnold Bennett

Innovation and discovery will continue to drive our economy in every industry. Whether it comes in the form of technology, business models, problem solving, or making current methods more efficient.

Now that the tide has washed out, we have truly begun to see who was swimming naked. And that’s a fantastic thing. To the businesses, investment funds, and individuals who were overcome by greed, took too much reckless risk, never added value, and thought that things would always be easy—farewell. And good riddance.

My only hope is that the current economic problems won’t diminish our drive to take risks. Based on history alone, I don’t believe it will. After all, if no one takes any risks, society won’t progress. (And by “risk”, I don’t mean “financial speculation.”)

2008 may have marked the worst financial collapse since the Great Depression, but that will never stop the progression of ideas.

New York City skyline, 2008

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The following books were used as a reference for this post:
(both are highly recommended)

The Panic of 1907, by Robert Bruner and Sean Carr
America, 1908, by Jim Rasenberger

$700 Billion Bailout Celebrated With Lavish $800 Billion Executive Party

How Did The Economy Go Bad?

The Onion’s 2008 In Review: The Economy

And this: (not too far from the truth)

In The Know: Should The Government Stop Dumping Money Into A Giant Hole?

Forget about Mr. Market’s terrible mood swing. He is there to serve you, not to guide you. Why would he be offering such low prices for the businesses he owns? Who knows. Take advantage of his irrationality. If hearing it from me isn’t enough, listen to John Bogle. (Image credit: The Principles of Uncertainty)

Berkshire Hathaway Letters (2003-2007)

A word cloud is a visual representation of a group of words, with the size of each word weighted to how many times it appears. The above two examples use the Berkshire Hathaway shareholder letters for the 5-year periods ending in 1987 and 2007. You can see some often-used words between the 20-year period: business, earnings, value, company, insurance. Word clouds are a good representation of what subjects the author is focusing on.
Below are a few more examples: (all created at Wordle)

Benjamin Zander: Classical music with shining eyes

Benjamin Zander has two infectious passions: classical music, and helping us all realize our untapped love for it — and by extension, our untapped love for all new possibilities, new experiences, new connections. [See Zander's book "The Art of Possibility"].

Chris Abani tells stories of people: People standing up to soldiers. People being compassionate. People being human and reclaiming their humanity. It’s “ubuntu,” he says: the only way for me to be human is for you to reflect my humanity back at me. [See his first TED speech here].

Sir Ken Robinson makes an entertaining and profoundly moving case for creating an education system that nurtures (rather than undermines) creativity. [This is an old talk, but if you've never seen it, stop everything you're doing and watch it now.]

Phil Gordon Answers Your Poker Questions / Great interview with poker pro Phil Gordon where he talks about randomness, psychology and the future of card playing.

Not-So-Free Ride: The trouble with negative externalities / On creating better-aligned incentives to deal with the effects of cars and the environment/costs to society. Perhaps some good suggestions for Buffett’s GEICO subsidiary.

This article by Sanjay Bakshi courtesy of Reflections on Value Investing explores the sunk-cost fallacy and the endowment effect. Both good heuristics to be aware of when making decisions.

On that note, I’ll take this time to thank all the readers and subscribers of this blog. It’s been running for about 6 months now, and has received about 15k views from 78 countries around the world. I don’t write as often as some other blogs, but when I started FutureBlind I wanted the quality of the posts to make up for it. So hopefully you’ve either enjoyed the articles, learned something new, or gotten some kind of insight from this blog.

In the first part of May, I will be attending the Berkshire Hathaway annual meeting in Omaha, Nebraska. I hope to see any readers who will be at the meeting or at the Yellow BRK’er party Friday night. For those who can’t make it, I’ll probably be posting a brief summary of my experience (every year it seems there are plenty of bloggers/writers who give great summaries of the meeting). This is the second Berkshire meeting I’ll have gone to (first time in 2006), and hopefully it will be just as good as the last.

Here’s a few good links before I go:

Fear of a Black Swan — interview with Nassim Nicholas Taleb.

Sam Zell: A Tough Guy in a Mean Business

Evolving the Wow! Factor – Olivia Judson is a science writer for the NYT. She is an evolutionary biologist and always has very fascinating articles. For anyone interested in evolutionary mental models, Olivia is one of the best writers out there.

Place Your Stock Bets Here — A post on the Freakonomics blog on the site Inspectd.com. A good site to show you how futile charting and technical analysis techniques are (once again, the rear-view mirror doesn’t help much).

The above also links to another good Freakonomics post on the media’s insistence on finding a reason for every market move. My favorite future headline: “Stocks Dive: Three First-Movers Sold Hard and Then Everyone Else Inexplicably Followed“.