Bruce Greenwald: From Graham to Buffett and on to Modern Value Investing

“It is not the strongest or the most intelligent who will survive but those who can best manage change.” —Leon C. Megginson

The Past, Present, and Future of Value Investing

There’s a new video out, as part of the celebration of Columbia Business School’s storied history over the past 100 year, in which Professors Bruce Greenwald and Tano Santos sits down and discusses a few different topics related to value investing.

Click image below to watch and listen to the interview.


Bruce Greenwald on Warren Buffett’s Approach to Industry and Business Analysis

Below is a transcript of a part of the interview where Bruce Greenwald discusses a few different industries and businesses that Warren Buffett successfully has invested in, and why these industries may have caught Buffett’s interest. Transcript is from 28:05 — 33:57 (emphasis added).

Tano Santos: But what I mean with evolution is something different. I want to understand a little bit, you know, a want to think… if I think about Warren Buffett’s career, and if I think about the distinct phases he’s gone through, you know the traditional Graham & Dodd, his practice of franchise, his recent partnership with 3G, and…

Bruce Greenwald: So let me talk about that. If you’re talking about the intellectual evolution

Tano Santos: Exactly, that’s what I’m talking about.

Bruce Greenwald: We’ve done the exact right thing. We’ve watched what’s successful practitioners have done, and we’ve shamelessly appropriated them. And basically, what I think Graham didn’t understand, although he had inklings of it was that you could make money without assets if you were in an economic position that kept out the competition. That if you were in, what in Warren Buffett’s language is now called a franchise business, and the next evolution is that, I think mostly Warren Buffett, but I think there are others who understand this fairly early on in the 60s and 70s too, begin to understand that these economic forces will create hugely valuable businesses, and valuable businesses in a sense that the old Ben Graham businesses were not. So to grow profits in the old Ben Graham world you had to invest. And in the face of competition you were likely to earn what you had to pay the investor. So the growth didn’t add value. I mean you had to raise money at 10 percent, and there were lots of people willing to invest at 10 percent, and there where no protected economic positions competition was gonna drive the return to 10 percent. So you make 10 percent and you pay 10 percent, there’s no value in growth. And that’s why Benjamin Graham was never particularly interested in growth companies. He talks a little about how R&D can create pattern protected industries. But there is a sense that he had that it’s rare, and the cost of finding those technologies may be just another form of assets.

What Buffett does is he looks very carefully at these industries that’s interestingly enough. He does it in industries that he knows a lot about. And the first one I think, going back, are industries around Omaha. So he right away understands things like Nebraska Furniture Mart, and dominate the Omaha furniture market. And it it’s got 70 percent of the business, it’s got distribution economies, advertising economies that are gonna be very hard for a competitor to replicate. And Omaha is sort of an isolated city. And he understood that the force of that dominant market position meant first of all that they we’re gonna have in the end, cost advantages due to economies of scale and that they could exploit… and pricing power cause they could keep other people out. And as the market grew they we’re gonna get that market without having, because they had the economies of scale, additional investment. He clearly understands that about newspapers. Local newspapers have a hugely expensive distribution, advertising sales and reporting infrastructure. If you are established as a local paper and everybody is renewing their subscription, then nobody is gonna be able to enter that market. And again, you’re gonna be able to charge for it and have the economies in distribution and you get the growth. And then he understood, I think, in banking… there are famous instances in banking. The one was, for years, tobacco lending in actually Virginia and North Carolina and the rest of the back of the south was dominated by Wachovia Bank, and they knew all about the growers, and they knew all about the warehouse processes, they knew everything. And that meant they knew about good risk and bad risk. And I think a foreign bank decided these were the most profitable loans out there and they we’re gonna go in and enter that market. And what they did was of course they went to the Wachovia customers and they offered them lower loan rates. If that lower loan rate was profitable, Wachovia knew it and they would match it and they kept all the good risks. And if it was a marginal credit that wasn’t, Wachovia would call ’em in and say “God, we really like to keep you but that’s such a good offer. We suggest you go to this European bank.” And the European bank wound up with a 90 percent default rate. And in addition there were all the economies of scale in information collection in news. And really all economies of running local branches, which are like local economies. So he seems to have understood that. And then with Coca-Cola where there are huge economies in distribution. And in all these cases you could protect your market share cause there’s a lot of customer captivity. So he started to develop an idea of what these franchise businesses looked like. And I think also how you go ahead and value them, cause now assets are irrelevant and you have to think about other things, and growth matters a lot. And I think it’s that evolution that really starts to get you into modern value investing.


KKR and RJR Nabisco: Video + Case

“I think Henry might tell you today that part of what was driving him subconsciously was the desire to win. The single most deadliest sin that you could have in the acquisitions business.” —Bryan Burrough, Author “Barbarians at the Gate”

Warren Buffett wrote about RJR Nabisco as a major arbitrage position in the Berkshire Hathaway’s letter to shareholders for fiscal year 1988, as follows:

At yearend, our only major arbitrage position was 3,342,000 
shares of RJR Nabisco with a cost of $281.8 million and a market 
value of $304.5 million. In January we increased our holdings to 
roughly four million shares and in February we eliminated our 
position. About three million shares were accepted when we 
tendered our holdings to KKR, which acquired RJR, and the 
returned shares were promptly sold in the market. Our pre-tax 
profit was a better-than-expected $64 million.

     Earlier, another familiar face turned up in the RJR bidding 
contest: Jay Pritzker, who was part of a First Boston group that 
made a tax-oriented offer. To quote Yogi Berra; “It was deja vu 
all over again.”

     During most of the time when we normally would have been 
purchasers of RJR, our activities in the stock were restricted 
because of Salomon’s participation in a bidding group. 
Customarily, Charlie and I, though we are directors of Salomon, 
are walled off from information about its merger and acquisition 
work.  We have asked that it be that way: The information would 
do us no good and could, in fact, occasionally inhibit 
Berkshire’s arbitrage operations.

     However, the unusually large commitment that Salomon 
proposed to make in the RJR deal required that all directors be 
fully informed and involved.  Therefore, Berkshire’s purchases of 
RJR were made at only two times: first, in the few days 
immediately following management’s announcement of buyout plans, 
before Salomon became involved; and considerably later, after the 
RJR board made its decision in favor of KKR. Because we could 
not buy at other times, our directorships cost Berkshire 
significant money.

RJR Nabisco – 1990, HBS Case

RJR Nabisco – 1990, HBS Case Solutions

A Case Study of a Complex Leveraged Buyout

Collection of RJR Nabisco newspaper articles

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Bruce Greenwald Presentation

Value Investing and the Mis-measure of Modern Portfolio Theory

The 12th International Post Keynesian Conference: Pre-Conference Presentation by Professor Bruce Greenwald

Described as “the guru to wall street gurus”, Dr. Bruce Greenwald, the Robert Heilbrunn Professorship of Finance and Asset Management at Columbia Business School will kick-off the event with a pre-conference lecture on “Value Investing and the Mismeasure of Modern Portfolio Theory”, Wednesday September 24th, 6pm. His lecture is free and is open to the public. (Source)

For those who didn’t have a chance to be there, see here:

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.