Supermoney

By Adam Smith and John C. Bogle

"Adam Smith continues to dazzle and sparkle! With the passage of time, Supermoney has, if anything, added to its power to inspire, arouse, provoke, motivate, inform, illuminate, entertain, and guide a whole new generation of readers, while marvelously reprising the global money show for earlier fans."
-David M. Darst, author of The Art of Asset Allocation Managing Director and Chief Investment Strategist, Morgan Stanley Individual Investor Group

"Nobody has written about the craft of money management with more insight, humor, and understanding than Adam Smith. Over the years, he has consistently separated wisdom from whimsy, brilliance from bluster, and character from chicanery."
-Byron R. Wien, coauthor of Soros on Soros Chief Investment Strategist, Pequot Capital Management

Supermoney may be even more relevant today than when it was first published nearly twenty-five years ago. Written in the bright and funny style that became Adam Smith's trademark, this book gives a view inside institutions, professionals, and the nature of markets that has rarely been shown before or since. "Adam Smith" was the first to introduce an obscure fund manager in Omaha, Nebraska, named Warren Buffett. In this new edition, Smith provides a fresh perspective in an updated Preface that contextualizes the applicability of the markets of the 1960s and 1970s to today's markets. Things change, but sometimes the more they change, the more they stay the same.

• Language: English
• Publisher: Wiley
• Release date: Dec 23, 2010
• ISBN: 9781118040775

Book preview

Preface to the 2006 Edition

Who’s Warren Buffett? What Is Supermoney?

The handwritten letter appeared in 1970; it was from La Champouse, 42 Avenue de Marseille, Aix-en-Provence. Benjamin Graham was living in the South of France, retired, with his lady friend, and translating Greek and Latin classics. That was a favorite avocation. The prescript of Security Analysis, the forbidding black bible of security analysts, is from Horace: Many shall be restored that are now fallen and many shall fall that are now in honor.

I hadn’t known him, but I had written some sentences about him in The Money Game. Graham, I had written, was the dean of our profession, if security analysis can be said to be a profession. The reason that Graham is the undisputed dean is that before him there was no profession and after him they began to call it that.

Graham liked being called the dean. He corrected, in Greek, a sentence in my book that no one had checked, and one or two other references. He said he had something in mind to discuss when he came to New York.

Shortly thereafter, he did appear in New York, to see a publisher about his translation of Aeschuylus and to see his grandchildren. I asked him what he thought of the market. Hoc etiam transibit, he said, This too shall pass.

Graham said he wanted me to work on the next edition of The Intelligent Investor, the popular version of his textbook. There are only two people I would ask to do this, he said. You are one, and Warren Buffett is the other.

Who’s Warren Buffett? I asked. A natural question. In 1970 Warren Buffett wasn’t known outside of Omaha, Nebraska, or Ben Graham’s circle of friends.

Today, Warren is so well known that when newspapers mention him they sometimes need no phrase in apposition to identify him, or if they do, they say simply, the investor. There are full-length biographies on the shelves. He is indeed the investor, one of the best in history. Investing has made him the second-richest person in the country, behind his bridge buddy Bill Gates.

Even in 1970, Warren had an outstanding investment record, and with an unfashionable technique. He had started an investment partnership in 1956 with $105,000 from friends and relatives. When he terminated the partnership in 1969, it had $105 million and had compounded at 31 percent. Warren’s performance fee meant he was worth about $25 million. He ended the partnership because he said he couldn’t understand the stock market anymore.

I was not the right author to work on the next edition of The Intelligent Investor. I was an acolyte of Sam Stedman (not the mutual funds or the bridge conventions) by way of Phil Fisher. Stedman’s investment philosophy, loosely called growth, said you should find a couple of rapidly growing companies whose growth rates were secure. The companies would have a competitive advantage because of their patent protection or impregnable market positions; they would have three years of earning visibility; and you would buy them at less than their growth rates, because their prices would seem high compared to the average stock and they paid no dividends.

The machine that addicted us to growth investing was the Xerox 914. It was the first machine to copy plain paper, and I can remember writing that some day people would use the word Xerox as a verb. That seemed radical at the time. Xerox was a ten-bagger, and once you have a ten-bagger, everything else seems tame. The Xerox crowd even got to play the game again, with Rank Xerox in the United Kingdom and Fuji Xerox in Japan.

We all went to Dunhill on 57th Street and had suits tailored where the four buttons on the sleeves had real buttonholes. We did not think much about Ben Graham. Charming as he was, he had written, in 1949, that he could not buy IBM because its price precluded the margin of safety which we consider essential to a true investment.

At Graham’s urging, I had several conversations with Warren, and then I flew to Omaha to meet him, even though I still didn’t think I was right for the job. We had a steak dinner. We had a bacon, eggs, and potatoes breakfast. We got along famously. Warren was, and is, cheerful and funny. He has a gift of metaphor that is irresistible. And, as everybody now knows, he is very smart.

Warren didn’t look like the Xerox crowd. While he wore a suit and a tie, his wrists emerged from the sleeves, revealing an indifference to tailoring. (Today, as our senior financial statesman, he is dressed impeccably, but without, I suspect, intense interest in the process.) To a member of the Xerox crowd then, he looked like he had fallen off the turnip truck.

I went to Warren’s house on Farnam Street, which he had bought for $31,500 in 1958. It was a rambling, comfortable house. He had added a racquetball court to it.

How, I wanted to know, could he operate from Omaha? In New York, the portfolio managers were all trading stories at breakfast, lunch, and dinner.

Omaha gives me perspective, Warren said. He showed me a write-up from a Wall Street firm that said, Securities must be studied on a minute-by-minute program.

Wow! Warren said. This sort of stuff makes me feel guilty when I go out for a Pepsi.

I couldn’t interest Warren in the truffle hunt for the next Xerox. Our growth crowd was sniffing everywhere, talking to vendors, customers, competitors, the Phil Fisher geometry. Not that Warren didn’t do research his own way.

For example, Warren noticed that the bonds of the Indiana Turnpike were selling in the 70s, while the nearly identical bonds of the Illinois Turnpike sold in the 90s. The casual word among the bond crowd was that the maintenance allowance wasn’t high enough behind the Indiana bonds.

Warren got into his car and drove the length of the Indiana Turnpike. Then he went to Indianapolis and turned the pages of the maintenance reports of the highway department. He thought the Indiana Turnpike didn’t need that much work, and bought the bonds. They closed the gap with the bonds of the Illinois Turnpike. Not exactly the next Xerox.

Warren showed me the principles he had written out on a lined, yellow legal pad and framed:

a. Our investments will be chosen on the basis of value, not popularity.

b. Our investments will attempt to reduce the risk of permanent capital loss (not short-term quotation loss) to a minimum.

c. My wife, children and I will have virtually our entire net worth in the partnership.

Warren had ended his partnership, so I couldn’t have bought into it anyway. The partnership had bought shares in an old New England textile company, Berkshire Hathaway, and that stock was traded in the pink sheets. I looked up Berkshire. It seemed to be a failing New England textile company.

Berkshire is hardly going to be as profitable as Xerox in a hypertense market, Warren wrote to his investors, but it is a very comfortable thing to own. We will not go into a business where technology which is way over my head is crucial to the decision. Berkshire’s attraction was that it had $18 in net working capital, and Buffett’s investors had paid $13.

I didn’t buy Berkshire Hathaway. At the end of my stay, I said I didn’t want to work on Ben Graham’s book. Warren said he didn’t either. We wrote a note to Ben saying his book didn’t really need any improvements.

The little story about Ben and Warren went into this book. The original publisher, Random House, gave a party for the book. Warren came to the party, and had a good time. We have the pictures. My hair is embarrassingly long, and Warren’s haircut looks, well, mid-America. We kept in touch.

Who’s Warren Buffett? the people at The Washington Post Company asked when Warren bought a stake. They ordered 50 copies of Supermoney.

I tried the Washington Post idea on my Wall Street friends. They couldn’t see it.

Big city newspapers are dead, they said. The trucks can’t get through the streets. Labor problems are terrible. People get their news from television. And anyway, it wasn’t the next Xerox.

In 1976, Rupert Murdoch’s News Corp launched an unfriendly takeover of The New York Magazine Company. I had been one of its founders, with 5-cent stock. We had spent eight years building a unique property. We not only had New York Magazine, but also the Village Voice and a California magazine called New West. Now Murdoch had bought 50.1 percent of the stock.

I called up Warren and whined.

You want it back? he asked.

I got very attentive. He sent me News Corp’s annual report. It was full of British or Australian accounting terminology. I didn’t get it.

News Corp has a market cap of only $50 million, Warren said. For $27 million, you could have two big newspapers in Australia, 73 weekly newspapers in Britain, two television stations, 20 percent of Ansett Airlines, and you’d have your magazine back.

How do we do it? I asked.

"What is this we, kemosabe?" Warren said, using a term from our radio days with The Lone Ranger. You want your magazine back, I’m telling you how to do it.

But Murdoch controls News Corp, I said.

You didn’t read carefully, Warren said. Look at footnote 14. Clarendon has 40 percent. The rest is Australian institutions. Clarendon is Murdoch and his four sisters. I figure it would take one sister and the float and a year in Australia, and guess which one of us is going to spend the year in Australia?

I didn’t go, and we didn’t get the property back, either. I should have bought News Corp. Murdoch sold our magazines for many times what he had paid in the raid.

When we launched the weekly Adam Smith television show, we took it to Omaha right away. It was the first TV Warren had done, and for a long time, the only TV. It didn’t take much to get Warren to use his baseball metaphors.

When I look at the managers who run my companies, I feel like Miller Huggins looking at his lineup of the 1927 Yankees. (Those were the Yankees, of course, with Babe Ruth and Lou Gehrig.)

Or this one: In the stock market, it’s as if you are the batter and the market is the pitcher. The market has to keep pitching, but in this game there are no called strikes. The market can throw you a hundred different pitches every day, but you don’t have to swing until you get a fat pitch.

So, you might not swing for six months?

You might not swing for two years. That’s the beauty of Berkshire not being on Wall Street—nobody’s at the fence behind me calling out: ‘Swing, you bum!’

Warren continued this theme in subsequent television interviews with me.

You have said: ‘They could close the New York Stock Exchange for two years, and I wouldn’t care.’ But you are considered an investment guru. So how do you reconcile this?

"Whether the New York Stock Exchange is open or not has nothing to do with whether The Washington Post is getting more valuable. The New York Stock Exchange is closed on weekends, and I don’t break out in hives. When I look at a company, the last thing I look at is the price. You don’t ask what your house is worth three times a day, do you? Every stock is a business. You have to ask, what is its value as a business?"

Warren once sent me the collected annual reports of National Mutual Life Assurance, when Lord Keynes was the chairman of that company in Britain. This guy knows how to write a chairman’s report, Warren scribbled.

Warren’s own chairman’s letters for Berkshire Hathaway became even more famous than those of Keynes. They were teaching instruments. They carefully spelled out not only the businesses, but also the accounting procedures, and a very plain vanilla evaluation of the scene.

The annual meeting of Berkshire in Omaha draws more than 10,000 people, and Buffett and his vice chairman Charlie Munger answer questions for hours, questions on all sorts of subjects. It is a unique seminar with attendance hitting new records every year. No matter whether Berkshire has had a really good year or not, when you leave Omaha after this Woodstock of capitalism, you feel more lighthearted.

During the dot-com bubble, Buffett kept his cool. He said that if he were teaching an investment course he would ask: How do you value a dot-com? If the student answered anything at all, Buffett said: He would get an F.

Warren has never wavered either from the warm and folksy persona or from his sound, shirtsleeves wisdom. He is a powerful intellect, but he is also bien dans sa peau—comfortable in his skin —which mobilizes him and helps to keep him from second-guessing his perceptions.

Corporate and institutional icons have fallen, and others are under suspicion. Growth companies that once were accorded reverence are now said to smooth their earnings. A prominent accounting firm whose name was an imprimatur has lost its credibility. Many have fallen that had been in honor, as Horace wrote.

But Buffett is still Buffett: still in the same house on Farnam, still in the same office in Kiewit Plaza as when I first went to discuss the Ben Graham project. Warren was counted on by the government to right the wrongs at Salomon. He takes to print in the op-ed pages of the Washington Post on important issues. Recently, his chairman’s letter found him in high moral dudgeon. Charlie and I, he wrote referring to his vice chairman, Charles Munger, are disgusted by the situation, so common in the last few years, in which shareholders have suffered billions in losses while the CEOs, promoters, and other higher-ups who fathered these disasters have walked away with extraordinary wealth . . . to their shame, these business leaders view shareholders as patsies, not partners.

Warren Buffett was entitled to be in high moral dudgeon in the age of Enron and Worldcom and Adelphi. His comments met a receptive audience. The same moral dudgeon exists in this book. The financial world has always invited the sleight-of-hand artist; money is choreographed in numbers, and numbers are so easy to push around. Richard Whitney, president of The New York Stock Exchange at the time of the Great Crash, was photographed on the steps of Sing Sing, the prison that was to become his home. He was the Martha Stewart of his day, but society today is more forgiving; Richard Whitney did not emerge to host a radio show or star in a movie. This book, originally published in 1972, also has a distinguished character in high moral dudgeon: David Babson, founder of the firm that bears his name. He was the avenging angel described in the chapter, An Unsuccessful Group Therapy Session for Fifteen Hundred Investment Professionals Starring the Avenging Angel. I sponsored, I moderated that historic session, when the crusty New Englander said to the representatives of big banks and mutual funds still familiar today, Some of you should leave this business. He then read a list of stocks that had gone from lofty levels to 1, some even to 0, and cataloged his own Cotton Mather list of sins: the conglomerate shell game, accountants who certified earnings that weren’t there, CEOs and CFOs who treated the pension fund as a cookie jar, mutual fund managers who manufactured paper performance, and so on. Virtually nothing on his list is out-of-date, decades later. What fun David Babson could have had with the hedge funds. I’m sorry he is no longer with us.

Supermoney is the successor to The Money Game. Both books used some of the techniques of what was then called New Journalism, the first-person narrator, the dramatization of points with the actions of various characters. The Great Winfield, for example, appears handsomely in The Money Game, coming to work in jeans and cowboy boots, chasing stocks that went from 5 to 50. In Supermoney, his accounts have gone down 90 percent in the credit contraction and stock implosion of the early 1970s. But he was not perturbed. He still owned the side of the mountain in Aspen he had bought with his winnings, and he was studying art history at Columbia. He had bought some regulated utilities. The Great Winfield in utilities? I asked. Things change, m’boy, things change. We have to recognize them when they do, he said. The figure called Seymour the Head, sockless and tieless in this book, made the New York Times even in 2005. He was a figure in class-action lawsuits, and there was some problem about whether, as the aggrieved investor, he was kicking back to the law firms that brought the suits.

Things change, said The Great Winfield, but sometimes the more they change, the more they seem the same. For example, as this edition of Supermoney appears, we are engaged in an expensive and unpopular war, we are running big budget deficits, and the country is feeling divided and ill-tempered. Plus ca change. The scenario could be back in the early 1970s: Vietnam and its deficits, and the feeling that something unpleasant lurked around the next corner. In the financial world, structural changes are about to occur, just as they did at the time of the original edition. Those changes, in the 1970s, took out three quarters of the firms on Wall Street. We don’t know what will happen in this decade, but we can sense the tremors.

Beneath the anecdotal approach and the names of some of the characters, there are serious themes in these books. For example, The Money Game suggested that people viewed financial matters as rational, because the game was measured in numbers, and numbers are finite and definitive. But, said The Money Game, the truth was elsewhere. Any intelligent observer could see that behavior—psychology—had a lot to do with the outcome. Further, people did not behave as economists postulated, always assuming that people maximized their actions for rational gain. The Money Game, it said, right off, is about image and reality and identity and anxiety and money. Some of the aphorisms in it were "the stock doesn’t know you own it, prices have no memory, and yesterday has nothing to do with tomorrow. The founder of Fidelity, Mr. Johnson, tested the thesis, a crowd of men behaves like a single woman, and a psychiatrist postulated that some people actually want to lose. Mr. Johnson also said, somewhat prophetically, The dominant note of our time is unreality." This idea was startling enough that when The Wall Street Journal ran a front-page story about the book, its headline was New Book That Views Market as Irrational Is a Hit on Wall Street.

Several decades later, Amos Tversky and Daniel Kahneman did their pioneering work in what has now become the fashionable field of behavioral economics, and what did they find? That people can behave irrationally. They don’t maximize their odds, they fear loss. Tversky and Kahneman were psychologists, not economists. Their work in psychology had breathtaking ingenuity; they constructed games, puzzles, and situations that revealed how people actually behave, as opposed to the postulations of classical economics. They called this prospect theory, and published it in Econometrica, the economic journal, rather than Psychological Review, because Econometrica had published notable papers in decision making. Had the paper been published in a psychology journal, it might never have had the impact it did. My colleagues and I pored over Tversky and Kahneman looking for some edge in the market, and their follower Richard Thaler (without, I should say, particular financial results). Kahneman received the Nobel Prize in economics in 2002. (Tversky had died a few years before.)

Supermoney also attempts to take on some serious ideas; it expands from a visit to a new greenfield General Motors Plant to a discussion of whether the Protestant ethic, that engine of productivity, has been evaporating. Supermoney itself is a term I coined to describe the difference between the green bills in your wallet and the real wealth in the country, which is earnings, or profits, capitalized, when they are run through markets, that is, stocks. You might work very hard on your algorithms in your job at Google, but your weekly paycheck will be dwarfed by your Google options, which have the opinion of the market place applied to multiples of the stock. Cash your paycheck at Google, and you have money; cash your options and you have supermoney. So we have a wide gap in this country—indeed, all over the world—between those who have no currency, those who have currency, and those who have supercurrency. And Supermoney also mulls about how we account for the unquantifiable in our economic system. A 500-year-old sequoia redwood, chopped down, appears as a plus in the accounts of the gross domestic product; there is no minus for the lack of a redwood. And even large quantities of supermoney don’t guarantee a community in harmony. This book asks, Will General Motors Believe in Harmony? Will General Electric Believe in Beauty and Truth? The phrasing of the questions is done in an offhand, angular, journalistic tone, but the underlying questions bear some discussion and could still be asked today.

I would like to acknowledge the help of Craig Drill and Warren E. Buffett in the preface to this new edition. - AS

© Adam Smith 2006

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Supermoney

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METAPHYSICAL DOUBTS, VERY SHORT

NOT even a decade ago, everybody believed.

Events did seem under control. Inflation would creep, not gallop; the New Economics would fine-tune the economy; productivity would increase; wars would be fought, but not by us—we were the mediators, understanding but tough; problems would be articulated, and that articulation was half the solution; we would begin upon the solutions. Kennedy rhetoric: let us begin; let the word go forth; let us never negotiate from fear, nor fear to negotiate; let anybody call upon us. Confident, ambitious, optimistic, even naïve—the very best of the American tradition. Hail Columbia, happy

Reviews for Supermoney

[carterchristian1 · Rating: 5 out of 5 stars]

Amazing how timely this book sounds today. Even Buffett is still around. The author describes the new computerized trading in its earliest days, the debt days of Wall St traders. And funny. Really funny book.