In Peter Thiel’s book Zero to One, he talks about a question he likes to ask when interviewing someone for a job. The excerpt is below:
“Whenever I interview someone for a job, I like to ask this question: “What important truth do very few people agree with you on?” This question sounds easy because it’s straightforward. Actually, it’s very hard to answer. It’s intellectually difficult because the knowledge that everyone is taught in school is by definition agreed upon. And it’s psychologically difficult because anyone trying to answer must say something she knows to be unpopular. Brilliant thinking is rare, but courage is in even shorter supply than genius.”[1]
What important truth do very few people agree with you on?
Our investment strategy at S&C Messina Capital is largely predicated on our answer to this question. Simply: The truth that very few people agree with us on is how Warren Buffett generated the bulk of his wealth. That is, he became the wealthiest individual in the world by utilizing a stable form of leverage that served as permanent capital for his value investing strategy. The majority of this leverage came from insurance premiums in the P&C sector.
I think you have subscribed to our newsletter or invested in our fund because you GET IT. You understand this truth about the power of the costless leverage engine that propelled Buffett's wealth. So on this day of the 51st Berkshire annual shareholder meeting, which has turned into a cultish rock concert, it's unlikely Buffett or Munger will decide to finally explain this concept in a simple manner.
So perhaps, we, as a group of thousands of subscribers can share this truth. Share it with your family, friends, co-workers and see what they say. Share it with the "smartest" person you know (other than yourself, course). It's always a fun experiment. My guess is that the more money they make or closer they are to Wall Street, the less they will agree with you on this truth. Forward this email and link: How did Warren Buffett become the wealthiest person in the world? and watch what unfolds.
This isn't a conspiracy by any means, but what hasn't helped is how NOT straightforward Buffett has been about this truth. Yes, he discusses the "fountain of funds" provided by insurance premiums but he NEVER has once said anything along the lines of, "Our growth in book value is not simply a return on our net worth. More specifically, it is a levered return on our net worth."
What does this mean? It simply means that his return on assets are juiced by using borrowed money. So when he talks about growth in book value year-over-year, this is not how much his assets increased by - no this is a levered return that is higher (or lower) than the change in the value of his assets.
Now whether this is because Buffett thinks most Americans are too dumb to understand this or because he is keeping this "secret" close to his chest, by writing and speaking in veiled insurance lingo that is Greek to most Americans but clear to us as insurance experts, I have no idea.
What I do know is that if he were to be truly "folksy" and "down to earth" and academically straightforward as his mentor Ben Graham on this topic regarding the mechanics of his wealth generation over the past 50 years, then he would say something like this:
If you buy Coca-Cola stock at $40 per share in your Fidelity brokerage account and I buy Coca-Cola stock at the same $40 per share, we are both in the same boat. In one year, however, if Coca-Cola goes up to $44, you will have enjoyed a 10% return. But I get at least a 15-20% return. This is because my returns are levered (and I also get underwriting profits).
Why he never comes out and says this on CNBC, I will never know.
Regarding this topic of Buffett's wealth generation, we have talked to the sharpest minds and senior partners on Wall Street at every major private equity firm and hedge fund - you name it - Blackstone, KKR, Fortress and on and on. And almost every single person disagrees with my explanation. "That's an interesting theory." "What if there's a hurricane?" "You can't do it today because of regulatory pressures, just like the ones hurting banks."
For some reason, save for a few voices here and there, such as AQR in their writing of the paper titled "Buffett's Alpha", Wall Street just does not or has trouble agreeing with me on this truth. In the words of Peter Thiel, this is a truth that very few people agree with me on.
