IN STUDYING the great investment fortunes, and the great investors behind them, it is natural to wonder just how the dough was made.
With the return of pain and anguish after such a long absence, the topic seems particularly appropriate. (Pain and anguish can be quite lucrative, as we shall soon see.) The world is a different place today, but much of the old wisdom still applies. What follows is a recap of some of the basic strategies, if one could call them strategies, used in the past to amass serious wealth.
Strategy #1: superior information
One of the oldest and most successful wealth-building strategies hinges on superior information -- learning something important before everyone else.
In today's hyper-connected and heavily regulated markets, it is much harder to come by superior information (without a keen willingness to break the law). But back in the 18th and 19th centuries, no one played the superior information game better than the Rothschilds.
The Rothschilds were known for maintaining an extensive (and secretive) information network, connected by financial hubs in five European cities: London, Paris, Vienna, Naples, and Frankfurt. Nathan Rothschild, a bullion dealer on the London Stock Exchange, made legendary use of this information network during the Napoleonic wars... and in so doing laid the foundations of the Rothschild fortune.
Richard Bookstaber recounts the backstory in his book, A Demon of Our Own Design:
By the end of the final hour of the battle of Waterloo on June 17, 1815, just 10 hours after first contact, a quarter of the Duke of Wellington's troops lay dead. The French losses numbered nearly 30,000. Within the space of half a day, Waterloo claimed more casualties than any other battle in history. Given the communications limitations of the period, Great Britain could not immediately know about the carnage of Waterloo or the swift victory... Wellington's Envoy, Major Henry Percy, was dispatched to send the news of the victory to the War Office in London, but he and his horse were affected by the physical toll of the battle. Even with his best efforts, he did not arrive until late on the night of June 21. Until that time, all of Britain waited in suspense -- all of Britain but one man, Nathan Rothschild.
Because the Rothschilds were known for having superior information -- and because he had stopped by the Prime Minister's house on the way -- all eyes were on Nathan Rothschild when he took his usual post at the London Exchange.
England's victory was a hugely bullish event. But rather than buy British consols (the main trading vehicle of the day), Nathan began to sell. The heavy selling was a very loud, and very false, signal. Rothschild's actions fairly shouted, Britain has lost! Napoleon has won!
Of course, it was the exact opposite that had actually happened. So, once everyone had panicked out of their positions, and the market hit rock bottom, Nathan Rothschild turned around and began to buy. And the Rothschilds made a spectacular killing.
With the return of pain and anguish after such a long absence, the topic seems particularly appropriate. (Pain and anguish can be quite lucrative, as we shall soon see.) The world is a different place today, but much of the old wisdom still applies. What follows is a recap of some of the basic strategies, if one could call them strategies, used in the past to amass serious wealth.
Strategy #1: superior information
One of the oldest and most successful wealth-building strategies hinges on superior information -- learning something important before everyone else.
In today's hyper-connected and heavily regulated markets, it is much harder to come by superior information (without a keen willingness to break the law). But back in the 18th and 19th centuries, no one played the superior information game better than the Rothschilds.
The Rothschilds were known for maintaining an extensive (and secretive) information network, connected by financial hubs in five European cities: London, Paris, Vienna, Naples, and Frankfurt. Nathan Rothschild, a bullion dealer on the London Stock Exchange, made legendary use of this information network during the Napoleonic wars... and in so doing laid the foundations of the Rothschild fortune.
Richard Bookstaber recounts the backstory in his book, A Demon of Our Own Design:
By the end of the final hour of the battle of Waterloo on June 17, 1815, just 10 hours after first contact, a quarter of the Duke of Wellington's troops lay dead. The French losses numbered nearly 30,000. Within the space of half a day, Waterloo claimed more casualties than any other battle in history. Given the communications limitations of the period, Great Britain could not immediately know about the carnage of Waterloo or the swift victory... Wellington's Envoy, Major Henry Percy, was dispatched to send the news of the victory to the War Office in London, but he and his horse were affected by the physical toll of the battle. Even with his best efforts, he did not arrive until late on the night of June 21. Until that time, all of Britain waited in suspense -- all of Britain but one man, Nathan Rothschild.
Because the Rothschilds were known for having superior information -- and because he had stopped by the Prime Minister's house on the way -- all eyes were on Nathan Rothschild when he took his usual post at the London Exchange.
England's victory was a hugely bullish event. But rather than buy British consols (the main trading vehicle of the day), Nathan began to sell. The heavy selling was a very loud, and very false, signal. Rothschild's actions fairly shouted, Britain has lost! Napoleon has won!
Of course, it was the exact opposite that had actually happened. So, once everyone had panicked out of their positions, and the market hit rock bottom, Nathan Rothschild turned around and began to buy. And the Rothschilds made a spectacular killing.
Strategy #2: by hook or by crook
For a thousand years -- from roughly 800 AD to 1800 AD -- the Rhine River in Europe served as a revenue source for the Holy Roman Emperor and his minions. Cargo ships were required to pay tolls at various points along the Rhine, providing a sort of interstate tax revenue on traded goods.
The Raubritters, or Robber Barons, were originally renegade feudal lords who levied "unjust tolls" on these passing ships, to the great annoyance of the emperor and the church. The term "Robber Baron" was later resurrected in the 19th century United States, applied to the financiers and captains of industry who had amassed huge sums by ruthless means.
Few of the latter-day Robber Barrons were as successful -- or as hated -- as Jay Gould.
In the aftermath of a failed gold corner, which in turn led to the Panic of 1869, Gould was dubbed "the Mephistopheles of Wall Street." In addition to being a railroad titan, Gould was known for being one of the most manipulative, cunning, and creative financiers in history. His strategic maneuvering included bribery, bankruptcies, lawsuits, insider trading, stock manipulation, and much more.
One of Gould's favorite techniques was the "bear raid," in which a company's shares would be hammered into the ground with strategic selling. This allowed Gould to then step in at rock-bottom prices (precisely when the selling onslaught stopped), wrest control from the board, and establish himself as chairman or president. Many of the maneuvers Gould pioneered would inspire the formation of the Securities and Exchange Commission (SEC), created some forty-odd years after his death.
In his book Dark Genius of Wall Street, Edward Renahan writes:
Jay Gould would transact virtually all of his Wall Street business for the balance of his short life through a series of special partnerships with a variety of brokerage firms. This device allowed him the luxury of trading anonymously whenever he cared to, and of trading on both sides of a speculation through different brokers. Eventually, Jay would spread his business over so large a network of Wall Street houses that he became something of a phantom; ever present, but frequently invisible and always inscrutable.
In light of his larger-than-life reputation as a heartless crook (still stoked by books and news articles to this day), Gould never really received credit for the positive things he achieved. Dirty dealings aside, Gould's business acumen greatly aided the expansion and development of America's railroads, thus aiding the dramatic long-term expansion that followed. Even mephistopheles had some good in him it seems.
Strategy #3: looking to the future
Claude Shannon, the brilliant scientist of Bell Labs fame, was perhaps best known as the father of "information theory"... an idea so big it is almost impossible to overstate its influence. Per Wikipedia,
[Information Theory] is at the crossroads of mathematics, statistics, computer science, physics, neurobiology, and electrical engineering. Its impact has been crucial to success of the Voyager missions to deep space, the invention of the CD, the feasibility of mobile phones, the development of the Internet, the study of linguistics and of human perception, the understanding of black holes, and numerous other fields.
Furthermore, in the late 1930s -- a decade before revealing his work on information theory -- Shannon hit on the idea of the digital computer, using Boolean algebra to prove that any problem could be solved with electrical circuits. This led to the 1s and 0s system of binary computing in use today.
Shannon's discoveries worked together beautifully, in that the 0s and 1s made digital computing possible, while information theory enabled the means of sending digital information across great distances without garbling the transmission. As far as digital technology goes, Claude Shannon basically cracked the philosopher's stone.
In terms of brilliance and influence, many rank Shannon above Einstein for this reason, and the follow-on impact of Shannon's ideas on the everyday world.
Just as a great scientist should be, Shannon was deeply playful. He loved to tinker with erector sets and odd materials, and was known to juggle in the halls of Bell Labs while riding around on a unicycle. He invented one of the first computer chess programs and one of the first artificial intelligence devices, among other things. One of his quirkier inventions was a cigar-shaped box with nothing but a switch on one side. On flipping the switch, a mechanical hand would come out, flip the switch off, and retreat back into the box again.
We mention Shannon here, of course, because he was a wildly successful investor. In his book Fortune's Formula, William Poundstone recounts Claude Shannon's view of markets:
"You know the economists talk about the efficient market where everything is equalized out and nobody can make any money really, it's all luck and so on," Shannon once said. "I don't believe that's true at all."
Given his investing track record, Shannon had good reason to doubt the academics. Poundstone reports:
When Warren Buffett bought Berkshire Hathaway in 1965, it was trading at $18 a share. By 1995 each share was worth $24,000. Over thirty years, that represents a return of 27 percent. From the late 1950s through 1986, Shannon's return on his stock portfolio was about 28 percent.
As of record books in the early eighties -- just before the great equity bull market took off -- Claude Shannon had the majority of his investment account in one stock, Teledyne, that he had purchased for $1.00 per share. In 1981, this $1 stock was worth $194.38 per share, a nearly 200-fold return.
Even more impressive, from an ROI standpoint, were Shannon's returns on Hewlett Packard... a stock he had purchased at just $0.13 per share. The Shannons had a 63,000 percent return on Hewlett Packard as of 1981. (Given Shannon's deep aversion to selling companies he believed in, that return no doubt grew more impressive in the years that followed.)
Claude Shannon not only invented the future, he and Betty (his wife) invested in it. But rather than take a cerebral, formula-laden approach as one might expect, the Shannons were the type of investors to sample a piece of Kentucky Fried Chicken before buying stock in the company. They looked to the future, bought companies they believed in... and held on.
For a thousand years -- from roughly 800 AD to 1800 AD -- the Rhine River in Europe served as a revenue source for the Holy Roman Emperor and his minions. Cargo ships were required to pay tolls at various points along the Rhine, providing a sort of interstate tax revenue on traded goods.
The Raubritters, or Robber Barons, were originally renegade feudal lords who levied "unjust tolls" on these passing ships, to the great annoyance of the emperor and the church. The term "Robber Baron" was later resurrected in the 19th century United States, applied to the financiers and captains of industry who had amassed huge sums by ruthless means.
Few of the latter-day Robber Barrons were as successful -- or as hated -- as Jay Gould.
In the aftermath of a failed gold corner, which in turn led to the Panic of 1869, Gould was dubbed "the Mephistopheles of Wall Street." In addition to being a railroad titan, Gould was known for being one of the most manipulative, cunning, and creative financiers in history. His strategic maneuvering included bribery, bankruptcies, lawsuits, insider trading, stock manipulation, and much more.
One of Gould's favorite techniques was the "bear raid," in which a company's shares would be hammered into the ground with strategic selling. This allowed Gould to then step in at rock-bottom prices (precisely when the selling onslaught stopped), wrest control from the board, and establish himself as chairman or president. Many of the maneuvers Gould pioneered would inspire the formation of the Securities and Exchange Commission (SEC), created some forty-odd years after his death.
In his book Dark Genius of Wall Street, Edward Renahan writes:
Jay Gould would transact virtually all of his Wall Street business for the balance of his short life through a series of special partnerships with a variety of brokerage firms. This device allowed him the luxury of trading anonymously whenever he cared to, and of trading on both sides of a speculation through different brokers. Eventually, Jay would spread his business over so large a network of Wall Street houses that he became something of a phantom; ever present, but frequently invisible and always inscrutable.
In light of his larger-than-life reputation as a heartless crook (still stoked by books and news articles to this day), Gould never really received credit for the positive things he achieved. Dirty dealings aside, Gould's business acumen greatly aided the expansion and development of America's railroads, thus aiding the dramatic long-term expansion that followed. Even mephistopheles had some good in him it seems.
Strategy #3: looking to the future
Claude Shannon, the brilliant scientist of Bell Labs fame, was perhaps best known as the father of "information theory"... an idea so big it is almost impossible to overstate its influence. Per Wikipedia,
[Information Theory] is at the crossroads of mathematics, statistics, computer science, physics, neurobiology, and electrical engineering. Its impact has been crucial to success of the Voyager missions to deep space, the invention of the CD, the feasibility of mobile phones, the development of the Internet, the study of linguistics and of human perception, the understanding of black holes, and numerous other fields.
Furthermore, in the late 1930s -- a decade before revealing his work on information theory -- Shannon hit on the idea of the digital computer, using Boolean algebra to prove that any problem could be solved with electrical circuits. This led to the 1s and 0s system of binary computing in use today.
Shannon's discoveries worked together beautifully, in that the 0s and 1s made digital computing possible, while information theory enabled the means of sending digital information across great distances without garbling the transmission. As far as digital technology goes, Claude Shannon basically cracked the philosopher's stone.
In terms of brilliance and influence, many rank Shannon above Einstein for this reason, and the follow-on impact of Shannon's ideas on the everyday world.
Just as a great scientist should be, Shannon was deeply playful. He loved to tinker with erector sets and odd materials, and was known to juggle in the halls of Bell Labs while riding around on a unicycle. He invented one of the first computer chess programs and one of the first artificial intelligence devices, among other things. One of his quirkier inventions was a cigar-shaped box with nothing but a switch on one side. On flipping the switch, a mechanical hand would come out, flip the switch off, and retreat back into the box again.
We mention Shannon here, of course, because he was a wildly successful investor. In his book Fortune's Formula, William Poundstone recounts Claude Shannon's view of markets:
"You know the economists talk about the efficient market where everything is equalized out and nobody can make any money really, it's all luck and so on," Shannon once said. "I don't believe that's true at all."
Given his investing track record, Shannon had good reason to doubt the academics. Poundstone reports:
When Warren Buffett bought Berkshire Hathaway in 1965, it was trading at $18 a share. By 1995 each share was worth $24,000. Over thirty years, that represents a return of 27 percent. From the late 1950s through 1986, Shannon's return on his stock portfolio was about 28 percent.
As of record books in the early eighties -- just before the great equity bull market took off -- Claude Shannon had the majority of his investment account in one stock, Teledyne, that he had purchased for $1.00 per share. In 1981, this $1 stock was worth $194.38 per share, a nearly 200-fold return.
Even more impressive, from an ROI standpoint, were Shannon's returns on Hewlett Packard... a stock he had purchased at just $0.13 per share. The Shannons had a 63,000 percent return on Hewlett Packard as of 1981. (Given Shannon's deep aversion to selling companies he believed in, that return no doubt grew more impressive in the years that followed.)
Claude Shannon not only invented the future, he and Betty (his wife) invested in it. But rather than take a cerebral, formula-laden approach as one might expect, the Shannons were the type of investors to sample a piece of Kentucky Fried Chicken before buying stock in the company. They looked to the future, bought companies they believed in... and held on.
Strategy #4: blood in the streets
Nathan Rothschild -- he of the superior information mentioned earlier -- is said to have coined the phrase, "Buy when there's blood in the streets and sell to the sound of trumpets."
One man who followed that advice, or the first part anyway, is Carlos Slim of Mexico. It seemed to work out pretty well... with holdings worth approximately $59 billion as of this writing, Slim is now officially recognized to be the richest man in the world, ahead of Bill Gates and Warren Buffett.
The WSJ calls Slim "Mexico's Mr. Monopoly," due to his extensive holdings:
It's hard to spend a day in Mexico and not put money in his pocket. The 67-year-old tycoon controls more than 200 companies -- he says he's "lost count" -- in telecommunications, cigarettes, construction, mining, bicycles, soft drinks, airlines, hotels, railways, banking, and printing. In all, his companies account for more than a third of the total value of Mexico's leading stock market index, while his fortune represents 7% of the country's annual economic output.
Carlos Slim was born with advantages, but it was a "blood in the streets" moment that really put him in the game. His father Julian, a Lebanese immigrant, fled to Mexico in 1902 to avoid turmoil in the Ottoman Empire. Julian put together a small fortune by starting up a general store and purchasing commercial real estate during the Mexican revolution.
After graduating from university as a trained engineer, Carlos started a brokerage firm and began acquiring industrial companies on the cheap with family capital. His big break came in 1982, when the Mexican economy fell apart. As the WSJ puts it,
That year, the collapsing price of oil threw Mexico into a tailspin. When departing president José López Portillo nationalized Mexico's banks, the traditional business elite feared the country was becoming socialist, and ran for the exits. Companies were selling for as little as 5% of their book value. Mr. Slim picked up dozens of leading firms for bargain-basement prices, a move that paid off when the economy recovered in the following years. He bought Mexico's largest insurer, Seguros de Mexico, for $44 million. Today, the company is worth at least $2.5 billion.
Some cast Carlos Slim as a modern day robber baron, arguing that much of his success comes from heavy-handed monopoly tactics and political ties to the Salinas government of the 1990s. There is no question, though, that the Slim's first step towards dynastic wealth was willingness to bet, and bet big, when there was blood in the streets.
Strategy #5: damsels in distress
Though he is only third richest now on official rosters (never mind the Rothschilds), Warren Buffet is still the public face of successful investing. While the mantra from Berkshire Hathaway these days is "a great company at a fair price," a better mantra for getting rich the Buffett way might be "a great company at an insanely great price."
Such a combo (of great company and insanely great price) is extremely rare.... one could reasonably expect only a handful of such opportunities to come along in a lifetime. That in turn might explain why the majority of Berkshire's billions can be attributed to ten or fewer huge winners. The singles and the doubles and the triples certainly add up, but the home runs conquer all.
Here are examples of two "damsels in distress" that helped make Buffett, and his shareholders, many billions.
Damsel #1: American Express.
In the early 1960s, the credit card revolution was at hand, and American Express was at the forefront. It was only in the past few years that people had stopped carrying hard currency everywhere they went, and already a million people had put the American Express card in their wallets. The company's prospects were looking brighter than ever... until the salad oil scandal broke.
To make a long story short, an Amex-owned subsidiary owned a warehouse in New Jersey. This warehouse got into a transaction with a shady outfit called Allied Crude Vegetable Oil Refining, in which tankers full of salad oil were exchanged for warehouse receipts.
When Allied (the shady outfit) borrowed against the warehouse receipts and declared bankruptcy, the company's creditors came to collect the salad oil as collateral. At this point it was discovered the tankers in the warehouse didn't actually contain salad oil... they were filled with seawater. Due to Allied's empty pockets and the failure of the subsidiary, American Express wound up saddled with potential liabilities of $150 million.
As the ugly episode dragged on, with potential fallout unclear, Amex stock began to fall... and fall... and fall. Within six months or so of the scandal break, the stock was down by more than 40%.
All of Wall Street was relentlessly bearish, it seemed, except for Buffett. He saw one of the strongest franchises in the world, and believed the squall would prove to be a tempest in a teacup.
Buffett believed so strongly in American Express at that point, he put a quarter of his fund into it... and later even added to the position!(Split-adjusted from that day to this, Buffett has basically owned Amex from something like $2 a share.)
Damsel #2: the Washington Post
In 1973 the economy, and the markets, were in a terrible state. Fear and loathing dominated the street. Naturally it was a great time to apply a contrarian value style... Buffett was so excited by this gloomy state of affairs, in fact, he decided to borrow $20 million in cash for Berkshire so he could plow it into stocks.
With the rest of the world moping and selling, Buffett was able to score one of the bargains of the century, buying up nine percent of the Washington Post Co. for pennies on the dollar. In Buffett's own words,
It's a lot different going out to Kalamazoo and telling whoever owns the television station out there that because the Dow is down 20 points that day he ought to sell the station to you a lot cheaper. You get into the real world when you deal with a business. But in stocks everyone is thinking about relative price. When we bought 8 percent or 9 percent of the Washington Post in one month not one person who was selling to us was thinking that he was selling $400 million [worth] for $80 million. They were selling to us because communication stocks were going down, or other people were selling, or whatever reason. They had nonsensical reasons.
It's 2007... what now?
After that brief tour, it may seem that not many direct lessons apply. We can't exactly milk an information network like Nathan Rothschild, or hire corrupt judges and conduct insider bear raids like Jay Gould.
But apart from the, shall we say, less than sportsmanlike aspects of fortune-building, there is still value in examining the common threads. For every investor mentioned here, certain traits played a clear role in their success... traits like patience, foresight, guts, creativity, and perhaps more than a little contrarianism.
And of course, the beat goes on.
In regard to his $50 billion war chest and the current market turmoil, Buffett notes that he can "spend money faster than Imelda Marcos when the time is right." Other contrarian investors, particularly those with a taste for distressed debt, are keeping their eyes open for opportunity when the smoke clears. Beyond the appeal of assets on sale, there are at least five "megatrends" out there -- major, sweeping themes -- set to make savvy investors a lot of money over the next decade.
Finally, on the technological side of things, the accelerating pace continues. Thanks to a phenomenon Ralph Wanger calls "downstream effects," ever faster and more powerful computers are on the verge of creating explosive investing opportunities in new areas, like biotechnology and healthcare and developing world communications. In a world where baby boomers can have their bio-profiles screened for early health warnings while Bhutanese yak herders key in digital transactions on their mobile phones, there will surely be an amazing opportunity or two.
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