The Warren Buffett Way — Hagstrom: COMPLETE

The book's introduction opens with a question the course keeps for life: is Warren Buffett an exception that cannot be copied, or is his process a discipline anyone can learn — even if the outcome will never be the same? Hagstrom's answer is that the process is learnable but that it demands a temperament most people lack. To prove it, he divides his material into four parts: the education that shaped Buffett, twelve principles for buying businesses, the portfolio mathematics and the psychology.

The foreword to the third edition (2013) is written by Howard Marks, the second (2005) by Bill Miller, the first by Peter Lynch — three names that have themselves run billions and who all share the same conclusion: the record is extreme, but the method is public.

The record is the book's evidence and its problem. Buffett Partnership, started in 1956 with little more than a hundred thousand dollars of family and friends' money, returned on average over thirty percent per year for thirteen years against Dow Jones's barely ten — without a single losing year. Thereafter the book value per share of stock at Berkshire Hathaway compounded from 1965 at an annual pace of nearly twenty percent and the share price just above that, against an index of nine to ten percent including dividends — for almost half a century.

Such a curve, Hagstrom writes, is a five-sigma deviation: in a normal distribution it should occur roughly once in three and a half million. The course's controversy chapter (chapter 15) will take that number seriously — partly as tribute, partly as accusation.

The book exists in three versions and the course covers them as a whole. The 1994 edition established the twelve principles and the five original cases: Washington Post, GEICO, Capital Cities/ABC, Coca-Cola and General Dynamics. The 2005 edition added, among other things, Wells Fargo and American Express after the banking crisis of the 1990s and brought in the portfolio mathematics with the Kelly criterion.

The 2013 edition — the one the course mainly follows — added IBM in 2011 and H.J. Heinz in 2013 and updated the research on concentration. Hagstrom writes no biography: on the sugar, the father and Susie the course refers to the Snowball course; on the letters themselves to the Essays course. Here it is the process: what did he do, in what order and with which numbers.

For the AK1A ecosystem this book is especially useful for one reason: Hagstrom formulated a checklist a quarter century before checklists became investing's buzzword. The twelve principles — three on the business, three on management, four on the finances, two on the market — are in practice a structured fundamental model.

The course will therefore show, for each principle, where it lands in AKM1's twenty variables: profitability in V07-V09, the moat in V13-V15, capital allocation in V20 and capital burn in V19. That is the course's own thesis: Hagstrom showed that Buffett is a process; AKM1 makes the process measurable.

The first cornerstone is the most banal and the most difficult: a stock is not a lottery ticket but a share of a business. When Graham and Dodd wrote Security Analysis in the middle of the Depression the idea was radical — the market treated stocks as price-stamped paper that rose and fell on sentiment. Graham's counter-image was that every stock represents an ownership share in a running operation with assets, cash flow and the ability to generate profit.

Buffett compressed it into the line Hagstrom quotes: the price is what you pay, the value is what you get. Everything else in the method — analysis, patience, concentration — is a consequence of that sentence.

The second cornerstone is Mr Market, the allegory from the eighth chapter of The Intelligent Investor. Imagine, Graham writes, a co-owner who shows up every day and offers to buy from you or sell to you the share at a price he happens to feel like that day. He is helpful, not evil: one day he is euphoric and the price high, other days depressed and the price low. His mood is your opportunity, not your instruction.

Hagstrom notes that the allegory is at the same time behavioral science ahead of its time — chapter 16 returns to it as psychological apparatus — but the point here is operational: the course of prices exists to be exploited, not to be obeyed. Whoever measures his worth by Mr Market's daily quotations has changed role from owner to passenger.

The third cornerstone is the margin of safety — the thought Buffett has said he needed only two chapters of Graham's book to learn: this one and the one about Mr Market. Never buy an asset at its calculated value — buy it with a margin, so that arithmetic errors, changed assumptions and your own mistakes can be swallowed without permanent loss. Graham's own quantitative execution was the cigar butt: companies trading below their net assets, preferably below two thirds of working capital, »cigar butts« with one last free puff.

Buffett filled his early years with cigar butts and the course will not pretend that this was not where he began — but Hagstrom makes clear already here that cigar-butt mathematics is Graham's strictest application, and that Buffett's later development toward quality would require other teachers (chapter 3).

Hagstrom also highlights Graham's bequeathed warnings that Buffett kept for life: the market can stay irrational longer than the investor can stay liquid; never act on other people's opinions; and whoever cannot tolerate a stock falling fifty percent without panicking should not own stocks at all. From these three cornerstones — the stock as a share, Mr Market, the margin of safety — the whole building then rises: the business principles are the stock-as-share, the market principles are Mr Market, and the buying corridor in chapter 9 is the margin with numbers.

The iceberg is the same; Hagstrom's contribution is to show how far down it reaches.