Lessons From Buffett’s Experience With Dempster Mill

There have been a couple of points in

Warren Buffett (Trades, Portfolio)’s career which have helped define the Oracle of Omaha’s success. One of those was the acquisition and subsequent turnaround of Dempster Mill in the 1960s.

This was a traditional deep value investment which initially came onto Buffett’s radar in 1956. That is when the young investor started acquiring shares in the company for his partnerships.

A deeply undervalued stock

According to partnership letters and other sources, Dempster was a producer of windmills and farm equipment in Beatrice, Nebraska, about 100 miles south of Omaha. Buffett was initially attracted to the investment because the stock was selling at $18 a share but had a book value of about $72.

This was a traditional deep-value investment. The stock was deeply undervalued, and Buffett believed sooner or later the market would realize the mistake and re-rate the stock.

However, this did not occur immediately, and the young investor continued to buy the stock. By mid-1961, his partnership owned more than 70% of the company.

In the early years, Buffett was not against buying control of companies. He continued to buy stocks if they remained undervalued up to a level at which he became a substantial owner and was then able to push for change.

I believe this is one of the reasons why he was so successful in the early days. Rather than simply waiting for Mr. Market to re-rate undervalued equities, he pushed for change himself, which catalyzed the value and produced great returns, when other investors may have struggled to earn similar profits by waiting for the market.

This is precisely what Buffett did with Dempster. He called in a manager named Harry Bottle, who started to slash costs and laid off about 100 employees in the town of 12,000 people. Bottle also hiked prices. He reportedly increased the price of any item that was entirely proprietary by 500% and any item that could be bought elsewhere by 100%.

By using this approach, Dempster was able to turn inventory initially valued at $300,000 into a $2 million asset. Ultimately, the partnership went on to sell the investment, which cost approximately $1 million, for $2.3 million – a substantial profit.

Landmark moment

Looking back, this appears to have been a fantastic investment for the young Buffett. But it was also a landmark moment in his career. He later said about the Dempster Mill situation:

“Hiring Harry may have been the most important management decision I ever made. Dempster was in big trouble under two previous managers, and the banks were treating us as a potential bankrupt. If Dempster had gone down, my life and fortunes would have been a lot different from that time forward.”

If the turnaround hadn’t had worked out, Buffett may have lost a substantial percentage of his investment and partners’ capital. It is not clear if he would have been able to recover from this disaster. Even if he did recover, he would be working with $2.3 million less. To put a rough figure on how much that would have set him back, $2.3 million compounded at 15% per annum for 60 years would be worth $17.6 billion today.

There are a couple of things we can learn from this historical case study. First of all, it’s clear how close Buffett came to disaster. It is easy to look back with the benefit of hindsight and say he was a great investor, but this ignores all the challenges he encountered along the way.

Secondly, Dempster is a great example of how much of an impact Buffett’s personal relationships have had on his success over the years.

Charlie Munger (Trades, Portfolio) introduced Buffett and Bottle, and the three all became friends. Without this personal connection, Dempster could have been a disaster for Buffett. Dempster is a prime example of how just one investment can make or break an investor’s career.