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Financial Freedom

The Road to Riches: From Omaha to Wichita

This year was unique for me. It offered a chance to meet up with the two most successful investors and business leaders in the United States.

In May, I traveled to Omaha to attend Warren Buffett’s 50th shareholder meeting for Berkshire Hathaway (NYSE: BRK). Five months later, I flew to Wichita to meet with Charles Koch (pronounced “coke”), who just released his new book, Good Profit: How Creating Value for Others Built One of the World’s Most Successful Companies.

Buffett and Koch have much in common. For one thing, they are both Midwesterners who live only 300 miles apart. They were both born in the midst of the Great Depression. And they both developed in the Midwestern heritage of industry, thrift and folksy friendliness.

They also have a keen ability to make money. In the latest Forbes 400 Richest People in America issue, Buffett is ranked No. 2 and Koch is ranked No. 5. The only reason Charles Koch isn’t the wealthiest man in America is he shares No. 5 with his younger brother, David. Together, they are worth $82 billion – more than Bill Gates ($76 billion) and Warren Buffett ($62 billion).

Donald Trump made the cover of this year’s Richest 400 issue of Forbes. But Charles Koch makes the second cover page, and I am probably the only person who has a copy with the autographs of both men. (Trump spoke at my FreedomFest conference on July 11 in Las Vegas.) Talk about a collector’s item.

Both Buffett and Koch have also taken advantage of the law of compounding. Buffett’s Berkshire Hathaway reinvests all its profits rather than pay an annual dividend. And Koch Industries reinvests 90% of its net income each year.

But, as they say on Wall Street, “there is more than one way to climb a mountain.” Buffett and Koch differ considerably on how they made their fortunes.

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Buffett has done it by carefully buying well-managed companies at good prices and seeing those firms grow over time. He is fond of quoting his partner, Charlie Munger, who said, “A great business at a fair price is superior to a fair business at a great price.” (This and several dozen other Buffett quotes can be found in my book, The Maxims of Wall Street.) Their formula has done extremely well over the last 50 years, as Buffett’s company continually outperforms the market indexes. (Berkshire Hathaway has scored a 21% annualized return vs. 10% for the S&P 500 index.)

Charles Koch, on the other hand, actually manages the companies his firm acquires and imposes a discipline known as “Market Based Management” (MBM). MBM seeks to increase value added to the products they produce. This usually involves hands-on changes in incentives, compensation, product design and production processes. Using this formula, Koch Industries has done extremely well, returning an average 17% annualized return since 1960. A $1,000 investment in 1960 in Koch Industries is now worth around $100 million!

In sum, we have the following annual rates of return:

Another difference is that Buffett’s company, Berkshire Hathaway, is a publicly traded company, and Koch Industries is private. Koch is convinced that private businesses have far greater flexibility in what they can and cannot do than companies that are required to file quarterly reports to the public. Koch investors also don’t have to worry about the ups and downs of Koch’s stock, which would be far more volatile if it traded daily on the stock exchange.

Both Buffett’s Berkshire stock and Koch’s private stock have had a tough time this year, for different reasons. Berkshire Hathaway is down 11%, due to poor performance of stocks like IBM (NYSE: IBM), Wells Fargo (NYSE: WFC), American Express (NYSE: AXP), Procter & Gamble (NYSE: PG), and Wal-Mart (NYSE: WMT) – the Dow’s worst performer. Koch’s stock doesn’t trade on the exchanges, but, according to Forbes, Charles Koch’s fortune has declined 4%, maybe more, due to the collapse in energy prices (Koch Industries is a major refiner).

Finally, Buffett and Koch differ significantly on their political views and funding of causes. Buffett is a longtime social democrat who supports Planned Parenthood and Hillary Clinton. He plans to give half of his fortune to the Gates Foundation. Koch supports libertarian causes and Republican candidates.

Advice From Wichita: The Real Koch

The purpose of my visit to Wichita was to interview Koch and review his new book. I first met Koch back in 2007 in preparation for reviewing his first book, The Science of Success: How Market-Based Management Built the World’s Largest Private Company for The Wall Street Journal. His new book does a better job of introducing MBM to the lay reader by giving numerous personal stories and case studies.

For example, after buying out Georgia Pacific, maker of consumer products such as bathroom tissue and Dixie Cups, Koch gradually transformed the culture of the company. He did this by encouraging workers to seek out their best comparative advantage, as well as by improving production processes and product design rather than simply providing the lowest cost products.

Georgia Pacific also changed its compensation policies for employees so that they could earn more money by adding value, rather than being paid according to seniority or meeting budgets. Koch also values honesty, integrity and compliance with government regulations more than talent and knowledge skills.

Although Good Profit is primarily a guide for business owners and entrepreneurs, the book does offer advice for investors. Koch warns against overconfidence in making predictions, relying too much on experts and counting “sunk costs” based on past decisions (thinking “I’ll stay with this bad investment until it turns around and I get my money back”).

According to Koch, investors should beware of “confusing random events with patterns that are really unpredictable.” Technical or charting analysis can lead you astray when they go contrary to sound fundamentals about a company.

At the end of his book, Koch tells the story of a longtime employee who told him that working for Koch Industries not only resulted in a successful career, but gave him a whole new view on life. At Koch Industries, it’s not just a job, but a way of life.

Surely a formula that has turned $1,000 into $100 million in 65 years is worth examining closely. I consider Koch’s Good Profit and John Mackey’s Conscious Capitalism the two most important business books of the 21st century. If business leaders will follow the example of these two libertarian CEOs, we will see a whole new brand of capitalism.

Good Profit is a great read. I urge you get a copy at your local bookstore or on Amazon here.

Charles Koch Quotes From The Maxims of Wall Street

Like me, Charles is fond of Wall Street sayings. He keeps his favorite on his desk: “Don’t confuse brains with a bull market.” So true. I’d like to think we have taken an intelligent approach to investing that has proven successful: buying quality, profitable companies with high and rising dividends.

Good investing,

Mark Skousen

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