In the late 1950s and early 1960s, Dempster Mill Manufacturing Co. was a windmill and irrigation systems manufacturer based in Beatrice, Nebraska. Its stock sold for $18 a share with a steadily growing book value of $72 per share. In accounting jargon, book value is the value of a company’s assets reported on its balance sheet minus what it owes. Dempster’s assets were windmills, irrigation equipment, and its manufacturing plant.
An offer you can’t refuse?
Dempster attracted the attention of young Warren Buffett. At the time, he was conducting his pre-Berkshire Hathaway investing activities through a privately-owned investment partnership. Buffett began buying shares of Dempster for $18 per share. He soon snapped up enough stock (at an overall cost basis of $28 per share) to take majority control of Dempster.
While serving on the company’s board of directors, Buffett discovered why Dempster was trading at such a low valuation. Sales had flatlined, unsold inventory was piling up, and cash was quickly dwindling. Despite Buffett’s efforts to make beneficial changes in the company’s operations, Dempster continued its downward tailspin. The bank threatened to seize unsold inventory as security against unpaid loans, and Buffett worried the whole company would be shut down.
The Wealthpreneur Lesson
The Benefits of a Lousy Business
“I really think, if you want to be a good evaluator of businesses, an investor, you really ought to figure out a way without too much personal damage to run a lousy business for a while. I think you can learn a whole lot more about business by actually struggling with a terrible business for a couple of years than you learn by getting into a very good one where the business itself is so good that you can’t mess it up.”
“…it certainly was a big part of our learning experience, and I think a bigger part in the sense that being involved with good business was actually being involved in some bad businesses and just seeing… how awful it is and how little you can do about it. And our IQ does not solve the problem and a whole bunch of things. It’s a useful experience, but I wouldn’t advise too much of it.”
(Excerpts taken from a Q&A with Warren Buffett during the 2017 Berkshire Hathaway Annual Meeting)
From zero to hero
Charlie Munger, Buffett’s longtime friend and business partner, suggested hiring a turnaround artist. With the lure of a $50,000 sign-on bonus (the equivalent of approximately $500,000 in 2024), Buffett enlisted Harry Bottle. Bottle quickly cleared out inventory, closed unproductive branches, laid off 100 employees, raised prices of products that only Dempster supplied, and shut down unprofitable product lines.
By the end of 1962, Dempster was operating profitably. In a letter to his partners, Buffett estimated the value of the company had jumped from the previous year’s value of $35 per share to $51 per share. Dempster had accumulated approximately $2 million in cash (the equivalent of $20.5 million in 2024). But Buffett could not find attractive opportunities to invest the company’s growing cash hoard, and no private buyers were interested in the company. So, Buffett ran an ad in the Wall Street Journal announcing that Dempster would be sold at a public auction on September 30, 1963.
Leave while you still can
The citizens of Beatrice worried a new owner of Dempster might impose additional layoffs or close the plant, which was the city’s biggest and nearly sole employer. The townspeople launched a crusade to foil Buffett by raising nearly $3 million to keep the ownership in Beatrice. The townspeople were delighted they won the auction! Buffett was happy to sell the company while nearly tripling his investment.
Buffett’s takeaways
After his harrowing experience with Dempster, 33-year-old Warren Buffett had learned two important lessons that informed his later business decisions.
Lesson #1: Never throw good money after bad
Once Bottle turned Dempster into a cash-generating machine, Buffett decided to allow cash to accumulate within the company. He planned to invest the cash in an outside investment opportunity or possibly exit from company ownership entirely. He knew investing the surplus cash to manufacture additional windmills was not a great idea!
Interestingly, Buffett did not immediately learn from his Dempster experience. Two years after exiting his investment in Dempster, he acquired a controlling interest in a failing New England textile company called Berkshire Hathaway. Fortunately, Buffett was able to turn the business around and redeploy the resulting cash flow into a portfolio of marketable securities.
Earlier this week, Berkshire Hathaway’s market capitalization topped $1 trillion dollars making Berkshire one of only 7 U.S. companies to achieve that market value. Berkshire is the only non-technology company in this exclusive group.
Lesson #2: Hire Hall of Famers
Most Wealthpreneurs begin by working in their businesses. Successful Wealthpreneurs transition to working on their businesses and eventually to working above their businesses. From his experience with Dempster, Buffett discovered the challenges of running a company on a day-to-day level. Firing employees and getting down into the trenches was not his idea of a great day at the office!
When Buffett observed how Bottle’s leadership turned Dempster around, he gained valuable insight about the importance of great management. In the years since his Dempster exit, Buffett has only acquired companies with an exceptional manager at the helm!
Management Can’t Solve Everything
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” – Warren Buffett
Despite his affinity for talented business managers, Buffett repeatedly acknowledges that a business’s economics have the most impact on its financial outcome. The moral of the story: buy good businesses and hire future Hall of Fame operators!
Channel your inner Buffett
To learn more about best practices for running a private company, I recommend reading this article.
