During the spring of 2014, I spent hundreds of hours looking for new investment ideas. I screened lists of stocks, thought about various industries that might be attractive, read magazines and newspapers, brainstormed with my associates, and reviewed lists of stocks recently purchased by other investment managers.¹ But frustration was my companion. I could not find an attractive idea. I looked and looked and looked, but to no avail.

Then, on Friday, May 30, I noticed that the cover and lead story in the latest edition of Bloomberg magazine was about the three co-heads of Goldman Sachs’s investment banking business: David Solomon, Richard Gnodde, and John S. Weinberg. I had worked with John Weinberg’s grandfather, Sidney Weinberg, in 1966 and 1967, and had known John S.’s father, John L. Weinberg, who had been the co–senior partner of Goldman Sachs for many years. I decided to read the story, largely for entertainment. The article emphasized the strength and profitability of Goldman’s investment banking operations.

Out of curiosity, I went to my Bloomberg terminal and looked up Goldman’s share price: $159.80. I then looked up the company’s tangible book value² per share: $145.04. Flash through the mind! Goldman was a premier company that was selling at only a 10 percent premium to its tangible book value. Second flash through the mind! Goldman had two businesses that required very little capital (investment banking and investment management) and two businesses that required considerable capital (“trading” and investing). By calculating what the non-capital-intensive businesses should earn in a normal environment and by estimating that the capital-intensive businesses should be earning more than a 10 percent return on equity,³ I could estimate Goldman’s earnings power. Thus, I had an approach to modeling the company’s earnings.

I downloaded the company’s recent income statements. The non-capital- intensive businesses were earning $5+ per share after taxes in what appeared to be a somewhat subnormal environment for the businesses. I estimated that $4 of Goldman’s book value should be allocated to the non-capital-intensive activities and therefore that the remaining $141 per share should be allocated to trading and investing. Thus, I concluded that the earnings power of trading and investing should be more than $14 per share and that the earnings power of the whole company should be about $20 per share, which works out to approximately a 14 percent return on tangible book value. When I project estimates and returns, I think about the reasonableness of the estimates. Do they seem realistic? In this case, my conclusion that Goldman’s earnings power should be about 14 percent of its tangible book value made a great deal of sense to me. Much of investing is about reasonability, common sense, and judgment.

When valuing companies, we usually look out two years to the future. If Goldman’s earnings power was about $20 now, its earnings power certainly should be at least $22 by 2016 (the financial markets tend to grow at a 5 to 6 percent annual rate). I then thought about a deserved price-to-earnings (PE) ratio. The non-capital-intensive businesses were gems that should be worth a higher-than-average PE ratio. However, trading and investing were less attractive business lines that likely were worth less than an average PE ratio. On balance, I decided to value Goldman’s shares at 12 to 15 times their earnings power. Therefore, an early and preliminary conclusion was that Goldman’s shares could be worth $265 to $330 by 2016, or 65 to 105 percent above their present price. I finally had a possible idea.

I was excited. I dropped everything else I was doing and started reading Goldman’s Form 10-K. I particularly was looking for information that was counter to my initial analysis that the company’s shares were materially undervalued. I spent considerable time reading about pending litigation, which mainly stemmed from alleged unethical trades and other actions made prior to the 2008–2009 financial crisis. We generally shy away from investing in companies whose ethical standards are questionable, but I was convinced that the ethical lapses at Goldman were the doings of a relatively small percentage of the company’s 32,000 employees—and that the firm itself should not be faulted for the mal-advice given and the mal-transactions enacted by a relatively small number of its employees. It would be unreasonable to assume that any firm could hire 32,000 employees that did not include some bad actors. In my opinion, one should be careful not to condemn an entire organization for the immoral or illegal actions of a few.

Next, I studied Goldman’s balance sheet. After the financial crisis, the company decided to materially deleverage itself. In 2007, Goldman’s assets were 26 times as large as its shareholders’ equity. By the end of 2013, the ratio had declined to less than 12 times. I then tried to analyze the quality of the balance sheet, but this was difficult to do, partially because the assets owned by Goldman can change day to day. However, I did feel comfortable knowing that, as a result of the 2008 financial crisis, Goldman’s financial strength continually was being scrutinized by many regulatory bodies. Also, the Federal Reserve Bank had permitted Goldman to reacquire $6.2 billion of its shares in 2013, after reacquiring $4.6 billion in 2012 and $6.0 billion 2011. I believed that the Fed would not have permitted these large repurchases if the governors and their staff did not feel highly confident about the strength of Goldman’s balance sheet. The Fed can make a mistake. No business decision can be based on assuredly accurate information—and situations can change. But in an imperfect world, the scrutiny of the Fed still was an important consideration when analyzing the risks of owning Goldman’s shares.

Furthermore, while I always have been concerned about asset quality after a long period of prosperity because continuing prosperity often breeds overconfidence and resulting misassessments of risks, the reverse also should be true. After a scary financial crisis and a deep recession, managements usually are prone to be particularly risk averse.

A large segment of Goldman’s 10-K dealt with the increased regulation on investment banks. Many on Wall Street viewed the increased regulation as a negative. But I also saw it as a silver lining. The sharply increased capital requirements likely would cause weaker and less profitable firms to withdraw from some lines of business, thus reducing competition. Also, the costs of complying with Dodd-Frank and the other regulations would serve as large barriers to entry for possible new competitors. Thus, an unintended consequence of Dodd-Frank was to stifle competition and to increase the power and market shares of the large, well-capitalized financial institutions.

After reading the 10-K, I immediately convened a meeting with Greenhaven’s two other analysts: my son, Chris, and Josh Sandbulte. The three of us spent the next two hours discussing the pros and cons of Goldman Sachs’s businesses. We brainstormed. Our conclusions were that Goldman was a very strong company in a reasonably attractive industry and that the company’s shares were trading at a deeply undervalued and undeserved level. We reasoned that the shares were depressed because many investors generally remained concerned about the balance sheet risks of financial service companies and because many were concerned that the industry would become overregulated. We believed that these concerns were overblown and would mitigate with time. They were our opportunity.

I was amused that Goldman Sachs earned $15.46 per share in 2013, up sharply from $5.87 per share 10 years earlier. During the 10-year period, the company had suffered through the worst financial crisis and the worst recession since the Great Depression and through hostile litigation and hostile legislation, and yet the company’s profits had increased by 163 percent. My experience is that analysts and historians often dwell too much on a company’s recent problems and underplay its strengths, progress, and promise. An analogy might be the progress of the United States during the twentieth century. At the end of the century, U.S. citizens generally were far wealthier, healthier, safer, and better educated than at the start of the century. In fact, the century was one of extraordinary progress. Yet most history books tend to mainly focus on the two tragic world wars, the highly unpopular Vietnam War, the Great Depression, the civil unrest during the Civil Rights movement, and the often poor leadership in Washington. The century was littered with severe problems and mistakes. If you only had read the newspapers and the history books, you likely would have concluded that the United States had suffered a century of relative and absolute decline. But the United States actually exited the century strong and prosperous. So also did Goldman exit 2013 strong and prosperous.

Bloomberg archives many presentations made by managements. I wanted to hear what Goldman’s management was saying publicly, so I listened to about 10 recent presentations. I was particularly intrigued by comments made on May 30, 2013, by Gary Cohn, Goldman’s president and chief operating officer. Cohn stated that, in spite of a challenging environment in 2012, Goldman had been able to earn a 10.7 percent return on its equity (ROE). He added: “We are focused on positioning the firm to further expand our ROE … as the operating environment improves.” He elaborated on “opportunities we see to drive returns higher over the medium term.” One driver was revenues. Cohn pointed out that investment banking revenues had been cyclically low in recent years—and a return to normal activities would give revenues and earnings a major boost. He added that Goldman also had the opportunity to gain market share in investment banking because a number of competitors were retrenching in the wake of the financial crisis and in reaction to resulting increased regulation and higher capital requirements. Cohn emphasized: “You do not need a significant amount of retrenchment to create an important revenue opportunity for us.”

Cohn also emphasized that Goldman’s cost reductions should add to earnings. He stated that the company recently had completed a $1.9 billion cost reduction program and that the firm’s compensation expense as a percentage of revenues had materially declined over the past few years.

Gary Cohn made another point that sparked my imagination. He stated that Goldman “will continue to adjust and reallocate resources to maximize efficiency as necessary; we have a culture of adaptability.” My thought was that, if one area of Goldman’s activities was producing subnormal returns, the company could remove capital from that area in favor of another area that was producing high returns. This flexibility is a positive attribute of many financial service companies. Manufacturing companies, however, often are saddled with poorly designed or poorly located plants. If labor costs in Brazil become materially lower than labor costs in Alabama, it would be nearly impossible for a paper company to pick up a paper mill located in Alabama and ship it to Brazil.

Goldman’s presentations generally exuded a calm confidence in the company’s future. Their content signaled that management was aggressive and ambitious, but not arrogant. I realized that the presentations were carefully scripted, but nonetheless I was favorably impressed.

I then telephoned three acquaintances who had been high-level executives at Goldman. Each had similar impressions: management was excellent; the younger employees tended to be among the best and the brightest; bright and ambitious employees will find ways to make money for themselves and for the firm; and the firm continued to enjoy the best brand image in the business.

Experience builds intuition, and my intuition was to start purchasing shares in Goldman. The concept, the fundamentals, and the profit potential seemed compelling. Mr. Arthur Ross frequently counseled me that “we are not a debating society; we are not a debating society; act, Ed, act.” So I acted—and placed an order to buy shares of Goldman Sachs. Within a few weeks, we purchased a full position in the shares.

About a month later, I had lunch with Will Gordon, an investment manager at a medium-sized firm. I told Will that our Goldman idea was a godsend because we were having difficulty finding new ideas post the strong stock market in 2013. I also mentioned that our portfolios had appreciated substantially more than the market in 2013 and that we now had more than $5 billion under management and needed to find stocks that we could purchase in size, such as Goldman. I added that, given the level of the stock market and given our increased size, it was a challenge to keep our portfolios appreciating at buoyant rates. Will’s immediate comment was, “Well, Ed, I guess you will have to settle for lower returns in the future.” I had an immediate immensely adverse reaction to Will’s comment—and especially to the use of the word settle. Settle was not part of my investing vocabulary and would not be in the future. All my life I enjoyed the thrill of competing to win. I would not “settle” to play mediocre tennis, to have a mediocre round of golf, nor to have mediocre investment results. As a senior at Williams College, every day I walked past Hopkins Gate. Chiseled on one stone pillar of the Gate was the motto:

Climb high, climb far,

Your goal the sky,

Your aim the star

That is my mantra. I aspire to build a ladder to the stars and climb on every single rung. I believe that ambition, tempered by reason, permits a person to succeed and feel rewarded, and that, in a competitive world, settling for mediocrity often leads to failure. Yes, investing $5 billion at a time when the stock market is relatively fully valued is a challenge. But there are two disparate mind-sets to the word challenge. One is the frustration of encountering an apparently impenetrable wall. The other is the thrill and satisfaction of climbing the wall. To each his own, but I relish the latter. And I say hogwash to “settling” for lower returns in the future.

On a bright day in the fall of 2014, I received an invitation to have a breakfast meeting with Abebayo (“Bayo”) Ogunlesi, the lead director of Goldman’s board of directors. The main purpose of the breakfast was to discuss the company’s governance. I readily accepted the invitation. On the appointed day, I arrived at Goldman’s West Street headquarters about 45 minutes early. I believe that it is rude to be late to meetings, so I normally allow too much time for travel, fearing that a train will be late or that I will have difficulty hailing a cab. It is a Wachenheim idiosyncrasy. One of many. Usually when I am early, I kill time with a cup of coffee or a walk around the neighborhood. However, on this occasion, I made good use of the 45 spare minutes. I took an express elevator to Goldman’s 11th floor, which serves as a sky lobby. Most of Goldman’s employees change elevators on the 11th floor, and many come to grab a cup of coffee or a snack at the floor’s cafeteria. I found a comfortable chair, and for a good part of the 45 minutes, I people watched. By studying how Goldman’s employees communicate with each other, dress, and walk, I could get some sense of the type of people who work for the company. And I was impressed. The employees generally were friendly toward each other, smiley, neatly dressed, and seemingly intent upon their purpose. And I was impressed by the 11th floor itself, which was functionally laid out, elegant, in good taste, and definitely not gold plated. While it is dangerous to judge a book by its cover, I do find it useful to observe a company’s employees and offices.

A few minutes before the scheduled 9:00 a.m. breakfast meeting with Bayo Ogunlesi, I took an elevator to one of the top floors of the headquarters building and was escorted to Goldman’s boardroom. Just inside the boardroom, a spread of bagels, fruits, orange juice, and coffee was laid out on a cart. No eggs any way you like them. No bacon. No pancakes or French toast. And no waiters dressed in tuxedos. Just a simple, self-service breakfast. My favorable impression of Goldman Sachs increased by another notch. Goldman was not trying to impress its guests with opulence.

Bayo’s background is amazing. Born in the small rural village of Makun, Nigeria, he attended high school at Kings College in Lagos and then left Nigeria to attend Oxford. After receiving a BA at Oxford, he attended both Harvard Business School and Harvard Law School at the same time and, along with a classmate, became one of the first two students of African descent to become an editor of the Harvard Law Review. After receiving his LLB in 1979, Bayo clerked for Thurgood Marshall, becoming the first non-American ever to clerk at the U.S. Supreme Court. In 1983, Bayo joined Cravath, Swaine & Moore in New York City, but after several months practicing law, Credit Suisse asked Cravath if they could borrow Bayo to help negotiate and finance a $6 billion liquefied natural gas plant in Nigeria. Bayo never returned to Cravath, but instead quickly rose through the ranks of Credit Suisse, eventually heading the firm’s global banking division and being elected to the firm’s board of directors. In 2006, Bayo left Credit Suisse to become a cofounder of a private equity firm, Global Infrastructure Partners, which makes infrastructure investments, especially in the energy, transportation, and water industries. Who says that America is not a land of opportunity.

During the taxi ride to Goldman’s headquarters, I thought about the upcoming meeting and predicted that Bayo would emphasize that Goldman’s board is quite independent from management, that the board focuses on controlling risks, and that the board would keep a lid on management’s compensation. These were three obvious key issues. Sure enough, Bayo focused on the three issues, giving sales pitches that were designed to comfort a shareholder. Thus, I did not learn much from the meeting, but I had not expected to.

Another consideration weighed on my mind. Bayo was affable, articulate, and seemingly knowledgeable about Goldman Sachs’s operations. But how much could he really know? He had a full-time job elsewhere. His knowledge of Goldman probably mainly came from what management told him and from information in materials prepared for board meetings. Directors are outsiders. They normally cannot unobtrusively wander around the offices and trading desks of Goldman to find out what really is going on. I will never forget a board meeting of the lead smelting company that I was a director of in the 1970s. The meeting was held at a secondary smelter. At secondary smelters, old car batteries are crushed and processed to separate the lead from other materials. The lead is then purified in a furnace and resold. Secondary smelters tend to be dirty—in fact, filthy. When a battery is being crushed, it is difficult to contain all the lead and other materials in a controlled space. Yet the smelter where the board meeting was held was spotless. I imagined that the workers at the smelter spent hours with brushes, vacuum cleaners, mops, towels, chemicals, and even toothbrushes cleansing the smelter in advance of the arrival of the directors. My suspicions were corroborated when I took a bathroom break during the meeting. In the men’s room, after drying my hands, I noticed that the towel disposal container was filled with about 50 empty cans of Pledge. Similarly, I believe that the information that directors receive about a company usually is carefully scrubbed by management, who continually wish to look as good as possible.

In mid-December, I received an e-mail from Bayo announcing the election of two new directors to Goldman’s board. The e-mail included resumes. I was impressed, not only by the quality of the new directors, but especially by the effort Bayo made to e-mail me (and likely other larger shareholders as well) about the election. The e-mail reminded me of a comment made more than 40 years earlier by Bob Menschel, a friend, who by coincidence was a top executive at Goldman Sachs at the time. Bob’s comment was that small caring efforts toward employees pay off in favorable relationships and favorable morale. Remember birthdays. Ask about children or vacation plans. Occasionally, take an employee out to lunch. Buy employees small Christmas presents. Bayo was following Bob’s advice, and it paid off. Somebody at Goldman (Bayo or a person on his staff) made the effort to care about Greenhaven and me, and my positive feelings toward Goldman increased by yet another notch.

In May 2015, I received another invitation to Goldman’s headquarters, this time to meet with Gary Cohn and CFO Harvey Schwartz. Again, I leapt at the opportunity. The previous month, Goldman had reported that it had earned a surprisingly strong $5.94 per share in the first quarter of 2015, which was equal to a 15 percent return on tangible equity. The $5.94 is, of course, equivalent to an annualized earnings rate of nearly $24 per share. Remember, I had been projecting that Goldman might earn about $22 per share in 2016. Therefore, at least in the first quarter of 2015, Goldman’s earnings already were exceeding my projections.

At the meeting at Goldman’s headquarters, I peppered Gary and Harvey with questions about the sustainability of first-quarter earnings. What business lines were operating above trend line? How much were they above trend line, and why? What business lines were operating below trend line? How much were they below trend line, and why? Management was reluctant to disclose much of the information I sought, but I did leave the meeting with the belief that the company’s normal earnings power should be somewhere close to 15 percent of its tangible book value and that management was conservative and was bent on underpromising and overdelivering. When meeting with managements, I often hear a company’s “party line”—a line that dwells on the company’s greatness and future prosperity and that ignores the company’s weaknesses. In the case of Goldman, my gut feel was that Gary and Harvey were straight shooters and that their opinions largely could be trusted.

On June 2, during a presentation at Deutsche Bank, Gary Cohn said the following about the normality of the first-quarter earnings: “We saw an environment where our clients were a little bit more active. We do not think that this is the upside per se. We feel like we have got plenty of upside potential in our business model.” Of course, these words were music to my ears.

The music then continued as Gary listed reasons why Goldman should prosper in the future:

We are, in many ways, a technology firm, with about one quarter of our employees in our technology division. We have made a number of key technology investments that provide us with a unique competitive advantage.

We have transformed our financial profile. We have restructured our expense space. We have created robust tools and processes to inform our capital allocation decisions. We have a strong position within each of our businesses and have sold or shut down businesses that are likely to be dilutive to returns going forward. We are in an improving competitive position. And, we are well positioned to capture the opportunities as the environment improves.

Over the summer, I asked several competitors whether Gary’s words were credible or were “BS.” The competitors responded that Gary was a salesman but that his optimism was well founded and that Goldman was a powerhouse.

The more I learned about Goldman Sachs, the more I was convinced that we had made an exciting investment. But I still monitored the company closely, particularly on guard for any external development that might derail our analysis and conclusions. Occasionally, a black swan adverse event does derail one or more of our investments. When this happens, we must be ready to unemotionally rethink the economics of continuing to hold the investments—and, if necessary, sell.

This happened in the fall of 2014. At the time, we owned large positions in three oil and gas service companies and a smaller position in a producer of oil and gas. During the summer of 2014, the price of crude oil still was being supported at a high level by the OPEC cartel, and particularly by Saudi Arabia. It was clear to us at the time that increased production of oil from North American shale fields and from Iraq was creating excess capacity in the world, but we believed that it was in Saudi Arabia’s interest to reduce its production in order to eliminate the excess capacity and thus to maintain prices at a high level. But we were wrong. Evidently, the leaders of Saudi Arabia concluded that, instead of continually reducing their production to offset the increasing production elsewhere, it was advantageous to “nip it in the bud” and let prices fall to a level where drilling new higher-cost North American oil wells would become uneconomic and, as a consequence, North American oil production would stall or fall.

The price of crude oil, which was roughly $100 per barrel during the summer of 2014, started to decline in September. The decline continued in October, and by early November the price broke below $80. I then analyzed detailed estimates and projections of the supply and demand by geographic region and came to the conclusion that, unless production was curtailed by political or military unrest in unstable countries or unless production was curtailed by Saudi Arabia, the surplus of crude oil would continue to grow. I asked myself: if Saudi Arabia intended to maintain high price levels by curtailing production, why did the Saudis let the price of crude fall as low as $80? Most “experts” and the media were predicting that the OPEC cartel would hold and that prices would recover, but there is an old expression that one should not pay attention to the noise in the market, but rather to the price of the fish. And the price of the fish was telling me that the cartel might not be holding. My obvious concern was that the earnings and values of our oil-related holdings would deteriorate in a lower-oil-price environment. Oil and gas companies would have less funds and less incentive to drill new wells, and the value of oil reserves in the ground would decline. I then tried to estimate what the normal price for oil would be if the cartel did not hold. My conclusion was that the normal price would be somewhere in the range of $55 to $70 per barrel. If long-term prices were above $70, a sufficient number of shale oil and other higher cost wells would be economic that there would be excess production. But if longer-term prices were below $55, an insufficient number of wells would be economic to satisfy world demand. I then concluded that if the longer-term prices of crude were in the range of $55 to $70, our four oil-related holdings no longer would be sufficiently attractive. Because I lacked confidence that Saudi Arabia would reduce its production, on November 13, I started selling the holdings. On November 27, at a meeting in Vienna, OPEC officially declared that it was abandoning its policy of controlling production and prices. By early 2015, we no longer owned any oil- and gas-related investments.

In very late 2014, I had a long conversation with a portfolio manager who continued to be heavily invested in oil-producing companies. He told me that my supply-demand numbers were wrong because they underestimated future demand from emerging countries, especially China. He e-mailed me two projections by Wall Street security analysts that showed a tightening oil market in 2015. I had read many reports by Wall Street analysts and industry consultants. Almost all seemed to agree that there would be a surplus of supply in 2015 unless the Saudis curtailed production. It seemed to me that the portfolio manager had purposefully sought out two minority opinions that happened to agree with his original analysis—and had ignored the vast majority of opinions. He had closed his mind to a probable new development. He was engaged in wishful thinking. I believe that it is important for investors to avoid seeking out information that reinforces their original analyses. Instead, investors must be prepared and willing to change their analyses and minds when presented with new developments that adversely alter the fundamentals of an industry or company. Good investors should have open minds and be flexible.

In mid-2015, I had breakfast with the same portfolio manager who was retaining his holdings in oil-producing companies. He had given up on his theory that the oil market would tighten soon, but he now had a new theory. He believed that the five very large integrated international oil companies⁴ likely would be interested in acquiring U.S. oil producers because of the political stability of the United States and because of the opportunity to use horizontal drilling and multistage fracking to economically increase reserves and production in shale formations. He believed that one or more of his oil holdings would be acquired at a premium price by one of the five giant companies. After the breakfast, I went to my Bloomberg terminal and discovered that there were 28 medium-sized U.S. oil and gas producers that had a market value of $5 billion or more. One never knows where lightning will strike, so one never knows which of the 28 companies would be acquired by the 5 very large integrated companies, if any. Since I would not know which company might be acquired, I could even my bets by purchasing an equal-sized position in each of the 28 companies. If each of the 5 large integrated companies indeed purchased one of the 28 during the next 12 months, and if the acquisition price was at a 30 percent premium to the market price, then the basket of my 28 holdings would appreciate by about 5 percent, other things being equal. Greenhaven tries to achieve annual returns of 15 to 20 percent, so the prospect of acquisitions adding 5 percent to a portion of our portfolio is not very exciting. And the 5 percent assumes that each of the 5 large companies is in the mood to make an acquisition during the next 12 months, which strikes me as a low-probability occurrence. Simply, the economics of the portfolio manager’s new theory did not seem to justify an investment in the 28 companies. It seems to me that he was groping for a reason to continue holding his oil-producing companies. We have a straightforward approach. When we are wrong or when fundamentals turn against us, we readily admit we are wrong and we reverse our course. We do not seek new theories that will justify our original decision. We do not let errors fester and consume our attention. We sell and move on.

In late October 2015, a client, Mike Overlock, called to schedule a lunch date. Mike had been a star at Goldman Sachs, becoming a partner in 1982, head of the Mergers and Acquisitions Department in 1984, and co-head of the entire Investment Banking Department in 1990. In addition, in 1990, he was appointed to Goldman’s Management Committee, which is the committee that largely managed the firm when it was a partnership. When Mike retired from Goldman, the Wall Street Journal called him “one of Wall Street’s most powerful merger dealmakers.” Mike, of course, knew that I had purchased shares of Goldman Sachs for his account, and I thought the subject of Goldman likely would come up at our lunch. So I decided to be prepared—very prepared in view of Mike’s knowledge of the firm. I took out my file on Goldman, reviewed all my notes and memos, and rethought my rationale for purchasing the shares. And the more I rethought, the more I became convinced and excited about the probable rewards of owning the shares. I was happy. But I am almost always happy when working as an investment manager. What a perfect job, spending my days studying the world, economies, industries, and companies; thinking creatively; interviewing CEOs of companies; and having lunch with the Mike Overlocks. How lucky I am. How very, very lucky.