Dr. Joel Schlessinger and his family at the annual Berkshire Hathaway meeting
This weekend, Omaha was host to the annual Berkshire Hathaway meeting, where Warren Buffett, the third richest man in the world, and Charlie Munger, his VP, talked to the shareholders for over 6 hours, answering questions ranging from economic to societal to parental issues. As always, their wisdom far exceeded what would be seen at a typical shareholder meeting of any company.
Warren, just recently having been diagnosed with prostate cancer, spoke of his health on a few occasions, stating that he is ‘likelier to die at the hands of a jealous husband’ than from his prostate cancer. He intends to continue to work throughout his radiation therapy. Additionally, he stated that even if he does slow down a bit from it, that may keep him from making dumb decisions!
Much of the discussion concerned risk and how to mitigate it, how to react to it and how to avoid it. I think that was framed to some degree by his own health issues and the fact that when the change of the guard happens, it will set up one of those potentially risky and concerning situations as to what his successor will do. To me, it was somewhat reminiscent of Steve Jobs’ speech at Stanford, but presented during the 6 hour session in little vignettes. He has always done this, but this year, the emphasis on risk seemed obvious.
On the concept of energy independence, Munger said it was the stupidest thing he had ever seen. To him, the best thing that could happen would be to have other countries take their valuable resources and sell them to the US while we kept ours till the end, when they were even more valuable. So basically, use others’ resources up early and save yours till later. Warren asked Charlie if that applied to sex as well (to save it up for later in life) and Charlie responded that “at least you can use energy at that age…”
Charlie feels that the use of natural gas at low prices is stupid when it is going to be precious at some point and coal should be used first – Munger: “I think it is crazy to use up natural gas at these prices!” It is a very interesting concept as it speaks to the value of the asset being used versus the value it could be at some point in the future.
They spoke at some length about compensation analysts who are called in to determine the compensation of CEOs of companies. Quote: “This is the only profession where it would be a status upgrade to become a prostitute.”
Gold as an investment: As always, they have a very dim view about gold. They spoke about the cost of an investment that won’t ever produce versus one that will have the chance of producing benefit, such as farmland, etc. On the cost of gold vs Berkshire-Hathaway stock, gold was $20 an ounce and Berkshire was $15 a share when they started and now gold is $1600 an ounce and Berkshire is $120,000 a share.
They feel the chief job of a CEO is to be the chief risk officer and determine whether the risk is worth it in allocation of capital and who to select as officers. Unfortunately, risk decisions are usually delegated to those who are least able to assess it with seasoned judgment. Instead of using intellectual maturity and the wisdom that comes from years of experience, it is farmed out to consultants or younger associates who talk in terms of gaussian curves or sigma values, but don’t understand the actual risks themselves.
Talking about risk, they told the story of how one of their current directors, Sandy Gottesman, fired one of his employees who had great results but made risky choices that weren’t always the safest for the company. The employee asked him how he could fire him when he achieved such great results and Sandy said, “I can because I am a rich, old man and you make me nervous.”
On why insurance is needed: Because there is always some contract that will end up with poor performance, so that’s why everyone wants insurance.
The banking system in Europe is much more of a mess than the US because there isn’t an unifying system in place. While the EU is a start, it just hasn’t provided the unity of the US. Buffett repeated the quote from Henry Kissinger re the disunity of the EU: “Whom do I call if I want to speak to Europe?” This is the obvious advantage we have and will continue to have in the US over the EU.
The question of how to predict risk of a driver and whether devices that are placed in cars to monitor drivers are accurate predictors was answered by Warren with the quote that it is something they are looking into, but they still have faith in the questions they ask on each GEICO application. He said that it is pretty obvious that his risk from driving 3500 miles a year is less than that of a 16 year old boy trying to impress the girls.
They haven’t ever had much faith in business school education, but feel it is improving (“it started from a low base”). The silliest thing taught is investment according to Warren. Mathematically based investment going against revealed wisdom of elders is dangerous. The only two courses they think are effective are how to buy a business and how to value markets. Buffett: “When Ray Kroc bought McDonalds he didn’t think of the value of the options. He thought whether people would want to eat hamburgers. Business folks want to have an easy way to make a decisions,” but the schools aren’t teaching that.
On wind and solar power: Wind projects make sense with subsidies but not without them. It is good as a supplementary form of energy but can’t be the base. People don’t want to have their lights turn off if it isn’t windy.
On whether it is possible to succeed in this economy coming out of business school: I think you have all sorts of opportunities. “$5000 investment was too low an investment for us to ask of our partners when we started out.” They would ask for more now. Jokingly, they said the best hope is to have billions of dollars of cash and then not have to worry, but it took them 81 and 87 years to reach that point, so it may not be possible for everyone to do…
On buying businesses to flip rather than to keep it: It is more fun to keep a business than to flip it, but that isn’t the model now.
Best book: Benjamin Graham’s Intelligent Investor, especially chapters 8 and 20.
Buffett explained that “In 53 years of buying stock Charlie and I haven’t ever discussed macro effects when thinking about buying the stock.” He told about when he bought his first stock in 1942 when the US was actually losing WWII (until the Battle of Midway, when things turned around). He didn’t think to himself that it might not be a good time to buy the stock, he just thought about the business he purchased. “We know what we don’t know and just plan to not go broke.”
Capital intensive businesses are still OK to invest in versus others with 20% growth because that type of growth is unsustainable. Don’t listen to the siren songs! Ebidta and other measures other than true earnings aren’t reliable (they want EBE – Earnings before Everything!).
Someone asked about how they decide on purchasing a declining business (such as the newspaper business they recently purchased, the Omaha World Herald, and Worldbook Encyclopedia). Charlie said it goes without saying that a declining business has less opportunity that a growing business and it is impossible to state why to purchase one. On the other hand, they spoke of several businesses that have no earnings now, but had huge earnings over time.
Question from a younger person: What is folly or unwise as an investment? Buffett said they haven’t ever bought a new issue because it can’t ever be as good given all the commissions/etc that have to be paid. “We try to avoid a big disaster. If there’s a large commission initially, then you won’t have an advantage.” Don’t think about industries where there are many competitors and you are not sure who the winner will be. Buffett said that there can even be problems when you have only ONE competitor, explaining that one of his first investments ever was in a gas station where there was another one across the street and because of this he had to go with the gas price that the other station had, limiting his profit margin for the entire life of the gas station.
He went on to comment about ‘barriers to entry’ for a given business. How can you build a new version of Coke? Virgin Cola was a mistake, although it still could have been good. Lipitor is now unprotected and that reduces the barrier to entry for other companies, but no one is going to build a new railroad as it is too much infrastructure and the cost of recreating it from scratch would be astronomical. This is when he commented that Amazon will be very tough competitor in times to come for any retailer out there as they have that infrastructure and are in most people’s lives already with generally very positive comments about their service.
On Apple and Google as investments: They wouldn’t buy either, but wouldn’t short them! They like investments where they have knowledge: “We have the reverse of an edge with technology.” With their recent purchase of significant shares in IBM, the chance of being way wrong is less than with these investments as they have a longer history with it and it is a solid investment.
The railroad industry is much more efficient than trucking – 100 times cheaper! That is why the BNSF investment is such a good investment and will always pay off and stay viable. They feel it would be very dumb for the country to discourage railroads from spending money to invest in infrastructure of the US essentially by regulating them severely.
Warren spoke about his personal office and what is on the wall. When he started out, he photocopied 6 events in history of stocks and put them on the wall (for a total of $6 expenditure). He discussed one of them, the Panic of 1901, which involved the railroads and control of the Northern Pacific by what has now become BNSF, which he owns. He also discussed a beer brewer, Samuel Bolton, who killed himself that day by jumping into a vat of his beer after losing heavily. His point is that we don’t want to jump into a vat of beer over something that may not be all that bad in the long run. (as evidenced by where we are now and the status of the railroads, etc).
Again, discussing risk, he said that growth of a company is not always good. Not all growth is the same and this especially is the case in the insurance business. Quote: “No other company is as cheerful about losing business than we are.”
They spoke about the two new hires, Todd Combs and Ted Weschler, and how they are compensated. They have a base of $1 million a year in salary. They are in charge of $2.75 Billion apiece now and as he said, they could be making more than that if they were to be in other businesses, but they had motivational benefits of autonomy, applause (from their company) and decent compensation. He feels that they will do well as they get compensated 10% of their increase over the S&P on a three year basis for their funds. They get their first 1/3rd of it on the first year, but if it doesn’t hold, then they don’t get the second and third parts. Additionally, they are tied to eachother by only getting 80% of theirs and 20% of the other person’s, so they share information and help eachother in order to get maximal benefits for both. This is a genius idea. He remarked that most Wall Street people would starve on this compensation, but they have done great.
Quote by Buffett: “I can’t put passion into someone, but I can put a structure into place that doesn’t stifle it”
There was a bit of discussion about growth per capita in the US and what it would look like over time. Their feeling was that 1% growth per capita is incredible and asking for 4% is too much and impossible. They discussed that annual income had gone from about $6,000 in 1930 to $48,000 now, which is absolutely amazing and can’t happen again, but if we go up 25% in 20 years, that would be great.
They feel super pacs are not good and even though they can get your point across, they tend to lead to plutocracies. It is their view that democracies may have a natural progression to plutocracies.
One person asked what they would do with $1 million dollars in order to get a return of investment of 50%. They said there is no easy answer, but it can be done. Then they talked about whether they would be in a good position with all they know to do it with that little an amount of money (it would be impossible with the huge amounts they have to work with now) and Charlie commented that Warren had to learn new things each decade to get better and retain his superiority. Warren commented that, “I don’t worry much about mistakes and think about it. I’ve learned more about basic investment policy and people over the years. That improves but not consciously. Learn from others as it is a much more pleasant way to learn (from their disasters).” Basic idea: Be a student of other people’s folly.
Asked about his investment in the electric car company, BYD, Charlie responded that it will be slow in the US, but maybe more so in China and with fleets of cars/trucks. They talked about the CEO of BYD, Wang Chuanfu who started this after being an orphan in a peasant community. It now has over 100 million feet of space and he has won the equivalent of the Chinese Nobel prize. Having said that, they don’t think that even by 2030 there will be many electric cars in the US. As with most newer forms of technology, they will need subsidies to survive, but at present the electric car is an amazing feat and drives great.
One question regarded mismanagement at Liberty Mutual (thank you Michael Lofgren for your edit) and the high compensation of the CEO despite this. Charlie said that this is crazy, but Boston has always had a strong history of egregious mismanagement and brought up the situation where Mayor Curley was elected mayor while serving a sentence in jail (one of many incarcerations for him).
Charlie feels that Paul Krugman is a genius about the economic realities. They both feel that “every president wants fiscal virtue, but just not quite yet,” just like St. Augustine ( “Give me chastity and continence, but not just now.” ).
It is their opinion that it is better to spend money now, but on good things like infrastructure (highways, airports, etc) that will help us in the long run. Charlie feels we need a Value Added Tax (VAT) in order to get our finances in order as it is better to take it initially and give back than to ask for it via a tax later.
This was a particularly good (and positive year) for the meeting, with both Warren and Charlie in good spirits and with good things to say about the opportunities for Berkshire in the future. Thanks for reading this and let me know if you have any other questions.