University of Berkshire Hathaway
von Daniel Pecault
On Intrinsic Business Value This concept is the centerpiece of Buffett’s approach. Buffett defines it as “what a company would bring if sold to a knowledgeable buyer.” This definition departs from Ben Graham’s numbers-oriented valuation as it gives value to such intangible items as management talent and franchise value. It is Buffett’s genius in identifying and evaluating these intangibles that sets him apart from the crowd.
Buffett said he pays no attention to economic outlooks. His decisions are based simply on intrinsic business values.
occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
“I would rather be vaguely right than precisely wrong.”
“Everyone talks about the big money made in real estate, but they forget to talk about the big money lost in real estate.”
“Someone figured out the Van Gogh painting that sold for $40 million last year yielded a 13% compounded annualized return. Berkshire shareholders have done much better.”
an “old windmill enthusiast” and suggested that encyclopedias will be little changed 20 years from now.
As an example, he explained that if you were a person of vision in the passenger train business in 1930, you might have seen the coming of the airplane. But the answer was not to get into the airline business, which is a terrible business. The answer was to get out of the passenger business altogether.
Buffett and Munger steadfastly refused to get into a long discussion of macroeconomics.
In other words, rather than worry about economic projections, these brilliant investors focus on finding good businesses at bargain prices within our resilient economy.
To a question about what books to read, Munger replied that he is a biography nut and heartily recommended biographies as a way to “make friends among the eminent dead.” Buffett quipped, “And they don’t talk back.” Munger went on to say that biographies give you marvelous experience, extend your range and may even improve the quality of your friends. He noted that Golden Arches and The Big Store offer great lessons on business.
Buffett said to determine the IBV of an asset, simply take the present value of the net cash flows from here to eternity, based on current bond rates.
As Buffett summed up, “If investors only had to study the past, the richest people would be librarians.”
“It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
At the Source Capital annual meeting, Michaelis explained that there have been two basic themes in value investing: 1) buy assets and 2) buy earnings power.
Michaelis prefers the earnings power approach. If a company earns very high returns year after year, he explained, then, ultimately, those will be the shareholders’ returns as well.
Munger lamented that business schools would produce better managers if they would study what makes a good business good and what makes a bad business bad. But they don’t.
If you are going to be a lifelong buyer of food, you welcome falling prices and deplore price increases. So should it be with investments.
Buffett explained that financial disasters come about because stupid decisions in financial companies are not accompanied by immediate pain. Instead, people give you more money. Seeing this, competitors indulge in mindless imitation. Thus, when failure comes, it is huge.
When asked how he spends a day, Buffett responded that he tap dances into work (obviously, he’s following his own career advice), reads a lot, talks on the phone a bit, and that’s about it.
Munger also claimed that much can be discerned from “the paper record.” The documented record of how people have behaved over many years has far more predictive power than a personal interview. Buffett added that this is why they don’t hire fresh MBA graduates. There is no record of on-the-job performance.
“A well-educated orangutan could see the success of our approach, and yet no one is doing it.”
business is the key. Coca-Cola went public in 1919 at $40 per share. In 1920, the stock plunged to 19 ½ as sugar prices changed. After seven decades of wars, depression, etc. that initial $40 share would now be worth $1.8 million (About 16% compounded annually).
With many executives making tens of millions in compensation in 1991, this has been a hot topic in the press. Buffett’s response: There should be no cap (you simply cannot overpay for truly great performance). Longevity is irrelevant. Relate compensation directly to the performance of the business. (Yardsticks will vary depending on the business and the amount of capital employed). What he finds objectionable is the large sums being paid for mediocre performance.
They ignore the simple fact that when you buy a business, you own a business.
I find Buffett’s story stunning because the two people who most certainly knew Buffett was one great swimmer (investor) discouraged him from entering the water because they were concerned about the current (market). Even Ben Graham succumbed to the seduction of making a market call, which illustrates just how difficult it is to focus on identifying great swimmers instead of predicting the current.
All Investing Is Value Investing Buffett commented that the distinction between the growth and value styles of investing is nonsense. Value is the only concern for any economic commitment. To calculate your expected return, compute the discounted present value of the flow of all cash from the business between now and judgment day. To do so, you must A) determine the amounts and certainty of cash flows in and out and B) select a discount rate. Buffett noted that growth can enhance or detract from the calculated value. For example, electric utilities were forced to grow and to invest capital in the 1970s, which lowered their returns.
Buffett also noted that book value is seldom meaningful in analyzing the value of a business. Book value simply records what was put into the business. The key to calculating value is determining what will come out of the business.
An interesting point – Berkshire’s position in U.K.-based Guinness is unhedged. Buffett claimed that currency hedging would be not only expensive and time-consuming but unnecessary as well since Guinness itself already earns money in many different currencies. In the long run, the currency factors should wash out.
He believed the long-term government bond rate (plus a point or two if interest rates are low) is the appropriate discount rate for most assets.
True investing is really more like betting against a parimutuel system, trying to find a 2-to-1 shot that pays 3 to 1. Value investing is looking for a “mispriced gamble.”
Buffett gave two criteria for evaluating the performance of management: 1) How well do they run the business? and 2) How well do they treat the owners?
Munger added that they are agnostic on macroeconomic factors. Instead, they spend all their time on individual businesses. “To think about what will happen versus when is a far more efficient way to behave.”
Buffett said to beware projections (“Don’t ask the barber if you need a haircut.”) and to keep things simple (“I’d rather multiply by three than by pi.”).
do not have to make it back the way you lost it.
Munger said the ideal business has a wide and long-lasting moat around a terrific castle with an honest lord. The moat represents a barrier to competition and could be low production costs, a trademark, or an advantage of scale or technology.
Buffett noted it is important to differentiate between a business where you have to be smart once versus one where you have to stay smart. For example, in retail, you are under assault at all times versus a newspaper, where you just need to be first.
He noted that Berkshire’s collection of businesses has been lovingly put together so as not to require continuous intellect at headquarters.
Buffett noted that he likes to put a lot of money in things he feels strongly about. Diversification makes no sense for someone who knows what they are doing. “To buy number one on your list equally with number 37 strikes us as madness. Diversification is a protection against ignorance, a confession that you do not know the businesses you own.”
Buffett continued, saying that MPT has no utility. It is elaborate with lots of little Greek letters to make you feel you are in the big leagues.
He explained that with food, you will never get the total certainty of dominance of Coca-Cola or Gillette. People move around with restaurants, seeking variety. Convenience is a huge factor – people stop at the one they see. In contrast, Buffett claimed there will never be another major soft drink company. Coke’s infrastructure is incredible.
Buffett said how one comes out in this lottery is far more important than anything else to one’s future. He and Munger were huge winners having been born American (“in Afghanistan, we wouldn’t be worth a damn”), male (at a time when many women could only be nurses and teachers), white (when opportunities for minorities were slim) and good at valuing businesses (in a system that pays for that like crazy).
Good Businesses – Go with those that are understandable with a sustainable edge. The pond you choose is far more important than how well you swim.
As in years past, Buffett was asked what he thought about the stock market. As in years past, he said, “We don’t think about it.”
Buffett noted that a dollar of earnings from “.com Inc” and a dollar of earnings from “Horseshoe Corp” are equal. What really matters is the “moat” around the business. The greater the moat, the greater the certainty and the amount of future cash flows.
Buffett contended that the average college student has the same standard of living as he does. Same food. No important difference in clothes, cars,
After you have enough for daily life, all that matters is your health and those you love. Likewise in work, what really matters is that you enjoy it and the people with which you work.
Coca-Cola’s market share is marvelous, and its share of mind is overwhelmingly favorable with a ubiquity of good feeling.
Buffett returned to a concept he has brought up numerous times, relating that “if share of mind exists, the market will follow.”
He noted that 20 years ago, the U.S. had an inferiority complex over its place in the world. American industry was falling behind that of Japan or Germany. But with software development now, “We’ve just swept everyone aside. We’re so far ahead that it is difficult to see who is number two.” He predicted that the software sector will become ever more important.
By learning the primary models in each major discipline (such as compound interest and probability in math and break-points and back-up systems in engineering) and applying all of them, he asserts that people will make better decisions.
Few investors understand one of the great secrets to Berkshire Hathaway’s wealth-compounding machine: float. Insurance companies collect premiums, of which a significant portion go into reserves to pay future claims. This reserve (“float”) earns money for Berkshire, leveraging the company’s return on capital.
In his 1999 Fortune article, Buffett talked about the unlikelihood of corporate profits in the U.S. getting much higher than 6% of GDP. The range has been 4%-6% historically, and we’ve been up around 6% recently. Buffett continued that if you’re already capitalizing those profits at a very big multiple, then you have to conclude that the value of American business will grow roughly at the rate of GDP growth. That growth, in turn, should probably be around 5% a year with a couple of points a year of inflation as well. Buffett concluded that stocks are a perfectly decent way to make 6% or 7% a year over the next 15 to 20 years. But anybody that expects to make 15% per year is living in a dream world.
He acknowledged that he was fortunate that his dad paid for his education. As a result, he was able to save $10,000 by the time he was 21 – a huge head start. He noted that it’s much easier to save during your teen years when your parents are taking care of your financial obligations. He surmised that every dollar saved then is worth $20.
Buffett asserted that the very best investment you can make is in yourself.
Buffett would pay any bright student probably $50,000 for 10% of their future earnings for the rest of his life. So each student is a $500,000 asset just standing there. What you do with that $500,000 asset should be developing your mind and talent.
He said he doesn’t really care whether they’re buying into raw-material-intensive businesses, people-intensive businesses or capital-intensive businesses. The key is to understand a company’s costs and why it’s got a sustainable edge against its competitors.
Since airline travel is pretty much a commodity business, costs are the key factors. The biggest cost is labor.
With graduation season upon us, Buffett offered some appropriate worldly wisdom. Imagine a genie comes to a 17 year old and offers to get him any car he wants. However, there is one catch – whatever car he chooses he must make it last a lifetime. Well, you can imagine that the young man would read the owner’s manual 10 times, would change the oil twice as often as suggested, etc. to help that car last 50 years. In the same way, Buffett continued, we each receive one body and one mind for a lifetime. You cannot repair them at age 60. You must maintain them. One’s greatest asset is one’s self. Develop your mind and good health habits when you are young, and it will enhance your life. If not, you may have a wreck at age 70.
EBIDTA: More Fraud In a similar vein, Munger noted that the fraud group percentage is high for those who talk “EBIDTA.”(53) Buffett noted that such enormously successful companies as Wal-Mart, GE and Microsoft never mention EBIDTA. Those who do are probably conning you or conning themselves or both. As an example, Buffett chided telecom companies that talk about “cash flow” when they are spending every dime they get. It isn’t cash flow if it’s all flowing out. Professor Buffett continued that the “D” (depreciation) not only reflects a real cost, but the worst kind of cost. Depreciation reflects cash that is spent first, and the deductions only come later. Berkshire vastly prefers businesses where you get the cash up front (like insurance). Similarly the “T” (taxes) is a real cost. To pretend otherwise is delusional. Buffett concluded that it was amazing to him how widespread the usage of EBIDTA has become.
Munger noted many corporations have large M&A departments spending huge amounts of time to do huge amounts of due diligence. Yet at least two-thirds of acquisitions are duds. In contrast, Munger noted that Berkshire has done many great deals with no such time spent. They wait for the no-brainer, the fat pitch.
Buffett claimed that successful investing is not complicated. The Rosetta Stone of investing is to remember that a stock is part ownership in a business. That principle provides the foundation for rational investing.
He recommended realism in defining one’s circle of competence and discipline to stay within the circle. He added that it helps to insulate yourself from popular opinions. You’re better off sitting and thinking.
Buffett noted that lots of folks with very high IQs fail financially.
With a nation of 100 million workers and a $10 trillion GDP, having shareholders receive a 6% to 7% return is a perfectly acceptable outcome.
He added that “quality of GDP” would be an added factor worth knowing. GDP that leads to improved standards of living is one thing. Increased GDP from hiring more security guards is another – a lower quality GDP than the former.
the energy field, nearly every utility in the country was brought to ruin with participation in the sort of derivatives trading championed by Enron. In 1998, Long-Term Capital Management nearly paralyzed the entire financial system with troubles magnified by the use of derivatives.
He noted that if you are innumerate in business, you’ll be a klutz. However, business does not require high math, and it may even be a disadvantage to know high math. Buffett concluded with a smile, “When my mother sang me songs about compound interest, there was no need to go further.”
Munger added that it is critical to “avoid dumb stuff” like going to the race track, risking AIDS, experimenting with cocaine or getting into debt. He suggested developing good character and good mental habits and to learn as you go.
Buffett referenced an old study that found the top correlation of great managers to be the age at which managers started their first businesses. Buffett believes it has far more to do with the wiring than he would have thought 30 years ago.
the U.S. economy long term. In 1790, there were four million people in America, 290 million in China and 100 million in Europe. Yet 215 years later, America has 30% of the world’s GDP. It is an incredible success story.
Munger concluded, “If a mountain like Mount Everest stands up, you don’t have to be genius to see it’s a high mountain.”
Munger shared that a reporter once said to him, “You don’t seem smart enough to be doing so much better than everyone else.” The key is knowing the edge of one’s circle of competence.
Buffett noted that the CPI (Consumer Price Index) is not a particularly good measure of inflation. First, “core” inflation excludes food and energy. “Not much is more core!” Buffett exclaimed. Second, since CPI uses a rent equivalent factor for living costs, it hasn’t captured the rising cost of housing. In sum, the CPI understates inflation.
Several years ago, numerous Korean companies sold for three times earnings.
One person told Munger that the accounting is better because positions are marked to market and said, “Don’t you want real-time information?” Munger replied that if you can mark to market to report any level of profits you want, you’ll get terrible human behavior. The person replied, “You just don’t understand accounting.”
Buffett’s view is that the most important job of the board is to pick the right CEO. The second most important job is to prevent the CEO from overreaching, which often happens in acquisitions.
Buffett asserted that to a large extent, gambling is a tax on ignorance. You put it in, and it ends up taxing many that are least able to pay while relieving taxes on those who don’t gamble.
Munger has often extolled Buffett’s relentless thirst for learning, calling him a “learning machine.” Buffett agreed that he is big on reading everything in sight and recommended good investors should read everything they can. In his case, he said that by the age of 10, he’d read every book in the Omaha public library on investing, some twice! Fill your mind with competing ideas, and see what makes sense to you.
He claimed that his best ideas haven’t done better than others’ best ideas, but he’s lost less on his worst ideas.
Munger put in his two cents, “At least 50% of what is taught is twaddle, but these people have very high IQs. We recognized early on that very smart people do very dumb things, and we wanted to know why and who so we could avoid them.”
He said that he read the book when he was young and that the book taught him to under-spend his income and invest the difference. Lo and behold, he did this, and it worked. He got the idea to add a mental compound interest as well. So he decided he would sell himself the best hour of the day to improving his own mind, and the world could buy the rest of his time. He said it may sound selfish, but it worked. He also noted that if you become very reliable and stay that way, it will be very hard to fail in doing anything you want.
If Buffett were teaching business school, he would make it shockingly simple. “Teach (1) How to Value a Business, and (2) How to Think about Market Fluctuations – that the market is there to serve you, not influence you.” That would be it. Professors fill the time with all sorts of formulas. Just as the priesthood of Biblical scholars would not have much to do if the masses simply followed the 10 Commandments, so do business school professors need something to teach and impress the students.
Concentration Munger and Buffett were in complete agreement about the benefits for the professional investor of loading up on your best ideas. Buffett claimed that concentration is a good thing in investing, noting that he has had 75% of his non-Berkshire net worth invested in a single idea numerous times. It would be a mistake not to have 50% of your net worth in a really good situation. The big mistake is having 500% of your net worth in things. Long-Term Capital Management had 25 times its net worth up, so it couldn’t play out its hand when things went against it.
Buffett noted that it’s important to think about risks, including those that have never happened before. The investment banks all had models, they had weekly risk committee meetings and they still didn’t have a clue. Buffett opined that “a chief risk officer is an employee that makes you feel good while you do dumb things.”
Munger also took a shot at Alan Greenspan, suggesting Greenspan had overdosed on Ayn Rand – adopting the belief that if things happen in a free market, they must be okay.
Berkshire has long been invested in branded food companies and recently took a more than 8% stake in Kraft Foods. Buffett observed that big food companies are good businesses. They earn good returns on tangible assets. Good brands like See’s, Coke, Mars, Wrigley’s are tough to compete with. Coke now provides 1.5 billion servings a day worldwide. Since 1886, Coke has been delivering “happiness” and “refreshing” associations. These associations get implanted in people’s minds. Good branded products are often a good investment.
A fascinating point: Buffett claims he could spend five months more on the idea, and it wouldn’t add value to his decision. Munger chimed in that they have a good “blotter out” system. They don’t waste time on certain things.
He also noted that he was lucky to find his passion so early in life. He recalled reading his dad’s books on investing as a boy and how that turned him on. (He joked that was before Playboy was invented.) He pointed out that it is a terrible mistake to sleepwalk through life, to just go through the motions. Ideally, you have a job that you would do for free. Surprisingly, he claimed that when he went to work for Ben Graham at the age of 24, he never even asked what his salary would be. He also noted that getting the right spouse is essential. He told the story of the man who spent 20 years looking for the perfect woman before he finally found her. Unfortunately, she was looking for the perfect man.
As he has counseled on numerous occasions, Buffett suggested the best investment one can make is in oneself. He noted that few people get the maximum horsepower out of life. Potential exceeds realization for so many. When he speaks to students, he suggests they adopt the mindset of someone who is picking one car for the rest of their lives. How would they treat it? They would read the manual carefully, change the oil twice as often and clean up the rust spots. Well, each of us gets one mind and one body for life. How will you treat yours?
Read Buffett reflected that he devoured books from an early age. He spends much of his day reading books, annual reports and newspapers. Munger noted that different people learn in different ways. He too has always been an avid reader. With books, he likes that you can learn just what you want to learn and at the speed of your choosing. Buffett concluded that if you read 20 books on a subject you are interested in, you are bound to learn a lot.
Buffett joked that in 600 B.C., Aesop, who was a very smart man, though he didn’t know it was 600 B.C., he couldn’t know everything – said, “A bird in the hand is worth two in the bush.” That’s really it.
Buffett added that this false precision only arises with very high IQs. You only need an IQ of 120 or so to be a good investor. In fact, he suggested, if you have a high IQ, keep your 120 and sell the rest. Higher math can lead you astray.
His two courses, if he were to run a business school, would be 1) How to Value a Business, and 2) How to Think About Markets. That would be it. In valuing businesses, it is important to understand the language of accounting, to stay within your circle of competence, and to focus on what is meaningful and sustainable. In thinking about markets, it is important to remember that markets are there to serve you, not instruct you. The key here is emotional stability, to have an inner peace about your decisions. It is important to think for yourself and to make good decisions over time.(108)
The best protection against inflation, according to Buffett, is your own earning power. If you constantly increase your earning power, you’ll be sure to get your share of the economic pie. The next best thing is to own wonderful businesses, especially those that have low capital requirements. For example, Coca-Cola requires little capital to grow and is sure to get its percentage of income, however it is measured, whatever the currency.
Munger suggested making it your practice that you go to bed each night wiser than when you got up. You may rise slowly, but you are sure to rise. Munger reminisced that the only business course he ever took was accounting.
We’ve had the Civil War…15 recessions…it certainly has not been a straight line of progress, but the power of capitalism has been amazing. Stimulus has helped our recent problems, but what will really bring us out of recession is capitalism. And the world has caught on. Buffett predicted that in the next 100 years, we will have 15 to 20 lousy years and that we’ll be so far ahead of where we are now that it will be beyond belief. Munger, in his characteristically sunny way, concluded that “Europe had the Black Death where one-third of the population died. The world will go on.”
Buffett declared the best inflation hedge is a company with a wonderful product that requires little capital to grow.
He cited Keynes Chapter 12 – “The State of Long Term Expectation” from The General Theory of Employment, Interest and Money – that such investing amounts to a beauty contest where you are betting not on whom you believe to be the prettiest contestant, but who others will believe is beautiful.
Munger noted that we’re here to go to sleep each day smarter than when we woke up. Buffett shared how he lived in the Omaha Public Library for four years.(127) He also noted that his Dale Carnegie course in 1951 cost him $100, and the value was incalculable as the value of good communication skills so dramatically enhanced his life. So Buffett’s big point was to develop yourself. Find your passion, and improve your skills.
He characterized “value at risk” as one of the dumbest ideas ever put forward. Buffett agreed that PhDs who should know better got hooked on their fancy math, which may not be applicable to human behavior.
As he has in years past, Buffett asserted that The Intelligent Investor chapters 8 (Mr. Market) and 20 (Margin of Safety) give you all you need to know. Build into your system that stocks get mispriced.
He noted that Ray Kroc had no need to know the option value of McDonald’s, but thought long and hard about how to make better fries. Buffett concluded, “If you think about business and buy businesses for less than they’re worth, you’re going to make money.”
Munger added that there’s a lot of false confidence on Wall Street. Risk on Wall Street may be measured with Gaussian curves, but the fat tails are not fat enough!
He added that Standard Oil was pretty much the only one that got “monstrously big and continued to do monstrously well.”
Munger noted that it is in the nature of things that sooner or later the leader is no longer the leader. As Keynes said, “In the long run, we’re all dead.”
Buffett was reminded of a 1999 Fortune article where he wrote that one would have to be wildly optimistic to think that corporate profits as a percentage of GDP could be much above 6% for a sustained period. Today, corporate profits are greater than 10% of GDP.
Concluding his thoughts on Harley Davidson, Buffett said, “Any company that gets its customers to tattoo ads on their chests can’t be all that bad.”
On the subject of their work habits, Munger offered a fascinating insight. By accident, he and Buffett have ideal habits for what they do. For example, they didn’t know when they started out about modern psychological evidence that you shouldn’t make important decisions when you’re tired and that difficult decisions are tiring. He joked that they didn’t know important decision-making was helped by consuming lots of caffeine and sugar.(143)
As in past years, Buffett asserted that health care costs are the biggest threat to American competitiveness. We’re spending something like 17% of GDP on health care, while our rivals are paying around 10%.
Buffett said he envies the baby being born today in the United States. That’s the luckiest individual ever. He opined that the baby will do better in all sorts of different ways than when he was born. Just as we live far better than people like John D. Rockefeller, the person born today will live far better than we do.
Munger observed that Buffett was drowning in opportunities when they first met, but what he lacked was money. Buffett finished with the punchline: “Now we’ve got the money and no ideas.”
He clearly believes equities are the superior choice to bonds and cash at this time. That’s a point worth noting.
We believe a big contributor is that Berkshire is hitting on all cylinders.
Berkshire is a smooth-running capital allocation machine.
Generating in the neighborhood of $20 billion a year in growing cash flow, Berkshire will easily generate more than $230 billion of cash in the next decade, an amount equal to its current equity value.
Deciding how much to allocate to each of these five areas ideally is driven by “opportunity cost.” In other words, each extra dollar should go where it gets the best risk-adjusted return over the long run compared to all other competing opportunities.
Mortgage originators sold the loans to investment bankers who sliced and diced the loans into derivative products where the eventual buyers often didn’t really know what they owned.
“Everyone has a job, and it all works out. They pretend to pay us, and we pretend to work.”
“Efficiency is required over time in capitalism.”
Buffett observed that they do have filters. A key one is whether they have a good idea of how the business is going to do over the next five or 10 years. That filter eliminates many businesses from consideration. Another filter is people. Buffett wants people to run the business the same way after selling to Berkshire as they ran it before selling to Berkshire. That filter also eliminates a lot of deals. Buffett concluded, “I can’t give you five criteria. Maybe Charlie has kept them from me.”
Culture comes from the top according to Buffett. The leader must be consistent, communicate well, and reward proper behavior and punish misbehavior. Since it takes time, it’s actually easier to inherit the culture you like.
“I think one thing that we have done that’s worked best is that we were always dissatisfied with what we already knew, and we wanted to know more. We kept learning, and that’s what made it work.”
Buffett noted that he would have never predicted five years of zero interest rates. “We’re operating in a world that Charlie and I don’t understand.” Munger wryly noted, “If we failed to predict what happened before, why would anybody ask us what our prediction was for the future?” Fortunately for shareholders, macro predictions are not essential to the Berkshire process. Buffett took pains to emphasize that he and Charlie had never, to the best of his memory, ever turned down an acquisition based on macro factors.
He said the real key is to be able to figure out what the average profitability of the business will be over the long term and how strong the business moat may be.
Buffett’s punch line, “We think that any company that has an economist has one employee too many.”
There was a very good question about valuations. One ratio that Buffett is known to track is the total market cap to GDP. Recently, it was at 125%, which is a level approached in 1999 during the Internet bubble.
From 1951 to 1999, that number ranged from 4.5% to 6%. More recently, that number has been up over 10%. Should investors be concerned about these numbers and the market?
Buffett replied that those percentages suggest that American business is doing very well, though that might be a concern for society. The valuation picture is very much affected by our zero-based interest rate structure. Clearly, stocks are worth far more when government bonds yield 1% than when they yield 5%. Munger noted that people have limited alternatives with bonds paying so little. This has pushed stocks to higher prices than they would reach otherwise.
Buffett’s formula for happiness is simple: “Do what I like with people I like.” He noted that he learned early in life that his favorite employer was himself. It avoids aggravation.
Munger shared that he’s as fascinated at age 92 as he’s been in any period of his life. While he wishes he had wised up sooner, Munger also saw the blessing in it: “At age 92, I still have lots of ignorance left to work on.”
Munger summed: “We’d prefer that derivatives were illegal.”
Buffett reminded folks that to buy a stock is to buy part ownership of a business. Don’t get hung up on daily price quotes. Instead, think about business performance and what you would pay for the business, just as you would a farm.
Despite 50% taxes for many years, price controls, regulations, and more, American business has done extraordinarily well over the last 200 years. America is a remarkably attractive place to do business. GDP per capita is up six-fold in his lifetime.
Buffett shared that the Valeant debacle illustrates a principle of Peter Kiewit: “If you need a manager, look for someone with intelligence and energy and integrity.
In addition, you have consultants charging fees. If the consultants just say, “Buy an S&P 500 Index fund and sit for 50 years,” they wouldn’t be able to charge much. The hyperactive traders and their “helpers” are, in aggregate, a tax on the system.
This is not new. Buffett mentioned Fred Schwed’s classic from 1940, Where Are the Customers’ Yachts?(154) Buffett asserted that far more money is made on Wall Street with selling talent than with investing talent.
Buffett noted that the main problem is Berkshire’s size. To a significant degree, size is the enemy of performance.
Cyber, nuclear, biochemical, and chemical attacks, that is. In a sobering digression, Buffett shared that CNBC is his handle for the world’s greatest problems. Buffett warned that something of the sort will happen. It’s just a matter of time because a percentage of the population comprises psychotics, megalomaniacs, and religious fanatics. And the problem is growing. There are more of them when the world population is 7.4 billion versus 3 billion. Also, we have innovated beyond bows and arrows, and spears, so the potential damage has increased. In 1945, with the dropping of the bomb in Japan, we unleashed a power like the world had never seen. That bomb was a popgun compared to what we can do now.
Asked how he does it, Buffett shared that he and Charlie read a lot. What matters most to him are micro factors, as opposed to the macro factors that so often get all the attention. He loves to know all the details of a business.
Buffett defended 3G, citing Tom Murphy, CEO of Cap Cities, who said the best approach is to never hire a person you don’t need, so you never have to lay anyone off. Buffett suggested that all kinds of companies have people not doing much. He’d let go of the staff economist and the investor relations department, for example.
He concluded that a lean staff is always better. Buffett noted that, when sloppy thinking appears in one area, sloppy thinking appears elsewhere. He recommended reading Barbarians at the Gate for a lesson on how a great business can get sloppy.
“Salomon pledge”: “Lose money for the firm and I will be understanding. Lose one shred of reputation for the firm and I will be ruthless.”
One error was to inadvertently incentivize bad behavior. In addition, as with any strong sales culture, there is a risk of pushing too hard. But the giant error here was that, when the program runs off the rails, the CEO must act.
Buffett revised Ben Franklin: “An ounce of prevention is worth a ton of cure.”
He summed up that what you want is an economic castle with a very wide moat and an honest, talented knight to handle marauders.
Munger insightfully concluded: “A lot of people are trying to be brilliant. We’re just trying to stay rational. That’s a big advantage. Trying to be brilliant is dangerous.”
Buffett noted that such a person would need a “money mind.” Even someone with an IQ of 140 can have a very different mind where they do poorly at investing. It takes a money mind to think well about money and investing.
Munger suggested that you must fish where the fish are. China has lots of fish. In the U.S. market, there are too damn many boats.