Berkshire AGM 1994 excerpts
Two yardsticks” for judging management
AUDIENCE MEMBER: How do I, as an average investor, find out what good management is?
WARREN BUFFETT: Well, I think you judge management by two yardsticks.
One is how well they run the business and I think you can learn a lot about that by reading about both what they’ve accomplished and what their competitors have accomplished, and seeing how they have allocated capital over time.
You have to have some understanding of the hand they were dealt when they themselves got a chance to play the hand.
But, if you understand something about the business they’re in — and you can’t understand it in every business, but you can find industries or companies where you can understand it —then you simply want to look at how well they have been doing in playing the hand, essentially,that’s been dealt with them.
And then the second thing you want to figure out is how well that they treat their owners. And I think you can get a handle on that, oftentimes. A lot of times you can’t. I mean it — they’re many companies that obviously fall in — somewhere — in that 20th to 80th percentile and it’s a little hard to pick out where they do fall.
But, I think you can usually figure out — I mean, it’s not hard to figure out that, say, Bill Gates,or Tom Murphy, or Don Keough, or people like that, are really outstanding managers. And it’s not hard to figure out who they’re working for.
It’s interesting how often the ones that, in my view, are the poor managers also turn out to be the ones that really don’t think that much about the shareholders, too. The two often go hand in hand.
But, I think reading of reports — reading of competitors’ reports — I think you’ll get a fix on that in some cases. You don’t have to — you know, you don’t have to make a hundred correct judgments in this business or 50 correct judgements. You only have to make a few. And that’s all we try to do.
And, generally speaking, the conclusions I’ve come to about managers have really come about the same way you can make yours. I mean they come about by reading reports rather than any intimate personal knowledge or — and knowing them personally at all.
How Berkshire keeps great managers
WARREN BUFFETT: We basically try to run a business so that — Charlie and I have two jobs. We have to identify and keep good managers interested after we’ve figured out who they are.
We’ve got a wonderful group of shareholders. Before I ran this, I had a partnership. I had a great group of partners. And essentially, I like to be left alone to do what I did. I like to be judged on the scorecard at the end of the year rather than on every stroke, and not second guessed in a way that was inappropriate.
And so the important thing we do with managers, generally, is to find the .400 hitters and then not tell them how to swing, as I put in the report.
The second thing we do is allocate capital.
Don’t pay attention to what people say about stocks
WARREN BUFFETT: It really doesn’t make any difference. I mean, what — we don’t pay any attention to what people say about Coca-Cola stock or Gillette stock or any of those things.
I mean, on any given day, two million shares of Coca-Cola may trade. That’s a lot of people selling, a lot of people buying. If you talk to one person, you’d hear one thing, and you’d talk to another — you really should not make decisions in securities based on what other people think.
If you’re doing that, you should think about doing something else, because it’s —
A public opinion poll will just — it will not get you rich on Wall Street. So you really want to stick with businesses that you feel you can somehow evaluate yourself.
And, I don’t think — I mean Charlie and I, we don’t read anything about what business is going to be — the economy is going to do, or the market’s going to do, or what anybody —
Anytime I see some article that says, you know, these analysts say this or that about some business, it just — it doesn’t mean anything to us.
You cannot get rich with a weather vane.
Cutting USAir’s costs will be “enormously tough”
WARREN BUFFETT: USAir has a cost structure which is non-viable in today’s airline business. Now that, in an important way, involves its labor cost, but it involves other things, too. But it certainly involves its labor costs.
And they’ve stated this publicly. And I think — and they have — they are talking with their unions about it and they’re talking with other people about other parts of their cost structure.
Why we have no short-term opinion on stocks
WARREN BUFFETT: The best thing that can happen from Berkshire’s standpoint — we don’t wish this on anybody — but is that over time is to have markets that go down a tremendous amount.
We buy businesses. We buy pieces of businesses: stocks. And we’re going to be much better off if we can buy those things at an attractive price than if we can’t.
So we don’t have any fear at all. I mean, what we fear is an irrational bull market that’s sustained for some long period of time.
You, as shareholders of Berkshire, unless you own your shares on borrowed money or are going to sell them in a very short period of time, are better off if stocks get cheaper, because it means that we can be doing more intelligent things on your behalf than would be the case otherwise.
CHARLIE MUNGER: No. I think the — if you’re agnostic about those macro factors and therefore devote all your time to thinking about the individual businesses and the individual opportunities, it’s just, it’s a way more efficient way to behave, at least with our particular talents and lacks thereof.
WARREN BUFFETT: If you’re right about the businesses, you’ll end up doing fine.
Risk is “inextricably wound up” in how long an asset is held
WARREN BUFFETT: Well, we do define risk as the possibility of harm or injury. And in that respect we think it’s inextricably wound up in your time horizon for holding an asset.
I mean, if your risk is that you’re going — if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, I mean, that is, in our view, that is a very risky transaction. Because we think 50 percent of the time you’re going to suffer some harm or injury.
If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially, is so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction.
Now, as I pointed out in the annual report, it became very fashionable in the academic world, and then that spilled over into the financial markets, to define risk in terms of volatility, of which beta became a measure.
But that is no measure of risk to us. The risk, in terms of our super-cat business, is not that we lose money in any given year. We know we’re going to lose money in some given day, that is for certain. And we’re extremely likely to lose money in a given year.
Our time horizon of writing that business, you know, would be at least a decade. And we think the probability of losing money over a decade is low. So we feel that, in terms of our horizon of investment, that that is not a risky business. And it’s a whole lot less risky than writing something that’s much more predictable.
Don’t need interest rate outlook to value companies
WARREN BUFFETT: Well, the value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100 percent sensitive to interest rates, because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in, over a period of time. And the higher interest rates are, the less that present value is going to be.
So every business, by its nature, whether it’s Coca-Cola or Gillette or Wells Fargo, is in its intrinsic valuation, is a hundred percent sensitive to interest rates.
Now, the question as to whether a Wells Fargo or a Freddie Mac or whatever it may be, whether their business gets better or worse internally, as opposed to the valuation process, because of higher interest rates, that is not easy to figure.
I mean, GEICO, if they write their insurance business at the same underwriting ratio — in other words they have the same loss and expense experience relative to premiums — they benefit by higher interest rates, obviously, over time, because they’re a float business, and the float is worth more to them.
Now, externally, getting back to the valuation part, the present value of those earnings also becomes less then.
But the present value of Coke’s earnings becomes less in a higher interest rate environment.
Wells Fargo, it’s — whether they earn more or less money under any given interest rate scenario is hard to figure. There may be one short-term effect and there may be another long- term effect.
Increased information speed doesn’t affect our decisions.
But usually that — it’s not — we’re not looking for needles in haystacks or anything of the sort. You know, we like haystacks, not needles, basically. And we want it to shout at us.
And I would say that, well, virtually everything we’ve done has been reading public reports, and then maybe asking questions around to ascertain trade positions or product strengths or something of that sort.
But we never have to — we can make decisions very fast. I mean, we get called on a business — or we can make up our mind whether we’re interested in two or three minutes. That takes no time. We may have to do a little checking on a few things subsequently.
Diversify if you don’t understand businesses
We are willing to put a lot of money into a single security. When I ran the partnership, the limit I got to was about 40 percent in a single stock. I think Charlie, when you ran your partnership,you had more than 40 percent in —
CHARLIE MUNGER: Sure. (Laughter)
WARREN BUFFETT: And we would do the same thing if we were running smaller partnerships,or our own capital were smaller and we were running that ourselves.
Because, no, we’re not going to do that unless we think we understand the business very well,and we think the nature of the business, what we’re paying for it, the people running it, and all of that lead up to virtually no risk, and —
But you find those things, occasionally. And we would put — assuming it were that much more attractive than the second, and third, and fourth choices — we would put a big percentage of our net worth in it.
You ought to really understand the business.
But people do that all the time, incidentally, in private businesses, which have got terrible prospects. I mean, they buy dry cleaning establishments, or filling stations, or whatever, and they put very high —franchises of some kind — they put a very high percentage of their net worth into something — a business that’s very risky, basically. I mean, it —
So it’s not crazy, if you understand the business well, and if the price is sufficiently attractive, to put a very significant percentage of your net worth in. If you don’t understand businesses, then you’re better off diversifying and fairly widely diversifying.
Calculating intrinsic value
WARREN BUFFETT: Well, the — in the 1992 annual report, we discuss that a fair amount.
But the economic value of any asset, essentially, is the present value, the appropriate interest rate, of all the future streams of cash going in or out of the business.
And there are all kinds of businesses that Charlie and I don’t think we have the faintest idea what that future stream will look like. And if we don’t have the faintest idea what the future stream is going to look like, we don’t have the faintest idea what it’s worth, now. Now that —
So, if you think you know what the price of a stock should be today, but you don’t think you have any idea what the stream of cash will be over the next 20 years, you’ve got cognitive dissonance, I guess, is what they call it. (Laughter) The —
So we are looking for things where we feel — fairly high degree of probability — that we can come within a range of looking at those numbers out over a period of time, and then we discount them back.
Capital allocation shouldn’t be delegated
WARREN BUFFETT: Yeah, we don’t have any staff to help us on it. I mean, basically we tell them to mail all the money to Omaha — (laughter) — and then when we get there, we put our arms around it. (Laughs).
And we allocate all the capital ourselves. I mean, that is our job.
And we don’t feel we should delegate, I mean, we wouldn’t do it anyway. Our personalities aren’t such that we would delegate our — allocating our own money to someone — letting somebody else allocate our own money.
But we feel that’s our job. And it’s interesting, and we’ve — I’ve written about this in the past — that that’s an important job for most managements. There’s some companies where it’s not, but it’s a — it usually is a very important job for most managements.
And if you take a CEO that’s in a job for 10 years, and he has a business that earns, say, 12 percent on equity, and he’s — and he pays out a third, that means he’s got 8 percent per year of equity. I mean, when you think of his tenure in office, how much capital he’s allocated, it’s an enormous factor over time.
And yet, probably relatively few chief executives are either trained for, or are selected on, the basis of their ability to allocate capital. I mean, they get there through other routes.
And Charlie and I take responsibility for all capital allocation decisions, other than just, sort of, routine expenditures at the operating businesses. And we don’t get into those at all.
For shorter form discussion on stocks , may subscribe on twitter
We release weekly newsletters ( see bottom to subscribe) .
Follow us on twitter
#Warrenbuffett #charliemunger #Berkshirehathaway