Berkshire AGM 1995 excerpts-1
MORNING SESSION
Graham’s principles for high-tech stocks?
WARREN BUFFETT: The question about — Charlie and I won’t be able to do it. We — Charlie probably understands high-tech. But you can see how hard it is to get any information out of him. So — (laughter) — he hasn’t told me yet. We try not to get into things we — that we don’t understand.
And if we’re going to lose your money, we want to be able to come before you, you know, next year and tell you we lost your money because we thought this and it turned out to be that. We don’t want to say, you know, somebody wrote us a report saying if, you know, “This is what’s going to happen,” in some field that we don’t understand and that, therefore, we lost your money by following someone else’s advice. So, we won’t do it ourselves.
At — I think that the principles — I think Ben Graham’s principles — are perfectly valid when applied to high-tech companies. It’s that we don’t know how to do it, but that doesn’t mean somebody else doesn’t know how to do it.
My guess is that if Bill Gates were thinking about some company in an arena that he understood and that I didn’t understand, he would apply much the same way of thinking about the investment decision that I would. He would just understand the business.
I might think I understand Coca-Cola or Gillette. And he may have a — he may have the ability to understand a lot of other businesses that seems as clear to him as Coke or Gillette would seem to me.
I think once he identified those, he would apply pretty much the same yardsticks in deciding how to act.
I think he would act — I think he would have a margin of safety principle that might be a little different because there’s essentially more risk in a high-tech company. But he would still have the margin of safety principle on a — sort of adjusted for the mathematical risk of loss in his mind.
He would have — he would look at it as a business, not as a stock. You know, he would not buy it on borrowed money.
I mean, it — a bunch of principles would be carried through. But our circle of things we understand is really unlikely to enlarge, maybe a tiny bit here or there. But if the capital doesn’t get too large, the circle’s OK. And — but we will not —if we have trouble finding things within our circle, we will not enlarge the circle. You know, we’ll wait. That’s our approach.
USAir: “You don’t have to make it back the way you lost it”
WARREN BUFFETT: Well, that’s a very good question. Because it is true that a very important principle in investing is you don’t have to make it back the way you lost it. And in fact, it’s usually a mistake to make — try and make it back the way that you lost it.
And we have — when we write our — an investment down, as we did with USAir at 89 million, we probably think it’s worth something more than that. But we tend to want to be on the conservative side. But it’s worth a whole lot less than we paid.
Beware of complicated fads and “high priests”
CHARLIE MUNGER: If Warren is using economic value added exactly the way they’re now teaching it in the business schools, he hasn’t told me.
Obviously, the concept has some merit in it. But the exact formal methods, I don’t believe we use. Warren, are you using this stuff secretly?
WARREN BUFFETT: No, we — (laughter) — in a sense, they’re trying to get at the same thing we do. Or we’re trying to get at the same thing they do. But I think it’s — A, I think it has some flaws in it.
Although I think it generally comes out with the right answers, it sort of forces itself to come out with the right answers.
But I really don’t think you need that sort of thing. I mean, I do not think it’s that complicated to figure out, you know, where it makes sense to put money. You can make mistakes doing it.
But in terms of the mental manipulations you go through, I don’t think it’s a very complicated subject.And I don’t think that — I think that the people marketing one or another fad in management tend to make them a little more complicated than needed so that you have to call in the high priest. It doesn’t take — it just doesn’t make it complicated enough. And I think there’s some of that in — quite a bit of that — in management consulting and in the books that you see and all of that, that come out.
CHARLIE MUNGER: It’s way less silly than the capital assets pricing model. So that, at least academia’s improving. (Laughter)
WARREN BUFFETT: Really, yeah. The capital asset pricing model, which is — I don’t know how much it’s used now. Certainly — you know, they had these great waves of popularity. You get that in management. You get it in investing. I mean, real estate, you know, may have been popular, or international. I — you can read Pensions & Investment magazine, which is a pretty good magazine. But you can just see these fads sort of going through. And then they have seminars on them and everything.
And, you know, the investment bankers create product to satisfy the demand. And there’re these fads in management — I mean, obviously, listening to your customer and things like that, I mean, that is — nothing makes more sense. But it’s hard to write a 300-page book that just says, “Listen to your customer.” (Laughter)
And, you know, that’s one of the things I liked about Graham’s book. I mean, you know, he wrote — everything he wrote sort of made sense. He didn’t sort of get into all the frills and try and make it more complicated than it really, truly is.
You know, I really didn’t need to read the November issue — 1994 issue of Fortune — to know that Coca-Cola had added a lot of value. (Laughter)
Derivatives: “Potential for mistakes and mischief”
WARREN BUFFETT:Last year and the year before, I think I said that derivatives often combine borrowed money with ignorance, and that that is a rather dangerous combination. And I think that we’ve seen some of that in the last year.
CHARLIE MUNGER: Well, I disapprove even more than you do, which is hard.If I were running the world, we wouldn’t have options exchanges. The derivative transactions would be about 5 percent of what they are. And the complexity of the contracts would go way down. The clearing systems would be tougher.
I think the world has gone a little bonkers. And I’m very happy that I’m not so located in life that I have to be an apologist for it.You know, a lot of these people, I feel sorry for them. You know, they had great banks. And they have to go before people, sometimes even including their children and friends, and argue that these things are wonderful.
Cards are key to future of American Express
WARREN BUFFETT: The question about American Express: we own just under 10 percent of American Express. And obviously, even though you mentioned they’re in a number of businesses, the — by far, the key, the most important factor in American Express’s future for a good many years to come — a great many years to come — will be the credit card.
And American Express entered into the credit card business out of fear. I mean, they were worried about what the credit card was going to do to their traveler’s check business.
Traveler’s check business had been originated back in 1890-something, I believe.And they became enormously successful with it. And the American Express card, as you know,had a terribly strong position in what they called the “travel and entertainment” part of the card business. And of course, the banks entered in on a big scale. And Visa’s been enormously successful.So, the card has a strong franchise in certain areas, like the corporate card.
Although people like First Bank System are very aggressive in going after them there.The card — but the card has a significant franchise, but it does not have the breadth of franchise that it had many years ago.For a while, it was “the” card. And now it’s “the” card in certain areas, but nothing like as broad an area as before. It has certain, very important, advantages and economic strengths and it has some weaknesses.
And you have to suss those, in deciding where it’ll be in the year 2000 or 2005.And we think that the management of American Express thinks well about the question of how to — how you keep the card special in certain situations. And they’ve reacted to the merchant backlash for higher discount fees, I think, in an intelligent way.
Decisions so obvious that exact numbers aren’t needed
And it is the framework in which we operate. I mean, we are trying to look at businesses in terms of what kind of cash can they produce, if we’re buying all of them, or will they produce, if we’re buying part of them. And there’s a difference. And then at what discount rate do we bring it back.
"Something will happen” and we want to be ready
WARREN BUFFETT: On the other hand, we want to be prepared for it. Something will happen. That’s always been our experience. You know, we have sat through some dry spells. And this is true in both the stock market and the acquisition business. You know, I closed up the partnership in 1969 because there was nothing that made sense to do. And I’m glad I did because that situation prevailed in ’71 and ’2.
But in 1973 and ’4, you know, there were all kinds of things to do.
And that will happen from time to time. People will behave, particularly in markets, just as foolishly in the future as they have in the past. It’ll come at unexpected times. But we will get a chance to do something.Now, that’s more of a cash-type purchase, obviously, in the market. But we will get a chance to use the preferred.
And we will try to think about big things. We may not find them. But Charlie and I, the larger something is, the more interested we are.
Big assets make float more flexible
The question relates to — we have that long table we put in — we introduced about four years ago or so in the annual report, that shows the amount of float and the cost of float.
And that’s a very important table. It — in terms of our operating businesses, that’s probably the most important piece of information in the report. And that float is, as you noted, well over $3 billion now — last year, because of various favorable factors, including the fact that our super-cat business was favorable, but also, because our other insurance businesses did very well — amazingly well.
The cost of that float, which is money that we’re holding that eventually — does not belong to us, but will go to somebody else. The cost of that float was less than zero, and that is a very valuable asset.And the question is, how much flexibility we have in investing that, which I think was the core of your question.The answer is we have a lot of flexibility. We are not disadvantaged by that money being in float, as opposed to equity, really, in any significant way.
Now, if we had a very limited amount of equity and a very large amount of float, we would impose a lot of restrictions on ourselves as to how we would do it, because we would want to be very sure that we were in a position to distribute that float, in effect, to policyholders, or claimants, or whatever it may be at the time that was appropriate.
But we have so much net worth that, in effect, that float is just about as useful to us as equity money. And that means quite useful. It’s a big asset of Berkshire’s.
Economics of the moat and the castle
WARREN BUFFETT: Mike Assail (PH) from New York City.In the mistake du jour section of the annual report, you mentioned a fundamental rule of economics that you missed. I’d like to know the two or three most important fundamental rules of economics you habitually get right.
In other words, what are the fundamental rules of economics you used to make money for Berkshire?And I’m not talking about Ben Graham’s principles here, but rather, rules of economics which may be found in an economics textbook. Thank you.
WARREN BUFFETT: We — Yeah, we try to — I mean, we try to follow Ben’s principles, in terms of the attitude we bring toward both investing and in buying businesses.
But the most important thing you can — you know, what we’re trying to do is we’re trying to find a business with a wide and long-lasting moat around it, surround — protecting a terrific economic castle with an honest lord in charge of the castle.And in essence, that’s what business is all about. I mean, you want to be the lord of the castle,yourself. In which case, you don’t worry about that last factor.
But what you’re trying to — what we’re trying to find is a business that, for one reason or another — it can be because it’s the low-cost producer in some area, it can be because it has a natural franchise because of surface capabilities, it could be because of its position in the consumers’ mind, it can be because of a technological advantage, or any kind of reason at all, that it has this moat around it.
And then our — then what we have to decide is — all moats are subject to attack in a capitalistic system, so everybody is going to try and — if you’ve got a big castle in there, people are going to be trying to figure out how to get to it. And what we have to decide — and most moats aren’t worth a damn in, you know, in capitalism. I mean, that’s the nature of it. And it’s a constructive thing that that’s the case.But we are trying to figure out what is keeping — why is that castle still standing? And what’s going to keep it standing or cause it not to be standing five, 10, 20 years from now. What are the key factors? And how permanent are they? How much do they depend on the genius of the lord in the castle?
And then if we feel good about the moat, then we try to figure out whether, you know, the lord is going to try to take it all for himself, whether he’s likely to do something stupid with the proceeds, et cetera. But that’s the way we look at businesses.
Charlie, you want to add anything?
CHARLIE MUNGER: Well, I think he wants it translated into the ordinary terms of economics.The honest lord is low agency cost. That’s the word in economics.
And the microeconomic business advantages are, by and large, advantages of scale — scale of market dominance, which can be a retailer that just has huge advantages in terms of buying cheaper and enjoying higher sales per square foot.So you’re — by and large, you’re talking economies of scale.
You can have scale of intelligence.In other words, you can have a lord with enough extra intelligence that he has a big advantage.
So you’re — by and large, you’re talking scale advantages and low agency costs.
WARREN BUFFETT: Yeah, to some extent, Charlie and I try and distinguish between businesses where you have to have been smart once and businesses where you have to stay smart. And, I mean, retailing is a good case of a business where you have to stay smart.
But you can — you are under attack all of the time. People are in your store. If you’re doing something successful, they’re in your store the next day trying to figure out what it is about your success that they can transplant and maybe add a little something on in their own situation. So, you cannot coast in retailing.
There are other businesses where you only have to be smart once, at least for a very long time.There was once a southern publisher who was doing very well with his newspaper. And someone asked him the secret of his success. And he said monopoly and nepotism. (Laughter) And I mean, he wasn’t so dumb. I mean, he didn’t have any illusions about himself. And if you had a big network of television affiliates station 30 years ago, there’s still a major difference between good management and bad management. I mean, a major difference.
But you could be a terrible manager and make a fortune, basically. Because the one decision to own the network TV affiliate overcame almost any deficiency that existed from that point forward.
And that would not be true if you were the first one to come up with some concept in retailing or something of the sort. I mean, you would have to be out there defending it every day. Ideally, you know, is you want terrific management at a terrific business. And that’s what we look for. But as we pointed out in the past, if you have to choose between the two, get a terrific business.
Why Berkshire doesn’t sell businesses
WARREN BUFFETT: The size is — you know, doubling 12 billion or so is harder than doubling 1 billion-2, which was harder than doubling 120 million. I mean, there’s no question about that.
The unwillingness to sell businesses, like I say, goes back a long way. That is not what — that —If that hurts performance, it’s peanuts. That’s simply a fact — a function of the attitude Charlie and I have, is that if we want to live our lives, we find it a rarity when we find people in the business that we want to associate with. When we do find that, we enjoy it.
Focus on Graham’s three principles
WARREN BUFFETT: Yeah, we’ve tried to put in the annual report pretty much how we approach securities. And book value is not a consideration — virtually, not a consideration at all.
And the best businesses, by definition, are going to be businesses that earn very high returns on capital employed over time. So, by nature, if we want to own good businesses, we’re going to own things that have relatively little capital employed compared to our purchase price.
That would not have been Ben Graham’s approach. But Ben Graham was — Ben was not working with very large sums of money. And he would not have argued with this approach, he just would’ve said his was easier. And it is easier, perhaps, when you’re working with small amounts of money.
My friend Walter Schloss has hewed much more toward the kind of securities that Ben would’ve selected. But he’s worked with smaller amounts of money. He has an absolutely sensational record. And it’s not surprising to me at all. I mean, when Walter left Graham- Newman, I would’ve expected him to do well.
But I don’t look at the primary message, from our standpoint, of Graham, really, as being in that — in anything to do with formulas. In other words, there’s three important aspects to it.
You know, one is your attitude toward the stock market. That’s covered in chapter eight of “The Intelligent Investor.” I mean, if you’ve got that attitude toward the market, you start ahead of 99 percent of all people who are operating in the market. So, you have an enormous advantage.
Second principle is the margin of safety, which again, gives you an enormous edge, and actually has applicability far beyond just the investment world.
And then the third is just looking at stocks as businesses, which gives you an entirely different view than most people that are in the market.
And with those three sort of philosophical benchmarks, the exact — the evaluation technique you use is not really that important. Because you’re not going to go way off the track, whether you use Walter’s approach — Walter Schloss’s — or mine, or whatever.
Phil Carret has a slightly different approach. But it’s got those three cornerstones to it, I will guarantee. And believe me, he’s done very well.
Don’t believe projections
CHARLIE MUNGER: Yeah. To the extent that the method of estimating future cash flow requires projections, I would say that projections, while they’re logically required by the circumstances, on average, do more harm than good in America.
Most of them are put together by people who have an interest in a particular outcome. And the subconscious bias that goes into the process, and its apparent precision, make it — makes it some — well, it’s fatuous, or dishonorable, or foolish, or what have you.
Mark Twain used to say a mine is a hole in the ground owned by a liar. And a projection prepared in America by anybody with a commission, or an executive trying to justify a particular course of action, will frequently be a lie. It’s not a deliberate lie, in most cases. The man has gotten to believe it himself. And that’s the worst kind.
So, I don’t think we should — projections are to be handled with great care, particular when somebody has an interest in misleading you.
WARREN BUFFETT: Charlie and I, I think it’s fair to say, we’ve never looked at a projection in connection with either a security we’ve bought or a business we’ve bought. We’ve had them offered to us in great quantities.
Now, the fact that we voluntarily turn them away when people try to thrust them upon us — I mean, it — the very fact that they are prepared so meticulously by the people who are selling the businesses, or by the executives who are presenting to their boards and all of that sort of thing, you know, I mean, either we’re wrong or they’re wrong.It’s a ritual that managers go through to justify doing what they wanted to do in the first place,in about nine cases out of ten.
I have never, you know, I have never met an executive who wanted to buy something that said, “Well, I had to turn it down because the projections didn’t work.” I mean, it’s just — it’s never happened.
And there will always be somebody that will come up with the projections that will satisfy the guy who’s signing his paycheck or will sign the deal that provides the commissions. And they will pass those along to whomever else they need, the bankers or the board, to approve it. It is total nonsense. I was recently involved in some — in a situation where projections were a part of the presentation. And I asked that the record of the people who made the projections, their past projections also be presented at the same time. (Laughter)
It was a very rude act. (Laughter)