Berkshire AGM 1996 excerpts
MORNING SESSION
GEICO benefits from being entirely owned by Berkshire
WARREN BUFFETT: Well, I would say that GEICO is a huge plus to Berkshire. Now, we owned 50 percent of it before. I mean, we’ve had a — we’ve benefitted from our GEICO investment in a big way, ever since 1976. So, it’s not entirely a new benefit that’s coming in.
We paid a good price for GEICO, but it is a terrific company. It has outstanding management. It has a low-cost method of distribution, which is very difficult for people to — I mean, everybody wants to have that. But they — very few come close to it. The management is focused on bringing costs down even further and widening that competitive moat.
GEICO — I personally think that, just from what I see, that GEICO — I would think GEICO’s growth rate is likely to be greater, at least, in the future, that I can see, over where it has been in the past. But it’s been perfectly satisfactory in the past. I think there are some advantages to it being part of Berkshire, in that there are costs attached to bringing new business on the books. And we care not at all about reported quarterly earnings. GEICO was relatively insensitive to those before. And that’s a compliment when I say that. But they had some more pressure on them in respect to reported earnings than they will have, as part of Berkshire.
And I think there’s some really big opportunities, in terms of what can be done with GEICO as part of Berkshire. So, I think five years from now, you’ll be very happy with the fact that we own a hundred percent of GEICO. And I think you will see that as marvelous a company as GEICO was independently — as an independent company — it will flourish maybe even a bit more as being part of Berkshire. Not because we bring anything to the party. I mean, the management will continue to run it autonomously. But there’s — there are some advantages for it in being part of a larger enterprise.
Insurance float: “Above all, get it cheap”
WARREN BUFFETT: Yeah, the — Charlie and I have lost about the same amount, at about 20 pounds each. The insurance business provides us with float. And float is money that we hold that doesn’t belong to us. It’s like a bank having deposits. A bank has deposits. The money doesn’t belong to it. But it holds the money. Now, when a bank holds deposits, on everything except demand deposits, there’s an explicit cost, an interest rate attached to it. And, then, there are the costs of running the system and gathering the money which is — also must be attributed both to demand and time deposit.
So there’s a cost to getting what they would call deposits and we could call float. In the insurance business, a similar phenomenon takes place in that policy holders give us their money at the start of the policy period. And therefore, we get the money paid in advance for the product.
And secondly, it takes time to settle losses, particularly in the liability area. If you bang up a fender on your car, you — it’s going to get settled very quickly, so there’s — but if there’s a complicated injury or something, it may take some years to settle. And during that period, we hold the money. So, we have, in effect, something that is tantamount to the deposits of a bank. But whereas the deposits of a bank, it’s quite easy to calculate the approximate cost, in the case of the float that the insurance company has, you don’t really know what the cost of that float is until all your policies and losses — policies have expired and your losses have all been settled. Well, that’s forever, in some cases.
So, you’re only making an estimate, as you go along, of what that float is costing. To date with Berkshire, in the 29 years we’ve been in the business, it appears — never certain, because you don’t know for sure what’s going to happen — but it appears that our float has not cost us anything, in — on average.
There’s been years when we’ve had an underwriting loss when there’s a cost. There’s been years when we had an underwriting profit. And so, we had a reverse cost. So we have obtained that float on very advantageous terms over the years. Far more than —fully as important as that— it’s important to get it at a low cost, in our case, no cost. But the other important thing is that we’ve grown it dramatically.
And so, we’ve gotten more and more money without having any cost attached to it. And if we still had our 16 — or 17 million, I guess — of float that we had in 1967 and it was no cost, it would be very nice. But 17 million of free money is worth something, but it’s not worth a ton.Having seven billion, if we can achieve that as free money, it’s worth a lot of money. And that growth has not, probably, generally, been appreciated fully in connection with Berkshire nor has the interplay of how having zero-cost money, in terms of affecting our gain in value over time.
People have looked at — always looked at our asset side, but they haven’t paid as much attention to the liability side. Charlie and I pay a lot of attention to that. And, I mean, this — it’s not entirely an accident that the business has developed in this manner.And we have intentions of trying to make it continue to develop in this manner, and in that manner, in the future. But we’ve got competitors out there, too.
Float, per se, is not a blessing. We can show you many insurance companies that thought it was wonderful to generate float. And they have lost so much money in underwriting that they’d be better off if they’d never heard of the insurance business. But, you know, the job is to get it, get it in increasing quantities, but above all, get it cheap. And that’s what we work at. And you do that in the business through having some kind of competitive advantages. You won’t do it just by having an ordinary insurance company. The ordinary insurance company is not a good business.
We have it, in certain respects, because of our attitude toward the business. We have it because of our financial strength gives us certain competitive advantages, and we have it in the case of GEICO, because of a very low-cost operation. And it’s us — up to us — to try and figure out ways to maximize each one of those competitive advantages over time.
We’ve built those advantages. I mean, in 1967, we were not looked at that way in the insurance business. We were — we’ve built a position of competitive strengths. And in the case of GEICO, they had it without us. But we have bought into it over time. It’s a very important asset. And you ought to pay a lot of attention over the years as to what is happening in — with that asset as to both growth and costs. And that will aid you in calculating intrinsic value.
Discount rate for estimating intrinsic value
WARREN BUFFETT: Yeah. We get asked that question a lot. And we’ve answered it to some extent in past annual reports about what discount rate to use.We basically think in terms of the long-term government rate.
And there may be times, when in a very — because we don’t think we’re any good at predicting interest rates, but probably in times of very — what would seem like very low rates — we might use a little higher rate.
But we don’t put the risk factor in, per se, because essentially, the purity of the idea is that you’re discounting future cash. And it doesn’t make any difference whether cash comes from a risky business or a safe business — so-called safe business.
So, the value of the cash delivered by a water company, which is going to be around for a hundred years, is not different than the value of the cash derived from some high-tech company, if any, that — (laughter) — you might be looking at. It may be harder for you to make the estimate. And you may, therefore, want a bigger discount when you get all through with the calculation. But up to the point where you decide what you’re willing to pay — you may decide you can’t estimate it at all. I mean, that’s what happens with us with most companies.
But we believe in using a government bond-type interest rate. We believe in trying to stick with businesses where we think we can see the future reasonably well — you never see it perfectly, obviously — but where we think we have a reasonable handle on it. And we would differentiate to some extent. We don’t want to go below a certain threshold of understanding.
So, we want to stick with businesses we think we understand quite well, and not try to have the whole panoply with all different kinds of risk rates, because, frankly, we think that’d just be playing games with numbers. I mean, we — I don’t think you can stick something — numbers on a highly speculative business, where the whole industry’s going to change in five years, and have it mean anything when you get through.
If you say I’m going to stick an extra 6 percent in on the interest rate to allow for the fact — I tend to think that’s kind of nonsense. I mean, it may look mathematical. But it’s mathematical gibberish in my view. You better just stick with businesses that you can understand, use the government bond rate. And when you can buy them — something you understand well — at a significant discount, then, you should start getting excited.
American Express has “slipped” in credit cards
WARREN BUFFETT: But credit cards are going to be a very competitive business over time. And you need to establish — American Express needs to establish — special value for its card in some way, or it gets more commodity-like.
It’s not an easy business. But their franchise — they’ve got a strong franchise. It is not what it was 20 years ago, relative to the competition.
“Change is likely to work against us”
WARREN BUFFETT: We generally look at businesses — we feel change is likely to work against us. We do not have great ability — we do not think we have great ability to predict where change is going to lead. We think we have some ability to find businesses where we don’t think change is going to be very important. Now, at a Gillette, the product is going to be better 10 years from now than now, or 20 years from now than 10 years from now. You saw those earlier ads going back to the Blue Blade and all that. The Blue Blade seemed great at the time. But they keep — the shaving technology gets better and better.
But you know that Gillette — although they had that little experience with Wilkinson in the early ’60s — but you know that Gillette is basically going to be spending many multiples the money on developing better shaving systems than exist now, compared to anyone else.
You know, they’ve got the distribution system. They’ve got the believability. If they bring out a product, and they say, “This is something that men ought to look at,” men look at it. And they found out here a few years ago that the same thing happened when they said to women to look at it in the shaving field. They wouldn’t have that same credibility someplace else. But in the shaving field, they have it. Those are assets that can’t be built. And they’re very hard to destroy.
So change — we think we know, in a general way, what the soft drink industry or the shaving industry or the candy business is going to look like 10 or 20 years from now. We think Microsoft is a sensational company run by the best of managers. But we don’t have any idea what that world is going to look like in 10 or 20 years. Now, if you’re going to bet on somebody that is going to see out and do what we can’t do ourselves, I’d rather bet on Bill Gates than anybody else.
But that — I don’t want to bet on anybody else. I mean, in the end, we want to understand, ourselves, where we think a business is going. And if somebody tells us the business is going to change a lot, in Wall Street, they love to tell you that, you know, that’s great opportunity. They don’t think it’s a great opportunity when Wall Street itself is going to change a lot, incidentally. (Laughter)
But they — you know, it’s a great opportunity. We don’t think it’s an opportunity at all. I mean, we — it scares the hell out of us. Because we don’t know how things are going to change. We are looking, you know — when people are chewing chewing gum, we have a pretty good idea how they chewed it 20 years ago and how they’ll chew it 20 years from now. And we don’t really see a lot of technology going into the art of the chew, you know? (Laughter) So, that — And as long as we don’t have to make those other decisions, why in the world should we? I mean, you know, if I — all kinds of things, we don’t know. And so, why going around trying to bet on things we don’t know, when we can bet on the simple things?