In the rest of this column, I will try to distill 18 pages of notes taken over five hours down to the most important things I heard. But even if I wrote 10 columns, I couldn't begin to communicate everything I learned, so the best advice I can give you is to buy at least one Berkshire B share and plan to attend next year's meeting.
(Note that all quotes are from Warren Buffett unless otherwise noted, and that in some cases I am paraphrasing because I couldn't write quickly enough.)
How to Think About Investing
"The first investment primer was written by Aesop in 600 B.C. He said, 'A bird in the hand is worth two in the bush.' Aesop forgot to say when you get the two in the bush and what interest rates are; investing is simply figuring out your cash outlay (the bird in the hand) and comparing it to how many birds are in the bush and when you get them."
The Difference Between Growth and Value Stocks
"There is no distinction in our minds between growth and value. Every stock is a value stock to us. The potential growth of the company is simply one factor that we consider." Munger chimed in: "All intelligent investing is value investing."
Sustainable Competitive Advantage
In response to a question about Harvard Business School Professor Michael Porter (my friend and mentor), Buffett said, "I've never read Porter, but know enough about him to know we think alike. He's written that durable, sustainable competitive advantages are the core of any business, and that's exactly the way we think. That is the key to investing. The best way to understand this is to study businesses that have achieved it. Ask yourself why there are no new entrants in the razor blade business. Or study Mrs. B. [the founder of the Nebraska Furniture Mart, which Berkshire Hathaway now owns]."
"We like to own castles with large moats filled with sharks and crocodiles that can fend off marauders -- the millions of people with capital that want to take our capital. We think in terms of moats that are impossible to cross, and tell our managers to widen their moat every year, even if profits do not increase every year. We think almost all of our businesses have big and widening moats."
(For more on what Buffett and Porter have to say about sustainable competitive advantage, see my column on this topic.)
Buying Great Companies to Hold for a Long Time
Munger: "If you buy something because it's undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That's hard. But if you buy a few great companies, then you can sit on your $%@. That's a good thing." Buffett added, "We want to buy stocks to hold forever."
"As Ben Graham said, 'In the short run, the market is a voting machine, but in the long run, it's a weighing machine.' Sooner or later, the amount of cash a business can disgorge will determine its value in the market."
"Think about a company with a market cap of $500 billion. To justify paying this price, you would have to earn $50 billion every year until perpetuity, assuming a 10% discount rate. And if the business doesn't begin this payout for a year, the figure rises to $55 billion annually, and if you wait three years, $66.5 billion. Think about how many businesses today earn $50 billion, or $40 billion, or $30 billion. It would require a rather extraordinary change in profitability to justify that price."
(For more on this topic, see "Valuation Matters.")
The Impact of Technology and the Internet
"For society, the Internet is wonderful, but for capitalists, it will be a net negative. It will increase efficiency, but lots of things increase efficiency without increasing profits. It is way more likely to make American businesses less profitable than more profitable." Munger added, "This is perfectly obvious, but very little understood."
I'm going to have to think about this some more, since I argued in a column last year that the benefits of technology would have a positive impact on companies' return of capital.
Stock Speculation in the High-Tech Sector
"We've seen companies with market caps of tens of billions of dollars that are worthless, and seen other companies that trade at 20-25% of their true value. It eventually gets sorted out. But the speculative mania in one area is not creating equivalent discounts elsewhere. We're not finding businesses at half their real value today. Forty-five years ago, I had lots of ideas and no money. Today, I have a lot of money but no ideas."
"I've seen companies valued at $10 billion that couldn't borrow $100 million. This sort of thing has happened before, but this is the most extreme ever, including the 1920s. In the past year, the ability to monetize shareholder ignorance has never been greater."
Munger added, "It's the most extreme in modern capitalism. In the 1930s, we had the worst depression in 600 years. Today is almost as extreme in the opposite way." Buffett noted, however, "That doesn't mean it's easy to predict the outcome. We can be cautionary, but not find opportunity."
"In time, people will see this era as one of enormous wealth transfer, but the only wealth actually created is by the businesses. Investors as a whole may feel richer, but they're not. It's like a chain letter. The early participants can make a lot of money, but no wealth is created. In fact, due to frictional costs (the cost of the envelope and postage, etc.), wealth is destroyed."
"Anytime there has been a real bubble (uranium, conglomerates, Nebraska farm land in the late 1970s), it has been corrected. But with a huge number of participants with a whole lot of money, the [speculative] game can go on for a long time. We know the game, but it just isn't our game." Munger added, "We use the phrase 'wretched excess' because the consequences are wretched."
Quote of the Day
Charlie Munger, on the benefits that the Internet and technology are providing to society compared to the evils of stock speculation in these sectors: "When you mix raisins and turds, you've still got turds."
Why They Don't Invest in Tech Stocks
"It's no religious thing why we don't invest in technology. It's just that we've never found a company were we think we know what the bush will look like in 10 years and how many birds will be in it. We will never buy anything we don't understand, defined as having a good idea what the business will be in 10 years."
"We understand technology, how businesses can apply it, its benefits, impact on society, etc. It's the predictability of the economics of the situation 10 years out that we don't understand. We would be skeptical that anyone can. I've spent a lot of time with Bill Gates and Andy Grove and they would say the same thing."
"The only way we know how to make money is to buy businesses we understand."
"We are enormously risk-averse. We don't knowingly go into a business where we see significant risk of change." (For more on this topic, see "Why Won't Buffett Invest in Tech Stocks?")
Berkshire Hathaway's Disappointing Performance in 1999
"There's nothing magic about a one-year period. We will have plenty of bad years in the future. It's been a fluke [that we haven't ever had a year in which book value declined]. The capital allocation job I did in 1999 was very, very poor." (I disagree, as I argued in "Warren Buffett's Capital Allocation.")
General Re, GEICO, and Berkshire Hathaway's Insurance Operations
"Gen Re has a terrific record over time. Even if you'd told me what Gen Re's figures would be [before we acquired it], we'd still have done the deal."
"GEICO is a great machine and we have a sensational man, Tony Nicely, running it. It's a very powerful business model. It's not as good a business today as it was three years ago, and it's better today than it will be in three years, but it's still a whole lot better than our competitors' [businesses]."
"Despite the unpleasant surprises, insurance will be a very good business for Berkshire Hathaway over time. It's one of the few that we can really grow. This is a tough industry, however. The average company will do poorly. But we do not have average operations. We have special things that we bring to the party that make us significantly above-average. I think we have a sustainable advantage. The results will not be steady or consistent though."
"There are always dumb competitors. If they misprice the risk, then we'll let them have the business. This is easier for Ajit [Jain, who runs Berkshire Hathaway's super cat insurance operation, National Indemnity] than Gen Re, which has 50-year relationships [that it doesn't want to jeopardize by losing a customer to an underpricing competitor]. Sometimes [writing policies at suboptimal prices] is a necessary evil." Munger added, "Underline evil, not necessary!"
"We have no need, none, to write more business next year than this year. We have no volume goals."
Munger said, "I've been amazed by the growth and cost of our float. It's wonderful to generate billions of dollars of float at a cost way below Treasury notes."
He later said, "Reinsurance is not as much of a commodity business as it might appear. There's such a huge time lag between when the policy is written and when it is paid that the customer has to evaluate the insurer's future willingness and ability to pay. We have a reputational advantage, though it's not as big as it should be."
Berkshire Hathaway's Future Ownership of Stocks vs. Wholly Owned Companies
"Ten years from now, we could be 10% in securities or 60-70%, depending on how the markets develop. I would prefer the former."
Berkshire Hathaway's Culture
Munger: "Our culture is very old-fashioned, like Ben Franklin or Andrew Carnegie. Can you imagine Andrew Carnegie hiring consultants?! It's amazing how well this approach still works. A lot of the businesses we buy are kind of cranky and old-fashioned like us."
What Happens When Buffett's Gone?
"The world will go on. I think you'll have terrific management in place. I've left 99% of my estate in Berkshire Hathaway stock. My successors will not be caretakers. That's the last thing we'd want."
"We did not repurchase any [of our own] shares."
Berkshire Hathaway's Size and Its Drag on Returns
"Given our size, we see a few good things [to invest in]. If we were smaller, then we'd see lots of good things."
Coca Cola and Gillette
"[Our disappointing performance in 1999] was partly because Coca Cola (NYSE: KO) and Gillette (NYSE: G) had bad years. But I would still call Coke's soft drink business and Gillette's razor blade business inevitable. Gillette has 70% (by value) of the world's razor blade business. Through its ownership in Gillette, Berkshire Hathaway has 6% of the world's razor blade business. The statistics for Coke are similar. But while these companies' businesses may be inevitable, the companies are not. Look at Gillette's diversification into inferior product lines. I don't worry about these businesses over time, however."
"American Express (NYSE: AXP) has a strong share of mind for financial stability. We think in terms of share of mind, not share of market. If you have share of mind, share of market will follow. American Express is not inevitable, but its name has huge value and the company, with proper nourishment, will likely do well." Munger added, "It would be easier to screw up American Express than Coke or Gillette, but it's an immensely strong business."
"MidAmerican is relatively well-positioned as a generator. We don't expect to make extraordinary profits, but we think it's a very good business. We're very likely to get a decent return. It's conceivable that we could make a very big acquisition in this space -- in the range of $5 billion. We have the right management to do it." (For more on this, see "A Look at Berkshire's MidAmerican Energy Acquisition.")
"We still own some Disney (NYSE: DIS). It's a terrific business and Eisner's done a terrific job."
The Government's Lawsuit Against Microsoft
Munger said, "Every business tries to turn this year's success into next year's greater success. It's hard for me to see why Microsoft (Nasdaq: MSFT) is sinful to do this. If it's a sin, then I hope all of Berkshire Hathaway's subsidiaries are sinners."
Buffett chimed in, saying that, "Twenty years ago, as a nation, we were depressed because other countries were eating our lunch in steels, autos, electronics, and other industries. But when the information age arrived, U.S. companies such as Microsoft swept the world aside. We've got something that works very well and it probably doesn't make a lot of sense to tinker with it. I would not go in with a meat ax into something that is pulling the country along in a huge way."
Munger had the final word, asking incredulously: "Someone whose salary is paid by U.S. taxpayers is happy to dramatically weaken the one place where we're winning big?!"
Buffett commented on one of the Boring Port's holdings: "Costco (Nasdaq: COST) is an absolutely fabulous organization. We should have bought a lot. Charlie was for it, but I blew it."
Exchange Rates, Interest Rates, and Other Macro Factors
"I'm no good on these macro predictions. The good thing about my economic predictions is that I pay no attention to them whatsoever. We focus on what's important and knowable. Exchange rates and interest rates are not predictable. The way we pick our investments, macro conclusions never enter the discussion."
"There is no logic to regularly paying out 10% or 20% of earnings as dividends."
Future Stock Market Returns
"We don't think the general ownership of equities is likely to be very exciting over the next 10 years." Munger added, "I recommend reading Warren's Fortune article two or three times. We're in for reduced expectations from investing in stocks." (I wrote two articles last year on this article, which you can read by clicking here and here.)
Stern Stewart and EVA
Munger: "I think there's an awful lot of twaddle and bull$%#* on EVA. The whole game is to turn retained earnings into more earnings. EVA has ideas about cost of capital that make no sense. Of course, if a company generates high returns on capital and can maintain this over time, it will do well. But the mental system as a whole does not work."
Julian Robertson's Tiger Fund and George Soros' Quantum Fund
"We don't consider ourselves in remotely the same business as Tiger and Quantum [both of which recently announced that they are closing down]. They are mostly buying and selling securities. We're structured poorly from a tax standpoint to own securities." (Corporations like Berkshire Hathaway pay a 35% tax rate on capital gains compared to 20% on long-term gains realized by private investment partnerships like Tiger and Quantum.) Munger added, "Soros couldn't bear to see others make money in the technology sector without him, and he got killed. It doesn't bother us at all [that others are making money in the tech sector]."
"Philip Fisher's books are classics. I'm a huge admirer of his." (My favorite of Fisher's is Common Stocks and Uncommon Profits. Though written in 1958, its lessons are timeless.) Munger, who is a prolific reader, said he couldn't recommend a single book he'd read in the past year. He said books like Guns, Germs, and Steel, which he recommended at each of the past two annual meetings, don't come along very often.
Common Stocks and Uncommon Profits and Other Writings (Wiley Investment Classics) by Philip A. Fisher
Buy new: $13.57 / Used from: $6.98
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