Thank you. When you asked me what I did, in this year’s annual report I tried to describe what I do...
[Told Beemer the Clown story; excerpt from 1990 Berkshire Hathaway annual letter:
Much of the extra value that exists in our businesses has been created by the managers now running them. Charlie and I feel free to brag about this group because we had nothing to do with developing the skills they possess: These superstars just came that way. Our job is merely to identify talented managers and provide an environment in which they can do their stuff. Having done it, they send their cash to headquarters and we face our only other task: the intelligent deployment of these funds.
My own role in operations may best be illustrated by a small tale concerning my granddaughter, Emily, and her fourth birthday party last fall. Attending were other children, adoring relatives, and Beemer the Clown, a local entertainer who includes magic tricks in his act.
Beginning these, Beemer asked Emily to help him by waving a “magic wand” over “the box of wonders.” Green handkerchiefs went into the box, Emily waved the wand, and Beemer removed blue ones. Loose handkerchiefs went in and, upon a magisterial wave by Emily, emerged knotted. After four such transformations, each more amazing than its predecessor, Emily was unable to contain herself. Her face aglow, she exulted: “Gee, I’m really good at this.”
And that sums up my contribution to the performance of Berkshire’s business magicians - the Blumkins, the Friedman family, Mike Goldberg, the Heldmans, Chuck Huggins, Stan Lipsey and Ralph Schey. They deserve your applause.]
We’ve never had a meeting of our managers. The fellow that runs the candy company we bought 19 years ago [See’s Candies], last year came to Omaha because he and his wife wanted to see what the annual meeting was like, but he’d never come to Omaha [before that]. We’ve never had a meeting with his board. We moved the company’s headquarters from Los Angeles to San Francisco because his wife liked living in San Francisco better than Los Angeles. We adapt our operations to the people that run our businesses.
We’ve got a uniform company in Cincinnati, Fechheimers. Does about $100 million. Bought it about five years ago. A fellow read the annual report where I list what I’m looking for. I run an ad in the annual report (I believe in advertising) and this fellow walked in and said “I fit those parameters, and the business does” and we made a deal with him. I’ve never visited Cincinnati. I’ve not seen that plant. It may be a [hoax] – for all I know, he makes up these little reports every five (garbled). But he sends me cash, and I like that.
So it’s a very peculiar operation. I bought a business eight years ago from an 89-year-old woman who started with $500, never put in another dime, and it was making about $12 million before taxes (about $18 million now). She doesn’t know what accruals are, she doesn’t know any of that sort of thing. She got mad at her grandsons, who work at the company, a few years ago, so she quit and went into competition with us. This taught me that the next time I buy a business from an 89-year-old woman, I’m getting a non-compete agreement. This woman now runs another successful business.
She’s a marvelous woman. She walked out of Russia. She landed in Seattle with a tag around her neck. She couldn’t speak a word of English. Fort Dodge, Iowa was where her relatives were. She got to Fort Dodge about 1920 or 1919, and they didn’t have a penny. She brought over seven siblings, as well as her mother and father, and that took her eight or 10 years, sending $50 bucks at a time. She made it selling used clothing. She started this company in 1937 with $500. She was boycotted by most of the suppliers, the main carpet companies in town. They took her into court on violation of fair trade laws. When she got before the judge, Judge Chase, she said “Judge, I paid $3 a yard for this. Brandeis (a carpet store) paid $3 too. They sell it for $6.99. I sell it for $3.99. Tell me how much you want me to rob people. If you tell me to rob them $1 a yard, I’ll charge them $4.99.” The newspaper picks up all this and the judge comes in and buys $1,400 worth of carpet. She beat them in court four times and every time she killed them.
This company is now the largest home furnishings store, by a factor of 2 to 1, over any home furnishings store in the United States. It does $160 million from one location. That one store makes about $18 million pretax. It has a 500,000 square foot warehouse (garbled).
That woman, who got an honorary degree from NYU business school about five or six years ago (garbled). You cannot beat her record. If you tell her this room is 38 by 16, she will tell you how many square yards it is, just like that. And she’s 97. She’ll tell you how many yards it is at $5.99, the extension, and she’ll have the sales tax, and she’ll knock off something if you’re a nice fresh face. And that’s it. She can do it all as fast as I’ve said that. She sold me the business in 30 seconds. She talked to me and told me how much she’d wanted. She’d never had an audit. I didn’t need an audit. Her word was better than the Bank of England.
We make all our deals that way. Our total legal and accounting fees on that deal, which was a $60 million deal, we had to file a 10Q with the SEC, we had to file a Hart-Scott-Rodino filing, our total legal and accounting fee came to $1,400 bucks. All on one page. There’s a mark where her name is. It says “Mrs. B on behalf of herself and her children.” She only owned 20% of the business. She made her mark, and the deal was cut.
All our deals are done like that. We’ve made all our deals, essentially, on the first contact. We never get warranties, we never get anything.
These people are rich, and we have to figure out if they’re the kind of people to keep working after they’ve sold out. We have to decide if they’re working because they love the business, or because they love money. And, if they love money, they’re not of any use to us because I can’t give them enough money after they’ve got all the money [from selling us] their business.
They’ve got to love the business. I would say that if we do anything very well at Berkshire, it’s spotting the kind of people that, after they are very rich, will work even harder. We get no budgets from them. We have one board of directors meeting a year, which follows the shareholders meeting. No one has to come in. All they have to do is run the businesses. And we’ve got a bunch of those now.
They mail me the money – that’s the second part of their job. And it’s my job to allocate capital. They can do whatever makes sense in the candy business, or the newspaper business, but they don’t have to go out and do a bunch of foolish things. We like businesses that generate cash. Sometimes we have something to do with it, sometimes we don’t. We prefer to buy businesses with it but if we can’t buy businesses with it, we buy pieces of businesses called stocks.
Our biggest holdings: we own 7% of the Coca Cola Company, worth about $2 billion. Your Chairman here [referring to the President of Coca Cola, Don Keough, who was also Chairman of Notre Dame’s board] used to live across the street from me in Omaha 30 years ago when he was a salesman for Butternut Coffee. He had six kids, making $200 bucks a week, and starving to death. He was telling at lunch how he went into his boss one day, and told him about the six kids, about the parochial school, paying him $200 bucks a week and “it just ain’t easy pal”, and while he was doing this his boss, Paul Gallagher [the owner of Butternut Coffee], reached into his desk and pulled out a scissors and starting cutting strands off his fraying shirt. He walked away. Fortunately, things have improved some.
We have 7% of Coke. There are 660 million eight ounce servings of Coca Cola products being served around the world today, so in effect, we’ve got a 45 million soft drink business with our 7%. We think of businesses that way. I say to myself “just increase the price a penny and that’s another $450,000 a day for Berkshire.” I mean, it’s a nice sort of thing. When I go to bed at night I figure that by the time I wake up 200 million Cokes will have been consumed. We’ve got some Gillette too, and every night I think about two billion plus men’s hair growing and four billion women’s legs with hair. It goes all night when I sleep.
So we buy businesses I can understand, whether all of them or small parts of them. We never buy anything that I don’t think I can understand. I may be wrong about whether I understand it or not, but we’ve never owned a share of a technology company. There’s all kinds of businesses I don’t understand. I don’t worry about that. Why should I (garbled). You mentioned Cities Service Preferred, I didn’t understand that very well when I bought it. Ever since I met Ben Graham, I was 19, I read his book when I was 18, it made nothing but sense to me. Buy pieces of businesses you can understand when they’re offered to you for quite a bit less than they’re worth. That’s all there is to it. That’s what we try to do with 100% of the business, 7% of the business, or whatever. My partner Charlie Munger and I have been together for about 15 years, and that’s all we do. And we’ll never do anything else.
Mrs. B is that way. I couldn’t have given her $200 million worth of Berkshire Hathaway stock when I bought the business because she doesn’t understand stock. She understands cash. She understands furniture. She understands real estate. She doesn’t understand stocks, so she doesn’t have anything to do with them. If you deal with Mrs. B in what I would call her circle of
competence... She is going to buy 5,000 end tables this afternoon (if the price is right). She is going to buy 20 different carpets in odd lots, and everything else like that [snaps fingers] because she understands carpet. She wouldn’t buy 100 shares of General Motors if it was at 50 cents a share.
I would say that the most important thing in business, and investments, which I regard as the same thing, from our standpoint, is being able to accurately define your circle of competence. It isn’t a question of having the biggest circle of competence. I’ve got friends who are competent in a whole lot bigger area than I am, but they stray outside of it.
In that book Father, Son & Co. [subtitle: My Life at IBM and Beyond] you may have read, that Tom Watson Junior recently wrote, he quoted his father as saying “I’m no genius. I’m smart in spots but I stay around those spots.” And that’s all there is to it in investments – and business. I always tell the students in business school they’d be better off when they got out of business school to have a punch card with 20 punches on it. And every time they made an investment decision they used up one of those punches, because they aren’t going to get 20 great ideas in their lifetime. They’re going to get five, or three, or sever, and you can get rich off five, or three, or seven. But what you can’t get rich doing is trying to get one every day. The very fact that you have, in effect, an unlimited punch card, because that’s the way the system works, you can change your mind every hour or every minute in this business, and it’s kind of cheap and easy to do because we have markets with a lot of liquidity – you can’t do that if you own farms or [real estate] – and that very availability, that huge liquidity which people prize so much is, for most people, a curse, because it tends to make them want to do more things than they can intelligently do.
If we can do one intelligent thing a year we are ecstatic. You can negotiate us down to one every two or three years without working very hard. That’s all you need. You need very few good ideas in your lifetime. You have to be willing to have the discipline to say, “I’m not going to do something I don’t understand.” Why should I do something I don’t understand? That’s why I find it an advantage to be in Omaha instead of New York. I worked in New York for a few years, and people were coming up to me on the corner and whispering in my ear all the time. I was getting excited all the time. I was a wonderful customer for the brokers.
Let’s talk about what you’re interested in.
[Comment from audience]
That’s a problem. It helps to have the efficient market out there. It’s very nice to have people out there saying, “none of this does any good.” It’s a real advantage to have. I don’t think it’s as strong now, but you really had the revealed truths, for a decade or so, saying it didn’t do any good to think. Investments presumably means businesses too. And once you say investments are all priced efficiently, you presumably have to go on and say businesses are priced efficiently, and you’re just throwing darts all the time. If this group were a bunch of chess players, or a bunch of bridge players, and they were all convinced that it did not pay to think about what to do, you’d have an enormous advantage. We’ve had tens of thousands of students in business schools taught that it’s [a waste of time to think].
You mentioned the five-sigma event; actually it was Bill Sharpe out at Stanford many years ago. My friend Charlie says that “as the record gets longer it’s easier to add a sigma than it is to reevaluate the theory.” Which is sort of true. I think it was Ken Galbraith that said “Economists are most economical about ideas. They make the ones they learn in school last a lifetime.”
[Tape flipped here]
The market generally is pretty efficient. You take the 30 stocks in the Dow and a bunch of very smart minds all looking at them and having the same information and most of the time, not all of the time, they’ll be priced efficiently. So what? You only have to be right a few times. Sometimes it’s very strange things. Sometimes it’s panic (garbled).
In ‘74 you could have bought the Washington Post when the whole company was valued at $80 million. Now at that time the company was debt free, it owned the Washington Post newspaper, it owned Newsweek, it owned the CBS stations in Washington D.C. and Jacksonville, Florida, the ABC station in Miami, the CBS station in Hartford/New Haven, a half interest in 800,000 acres of timberland in Canada, plus a 200,000-ton-a-year mill up there, a third of the International Herald Tribune, and probably some other things I forgot. If you asked any one of thousands of investment analysts or media specialists about how much those properties were worth, they would have said, if they added them up, they would have come up with $400, $500, $600 million.
Bob Woodward one time said to me “tell me how to make some money” back in the ‘70s, before he’d made some money himself on a movie and a book. I said “Bob, it’s very simple. Assign yourself the right story. The problem is you’re letting Bradley assign you all the stories. You go out and interview Jeb Magruder.” I said “Assign yourself a story. The story is: what is the Washington Post Company worth? If Bradley gave you that story to go out and report on, you’d go out and come back in two weeks, and you’d write a story that would make perfectly good sense. You’d find out what a television station sells for, you’d find out what a newspaper sells for, you’d evaluate temperament.” I said “You are perfectly capable of writing that story. It’s much easier than finding out what Bill Casey is thinking about on his deathbed. All you’ve got to do is assign yourself that story.”
“Now, if you come back, and the value you assign the company is $400 million, and the company is selling for $400 million in the market, you still have a story but it doesn’t do you any good financially. But if you come back and say it’s $400 million and it’s selling for $80 million, that screams at you. Either you are saying that the people that are running it are so incompetent that they’re going to blow the $400 million, or you’re saying that they’re crooked and that they’re operating Bob Vesco style. Or, you’ve got a screaming buy when you can buy dollar bills for 20 cents. And, of course, that $400 million, within eight or 10 years, with essentially the same assets, [is now worth] $3 or $4 billion.”
That is not a complicated story. We bought in 1974, from not more than 10 sellers, what was then 9% of the Washington Post Company, based on that valuation. And they were people like Scudder Stevens, and bank trust departments. And if you asked any of the people selling us the
stock what the business was worth, they would have come up with an answer of $400 million. And, incidentally, if it had gone down to $60 or $40 million, the beta would have been higher of course, and it would have therefore been [viewed as] a riskier asset. There is no risk in buying the stock at $80 million. If it sells for $400 [million] steadily, there’s much more risk than if it goes from $400 million to $80 million.
But that’s all there is to business. But now you say “I don’t know how to evaluate the Washington Post.” It isn’t that hard to evaluate the Washington Post. You can look and see what newspapers and television stations sell for. If your fix is $400 and it’s selling for $390, so what? You can’t [invest safely with such a small margin of safety]. If your range is $300 to $500 and it’s selling for $80 you don’t need to be more accurate than that. It’s a business where that happens.
At the time we bought Coca Cola just two years ago, [we ended up buying] 7% of the company. We paid a billion dollars, so we were paying $14 billion, essentially, for the whole thing. You can sit down in five minutes – I mean, everybody here understands Coca Cola. If Philip Morris were to buy Coca Cola that day, they would have paid $30 billion. And they wouldn’t have sold it for that. And you wouldn’t have sold it for that. The company’s actually repurchasing stock at the time. So, in effect, they’re buying for you. They’re buying out your partners, at 50 cents on the dollar or less, which is a magnificent sort of business, and there are no morals to it. It’s an easy business. There’s no doubt about it.
I don’t know a thing now that I didn’t know at 19 when I read that book. For eight year prior to that I was a chartist. I loved all that stuff. I had charts coming out my ears. Then, all of a sudden a fellow explains to me that you don’t need all that, just buy something for less than it’s worth.
[Question from audience]
The world, generally, is treated much more favorably in relation to buying businesses than we are because we’re restricted now to buying big businesses, or pieces of big businesses. And that is a big disadvantage. As Charlie says “there could be worse things.”
You’ll find this interesting. At market, we’ve probably got $7 or $8 billion in equities. In 1970, Berkshire had about $15 million in equities. We owned more securities then than we own now. We do not have it solved by buying more things. Every now and then we find something. In our annual report this year [we disclosed that] we made two large purchases. Each one was $300 or $400 million. Every now and then you’ll get an opportunity. And when they come, they come for 15 minutes [I think that’s what he said]. Some days it’s raining gold. Not very often, but when it is, you’ve got to be out there. And that will happen periodically. It’ll happen, but you can’t make it happen. In the meantime, you let the cash pile up if that’s what happens.
[Question from audience about how many of his investment ideas are pitched to him by others.]
Practically none. The Wall Street Journal is my deal source. There are 1,700 or 1,800 of America’s companies that I’m generally familiar with – a good many of them. And every day
they move around the prices of them. So here’s a business broker’s office if you want to call it that. And sometimes they change them pretty dramatically, like October 19th of ‘87. But they change them dramatically. And that is a great start. Any business that I buy will be measured against the yardstick of that business brokers office in Section C of the Wall Street Journal.
In terms of deals, our standards are such that very few are going to meet it. We are much more likely to find one from an owner, who owns the business himself, who wants to sell it to someone like us, and if they want to sell to someone like us, we’re the only one like us. I can promise them, a) since I control Berkshire, the only one who can double cross them or lie to them is me. If they start with the XYZ company, XYZ can be taken over tomorrow, the directors can get a new strategic [plan] tomorrow, they can have McKinsey come in and tell them to do something different tomorrow. And no one can really make them a promise there like I can make them a promise. I can tell them exactly what will and won’t happen when I make a deal, and to some people that is very important.
It’s important to me with Berkshire. I’ve got a lot of things in my will about (garbled) is better, and all kinds of things. I care where that goes, the same way I care about anything else I’ve spent my lifetime working on. When I run into somebody like that, we’ve got an advantage. To some extent, they know about us, and I’ll hear about them, but not very many. They’re very few. And they’re usually older when it happens. Sometimes they’ve got other members of the family in the business that are inactive and want to take the money out. We’ve arraigned, in three of our businesses, with younger generations to take 18%, or 15%, or 20% of the equity. We can do a lot of things, in terms of meeting objectives, that some owners may [appreciate] although most owners [don’t have complex requirements]. But it is not a question of answering the phone and taking an investment banker’s call.
In terms of marketable securities or new offerings, we’ve never bought anything [that’s been pitched to us by an investment banker or broker]. We don’t pay any attention to investment bankers or brokers. It’s not an efficient use of our time [to read their] reports. We read hundreds and hundreds of annual reports every year. I own 100 shares of everything. I find this much more reliable than asking to be put on a mailing list.
I was reading the Gillette report. I noticed that they’d bought in a bunch of stock. I’d known that before. Their net worth was below zero, which doesn’t make a lot of difference, but I thought it might bother them, with the kind of history the company had. So I saw the name of a director that was a friend of mine, Joe Sisco. I called Joe and said “I don’t know the people up there, but if they’re interested in doing something in the way of financing I would be interested and, if they’re not, I’ll never bother them.” Joe called me back in a couple of days, Coleman Mockler and I got together and we put $600 million in.
We bought Scott Fetzer (World Book, Kirby Vacuum, and all sorts of things). It had been mixed up for about a year and a half, being sort of in play. I’d never met Ralph Schey, never talked to him on the phone, never had any contact with him at all. And I wrote him a letter that said “here’s our annual report. If you’re interested in talking to me we’ll pay cash, our check will clear, it will be a one-page deal. If you’re not interested, I’ll never bother you again, and you’ll never hear again, and throw the letter out.” He called me back, we met in Chicago on a Sunday
and we made a deal that night, [signed the documents the] next week, and that was it.
[Question from audience: What was it about Gillette that appealed to you?]
I can understand (garbled) and shaving, the price flexibility, what I call the moat around the business. The most important thing with me in evaluating businesses is figuring out how big the moat is around the business. I want to know how big the capital is on the inside and then I want to know how big the moat is around it. What you love is big capital and a big moat. Obviously. World Book has a real moat. Kirby has a real moat. You can figure that out if you [studied] the distribution process and everything.
I’ve been in the textile business. We made half of the men’s linings in the United States for 25 years.
[re: Gillette] It was the kind of business we’d put capital into on the right basis.
One of the biggest early things was American Express back in 1962 at the time of the salad oil scam. There was a guy named De Angelis in Bayonne, New Jersey.
American Express had a field warehousing company which was a tiny, tiny, little subsidiary, with $12 [million] in capital. The field warehousing company’s job was to certify that inventories really existed. That was their job. They stuck their name on it, and you could take those certificates that said there was a given amount of whatever there was, and you could borrow against these certificates. Tino De Angelis had this tank farm about 15 miles from lower Manhattan. And the American Express field warehousing company authenticated the existence of salad oil in these tanks. And, at one time, they were authenticating the existence of more salad oil than the Department of Agriculture, in its monthly reports, was saying existed in the United States. But they never told us of that discrepancy. Late in 1962, right at the time Kennedy was assassinated, within a day or two, the thing blew. A couple of New York Stock Exchange firms went broke – Ira Haupt, (garbled), maybe one other – because they lent on these phony certificates.
And American Express, which never even thought of this little field warehousing operation, it was nothing, compared to their money order business, credit card, and travel, all of a sudden, they’ve got this little subsidiary, not the parent company, but the subsidiary, that was on the hook for tens and tens of millions of dollars, and nobody knows how much. And that is the nice thing about fraud (garbled)…
There was one other little wrinkle which was terribly interesting. American Express was not a corporation. It then was the only major publicly traded security that was a joint stock association. As such, the ownership of the company was assessable. If it turned out that the liabilities were greater than the assets, [then] the ownership was assessable. So every trust department in the United States panicked. I remember the Continental Bank held over 5% of the company and all of a sudden not only do they see that the trust accounts were going to have stock worth zero, but it could get assessed. The stock just poured out, of course, and the market got slightly inefficient for a short period of time.
The American Express Company was a unique company to understand. You could look at that credit card and you knew it was a winner. Diner’s Club had been the first, Carte Blanche had come along, but the American Express Card was killing them. They had raised prices every time. Their retention rate was higher. And finally, they raised prices, and Diner’s Club didn’t go along, and their growth far outstripped Diner’s Club even though they were selling at a higher price. So this was a dynamite asset.
The traveler’s check business had 60% of the traveler’s check business in the world while selling their checks at a higher price than the banks, B of A and what was then First National Citibank, which were the two main competitions. So here were two guys, B of A and First National City, undercutting them on price for 60 years and they still had 2/3 of the market. That is a moat around the business. I went out and did a little check to make sure this thing wasn’t affecting them and we bought 5% of the American Express Company for $20 million, which means the whole company was selling for about $150 million at that time. The whole American Express Company, synonymous with financial integrity and money substitutes around the world. When they closed the banks, when Roosevelt closed the banks, he exempted American Express Traveler’s Checks, so they substituted as US currency. It was not a business that should have been selling for $150 million, but everyone was terrified. It was very hard to tell how it would all come out in the end. But, probably, it was going to be between $60 and $100 million, and that was a lot more money back then in ‘62 than it is now. I just took the attitude that they’d declared a dividend of $75 million, sent it out and it got lost. Would that have caused a panic – somebody else gets your dividend but you don’t.
No one would have argued about the value of American Express. They just didn’t want to own it for a while. That’s what you’re buying periodically. They didn’t want to own the Washington Post in ‘74. All you’ve got to do is find one, two or three businesses like that in a lifetime, load up when you do, and not do anything in between. There will be bigger whales in the ocean and they’ll (garbled). There will be more of those as we go along. It’s harder when you’re working with more money, but there’ll always be something.
[Question from audience]
Well, I would say this. If we were working with $25 million – so we could sort of look at the whole universe of stocks – I would guess that you could find 15 or 20 out of three or four thousand that you would find that were A) selling for substantially less than they’re worth, and B) that the intrinsic value of the business was going to grow at a compound rate which was very satisfactory.
You don’t want to buy a dollar bill that’s sitting for 50 cents, and it demands positive capital, and it’s going to be a dollar bill ten years from now. You want a dollar bill that’s going to compound at 12% for [a long time]. And, you want to be around some competent people. Just the same thing as if you went in and bought a Ford dealership in South Bend. The same exact thought processes goes through you mind if some friend called you tonight and said “I’d like you to go into the Ford dealership” or whatever, is exactly the kind of thought as goes through mind about all the other businesses that are in Standard and Poor’s.
When I was 20, I went through Moody’s and Standard and Poor’s page by page – twice – because that is it, that’s the universe. The universe is much smaller now, unfortunately.
I found some strange things when I was 20 years old. I went through Moody’s Bank and Finance Manual, about 1,000 pages. I went through it twice. The first time I went through, I saw a company called Western Insurance Security Company in Fort Scott, Kansas. They owned 92%, at that time, of the Western Casualty and Surety Company. Perfectly sound company. I knew people that represented them in Omaha. Earnings per share $20, stock price $16. (garbled) ... much more than that. I ran ads in the Fort Scott, Kansas paper to try and buy that stock – it had only 300 or 400 shareholders. It was selling at one times earnings, it had a first class [management team]...
[Tape ends here]
... Incidentally, I would say that almost everybody I know in Wall Street has had as many good ideas as I have, they just had a lot of [bad] ideas too. And I’m serious about that. I mean when I bought Western Insurance Security selling at $16 and earning $20 per share, I put half my net worth into it. I checked it out first – I went down to the insurance commission and got out the convention statements, I read Best’s, and I did a lot of things first. But, I mean, my dad wasn’t in it, I’d only had one insurance class at Columbia – but it was not beyond my capabilities to do that, and it isn’t beyond your capabilities.
Now if I had some rare insight about software, or something like that – I would say that, maybe, other people couldn’t do that – or biotechnology, or something. And I’m not saying that every insight that I have is an insight that somebody else could have, but there were all kinds of people that could have understood American Express Company as well as I understood it in ‘62. They may have been...they may have had a different temperament than I did, so that they were paralyzed by fear, or that they wanted the crowd to be with them, or something like that, but I didn’t know anything about credit cards that they didn’t know, or about travelers checks. Those are not hard products to understand. But what I did have was an intense interest and I was willing, when I saw something I wanted to do, to do it. And if I couldn’t see something to do, to not do anything. By far, the most important quality is not how much IQ you’ve got. IQ is not the scarce factor. You need a reasonable amount of intelligence, but the temperament is 90% of it.
That’s why Graham is so important. Graham’s book [The Intelligent Investor] talks about the qualities of temperament you have to bring to the game, and that is the game. Now I can (garbled).
He may not know anything about a Coca Cola, or something of that sort, but that isn’t what makes you the money. What makes you the money is your attitude going in, your attitude toward stock market fluctuations. There’s two chapters in The Intelligent Investor, chapter 8 and chapter 20, they’re more important than everything that’s been written on investments, in my view, before or since. And there’s no specific technical knowledge in those things. It just tells you what frame of mind to be in when you come to the game. And people just don’t get it. But that is not because I’m particularly skillful. And bear in mind that I didn’t have that
(garbled). It’s not like I was Mozart and sat down at five or something. I mean I was churning things, I was computing odd lot statistics, I mean I loved all that stuff because I always liked numbers and playing around with them. It was like baseball averages or something. But what I needed was a philosophical bedrock position from which I could then go out and look at businesses, and probe through that filter, and decide whether that’s [a bargain or not]. And that’s Ben Graham’s contribution. And that’s the game. You don’t have to be that smart. You don’t have to know advanced accounting. It may help if you know something, particularly accounting. But the fact that you don’t know it may restrict your universe some.
[Garbled comment from audience]
It goes back to a debate I was having with Mike Jensen [a proponent of the efficient market theory who famously wrote in 1978 that “there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis”]. [I rebutted the efficient market hypothesis in] The [Super]Investors of Graham and Doddsville. It was an address I gave on the 50th anniversary of Security Analysis. Dave Dodd was there – 90 years old, marvelous guy. And in that room were a half a dozen or more of us who had gone on to study or work, or have some association with Ben Graham. We weren’t all five-sigma types, but we’ve always gotten five-sigma, or three-sigma, or something results. So it isn’t because he had carefully culled us out from all over the country, like the Notre Dame football team. We were there just because we kind of stumbled in. And we listened to the guy and then went out and applied it in different ways – totally different ways. I mean, Walter Schloss [has always] owned hundreds of different stocks. Walter is not a 150 IQ guy. Charlie Munger is. There were all different types of [people] with a common philosophical bond. They did not learn any little secrets of technique – they did not learn any systems.
Everybody wants a system. I mean they come to our annual meeting (garbled) the book guy, or the price/earnings, “do I buy them on Monday?” They all want some [system] that you can run through a computer and simulate it out. I mean I tell ‘em if past performance were the key to it, the Forbes 400 would consist of librarians. Everybody would be looking it up. It doesn’t work that way. They want it to work that way. It would be so nice if it did, but it is not that way. It’s like picking out a basketball team. You look for guys who are seven feet tall, you look for a guy who can stay in school, there are a whole bunch of things. And there are certain things that point you toward getting the best five guys out there on the court. But I can’t give them a formula. I can’t say “here’s a little formula and if you go to Emporia, Kansas and apply this formula without actually seeing the guys play basketball and working with them, you’ll pick up the best basketball team.” You won’t.
[Garbled question from audience]
To me, it’s absolutely fascinating that the teaching of investments has really retrogressed from 40 years ago, and I think it’s probably because the teachers are more skillful. They learn all these huge mathematical techniques and (garbled) and they have so much fun manipulating numbers they’re missing something very simple. And I think they have, on balance (aside: I say this at Stanford or Harvard), sent people off with the wrong message. And I get letters from students about it. I don’t see what the reason for having an investment course is unless you teach people
how to analyze the value of investments. If people thought there was nothing of utility that you could impart on the subject, except for the fact that there is nothing you can do useful, then I don’t understand... And I know it isn’t true because I’ve seen people teach other people how to make unusual returns over a 30- or 40-year T-Note.
Phil Caret wrote a book on investing in 1924. He’s still alive, he’s a shareholder of Berkshire, he’s 92 or 93 years old. He writes me letters that say “I approve of your no dividend policy because when I get older, then I want to start getting dividends.” But Phil Caret has got a record of 70 years. That is a lot of investments and it is a superior investment record. Not done exactly the same as Graham, but it’s the same general approach. Even Keynes came to that view. He started out as a market timer. But in the ‘30s he [changed approaches]. [Keynes later said: “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about.”]
You can’t teach people a formula. You can’t come in at the start of the term, and when they get all through, understand E=MC squared. It’s not like teaching geometry or something.
You shouldn’t buy a stock, in my view, for any other reason than the fact that you think it’s selling for less than it’s worth, considering all the factors about the business.
I used to tell the stock exchange people that before a person bought 100 shares of General Motors they should have to write out on a [piece of paper:] “I’m buying 100 shares of General Motors at X” and multiply that by the number of shares “and therefore General Motors is worth more than $32 billion” or whatever it multiplies out to, “because ... [fill in the reasons]” And if they couldn’t answer that question, their order wouldn’t be accepted.
That test should be applied. I should never buy anything unless I can fill out that piece of paper. I may be wrong, but I would know the answer to that. “I’m buying Coca Cola right now, 660 million shares of stock, a little under $50. The whole company costs me about $32 billion dollars.” Before you buy 100 shares of stock at $48 you ought to be able to answer “I’m paying $32 billion today for the Coca Cola Company because...” [Banging the podium for emphasis.] If you can’t answer that question, you shouldn’t buy it. If you can answer that question, and you do it a few times, you’ll make a lot of money.
[From the audience: “Well, you bought it, how did you answer it?”]
Well, it was only $14 billion. I would say this: “If you added a penny to price of every Coca Cola sold in the world this year, that would add $2 billion to pretax earnings.” Now you tell me whether you think there’s a penny, worldwide, of price flexibility per serving of Coke. Well, the answer is “you know there is.”
When they bought the Coca Cola Company, the Candler family bought it from Pembertons back in 1904 or 1906, they paid $2,000 for the company. If the Pemberton family had reserved a penny a serving royalty a serving, the Coca Cola company would be sending $2 billion to the Pemberton family every year and you wouldn’t even see the difference in the figures. It’s there.
Now that’s not true when I was selling [men’s suit] linings [Berkshire Hathaway’s original business]. I sold men’s suit linings for 20 years. We tried to raise our price a half a cent a yard, and on an 80-cent-a-yard product, people who’d done business with us for 80 years slammed the door in our face. (garbled) ... “but half a cent a yard”... Nobody ever went into a store and said “I’d like to buy a pinstripe suit with a Hathaway lining.” Never. They say “I want a coat” all over the world.
Now in this country, Pepsi is, unfortunately, more or less coexistent with Coke. This is their weakest market. They make more in Japan, with less than half the people and way less per capita usage than they make in the United States. Around the world a guy says “I’ll sell you an unmarked cola a penny cheaper” ... it isn’t going to happen. That is the fastest test.
A couple of fast tests about how good a business is. First question is “how long does the management have to think before they decide to raise prices?” You’re looking at marvelous business when you look in the mirror and say “mirror, mirror on the wall, how much should I charge for Coke this fall?” [And the mirror replies, “More.”] That’s a great business. When you say, like we used to in the textile business, when you get down on your knees, call in all the priests, rabbis, and everyone else, [and say] “just another half cent a yard.” Then you get up and they say “We won’t pay it.” It’s just night and day. I mean, if you walk into a drugstore, and you say “I’d like a Hershey bar” and the man says “I don’t have any Hershey bars, but I’ve got this unmarked chocolate bar, and it’s a nickel cheaper than a Hershey bar” you just go across the street and buy a Hershey bar. That is a good business.
The ability to raise prices – the ability to differentiate yourself in a real way, and a real way means you can charge a different price – that makes a great business.
I’ll try this on the students later: What’s the highest price of a daily newspaper in the United States? [Pause] The highest priced daily newspaper in the United States is the Daily Racing Form. 150,000 copies a day, $2.25 a copy, they go up in 25 cent intervals, and it doesn’t affect circulation at all. Why? There is no substitute. If you go to the track, assuming you’re a forms player, you don’t want “Joe’s Little Green Sheet”, you want The Form. And it doesn’t make any difference what it costs! There is no substitute. And that’s why they’ve got a 65% pretax margin. It doesn’t take a genius to figure it out.
There are products like that, and there are products like sheet steel. And they’re night and day.
[From Audience: You said you only had to have a couple of good ideas, we at Notre Dame had a good one in having you here.] [Applause]
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