Highlights from the 2006 Berkshire Hathaway Annual Meeting
by Kaushal B. Majmudar, CFA
Every May, thousands made a pilgrimage to Omaha, Nebraska in America's heartland to attend a meeting that is unique in global business. On Saturday May 6, 2006 this year, Berkshire Hathaway's Chairman and CEO Warren E. Buffett (the second richest man in the world after Bill Gates of Microsoft) and Vice-Chairman Charles T. Munger (his long-time friend and partner) welcomed 24,000 devotees to the Quest Center in downtown Omaha for an event that has been dubbed a "Woodstock for Capitalists."
Attending the Berkshire annual meeting is a transformational experience - those who attend receive priceless lessons in business, investing, and life. Long time shareholders have also profited handsomely a share of Berkshire Hathaway could have been purchased for $70 per share in 1971 and now sells for over $90000 a compound return of more than 23% per year (With characteristic cautiousness, Buffett warns attendees each year that Berkshire's current size virtually guarantees that future price appreciation will not approach the levels of the past).
The meeting attracts attendees from all 50 states and around the world. More than 500 of the attendees this year flew to Omaha from India, Australia, Europe, and other parts of Asia to attend. There were captains of industry in attendance, including Bill Gates (who sits on Berkshire Hathaway's board of directors) and Bob Iger (the CEO of the Walt Disney Company) in attendance. Many of the CEOs and managers of the Berkshire family of companies also attended, including Chuck Higgins of See's Candies, who has turned over the reins at See's to a successor.
The Berkshire meeting is both a social and an educational gathering. Most participants arrive prior to the meeting. While a number of professional investors and investment firms, including The Ridgewood Group, were represented in the audience, the most meaningful participation comes from the tens of thousands of "ordinary" fans who come to ask questions and learn from Buffett and Munger's generous insights and wisdom delivered with their trademark candor and humor.
Most participants arrive the day before, so on the Friday prior to the annual meeting, participants get acclimated to their new surroundings and renew their ties with past attendees and friends. On Saturday morning, the official meeting starts with a humorous hour-long movie and this year's movie did not disappoint. In addition to Buffett and Munger (as well as animated renditions of the duo), the movie included cameo appearances by celebrities and friends like Tiger Woods (with Warren Buffett as his caddy), Bono (the musician and activist during a photo shoot with Bill and Melinda Gates), Jimmy Buffett (the singer who is apparently a distant cousin of Warren's and was an early investor in Berkshire Hathaway stock), Jamie Lee Curtis (the actress playing a skit with Warren and Charlie), Governor Arnold Schwazenneger, Bill Gates (playing himself), and the cast of the Desperate Housewives (Disney's hit Sunday night show).
After the lighthearted movie, Buffett and Munger (who sit on a dais at the front of the arena) field questions from the audience for almost five hours (with a one hour lunch break in between the morning and afternoon). There is no restriction on the subject matter of the questions, so Buffett and Munger display intellectual breadth as they respond to inquiries in fields as wide ranging as terrorism, social security, the financial performance of Berkshire or one or more of its subsidiaries, and advice for students and aspiring investors. Although Buffett just celebrated his 75 birthday, he appeared to be in great health and displayed tremendous energy and mental acuity as he fielded questions with wit and humility.
Some of the highlights of Buffett and Munger's comments on a variety of subjects are included below (Note: The highlights below are personal and subjective recollections of what was said, rather than word for word transcriptions. For this article, we have focused mainly on the more interesting investment or philosophical observations from the meeting. For a more comprehensive account of what was said and transcripts, visit www.valueinvesting.info):
- Munger: It is a wise policy to trumpet your failures and to stay quiet about your successes (in response to a question about commodities, Warren admitted that he had made the mistake of buying a large stake in silver too early and then selling it too early if they still had the stake, they would have made many billions more on the investment)
- Buffett: My desk has three boxes (ed. note: metaphorically speaking), IN, OUT, and TOO HARD. We put a lot of stuff in the TOO HARD basket. It is important to know and stick to your circles of competence and pass on things that don't fit squarely in your areas of expertise (later when a questioner asked about what they thought could be done to improve and fix some of the problems in the $2 trillion health care industry, Munger quipped that that one was definitely in the TOO HARD category).
- Buffett: More than half the companies in America have executive compensation schemes that are grossly unfair to the owners in part because of management overreaching and in part because so many companies now rely on outside "compensation consultants" to set the incentives without proper oversight and accountability by the board of directors. A good compensation scheme should be long-term performance oriented and directly tied to the factors that the managers control (he gave the example that in an oil or energy company, a properly designed compensation system should not pay managers a lot more today because they are earning record profits based on oil prices hitting new highs a factor that has little to do with management's actions but should rather be tied to a long-term metric such as the company's recent average finding costs of oil a variable that is likely to more reflective of management's skill and performance and one that if low will also create significant value to shareholders in the long-term).
- Buffett: The worst of the seven deadly sins must be ENVY, because it makes the person committing the sin suffer more than anyone else (there was much laughter when he quipped that at least GLUTTONY, which he could fault himself with at times, and possibly LUST had some upsides for the sinner).
- Buffett: We don't participate in situations where businesses are being auctioned off to the highest bidder because we like to hear from people who care so much about their businesses that they consider it too important to be auctioned off. I can't recall ever buying a business at an auction. People who won't sell their business like it is a piece of meat and those who care deeply about the home in which their business ends up are the types of people that Berkshire wants to have as partners because it says that they care about their business and their customers and employees. Also, when companies are being auctioned, the investment bankers typically prepare projections that are just plain silly. I'd love to have a bet with the investment bankers running most auctions that the company won't achieve the projections they are selling and I think that would be a good bet most of the time. The calls we get (and like to get) are from people who care about their business and who for tax or family reasons want to sell to us. They want liquidity and a change in ownership structure, but not a change in the operating personality or culture of the company.
- Munger: Warren asked an investment banker how they made money and he replied "Off the top, bottom, the sides and the middle" (laughter)
- Buffett: In preparing our annual report, we strive to tell people what we would want to know if our positions were reversed. I try to tell you everything I would want to know if I had 100% of my net worth in the stock and try not to leave out anything. Also, we try to explain it the way we think about it. The annual report is the report I would be making to Charlie (or he would make to me), if one of us was running the business and the other was inactive.
- Buffett: We succeed by evaluating businesses where we have confidence in making a judgment about how the business will look (generally like it does today) in five years, i.e. businesses where the fundamentals won't really change much. As Tom Watson (of IBM) observed, "I'm no genius, but I am smart in spots and I stay around those spots." Our managers and Charlie and I employ this approach as well.
- Munger: Someone once remarked to me that "You don't seem smart enough to be so good at what you're doing." My explanation was that we know the edge of our competency better than most and that this is a very useful thing. It's not a competency if you don't know the edge of it.
- Buffett: If we were starting out today with an investment partnership like the one we started with 50 years ago, we would be investing in securities around the world and buying the stocks of smaller companies. We wouldn't be buying entire businesses because we would have no reputation and only $1 million. Charlie [Munger] started out in real estate development with only a little capital because with application of brain power and energy, you would magnify the returns in real estate unlike in other sectors. I'd just build it up one foot in front of the other over time. If I had been running a little partnership 3 years ago, I would have been 100% in Korea [Because of the low single digit PE ratios at the time on otherwise decent companies as a result of macro problems/fears].
- Munger: When making investments, you start by finding one really good thing to invest in and then compare everything else with that benchmark because that is your opportunity cost. This is a concept that is learned in basic economics that has not made its way into modern portfolio theory one of the obvious flaws in the theory. I'm not sure that Warren would have actually put 100% of his fund in Korea, but something close to it. You won't usually find a lot of great things to invest in, so you should look for a few things much better than anything else, and then act on those.
- Buffett: It is important in investing to focus on what is IMPORTANT and KNOWABLE. There are many things that are IMPORTANT and UNKNOWABLE and you obviously can't focus on those. If the market does something silly it gives you a chance to take advantage of it, if not just go play bridge and come back the next day. The key (from Ben Graham) is that the market basically just sets prices so it exist to SERVE you, NOT instruct you
- Buffett: You don't have to have a high IQ or be very smart in investing to take advantage of the occasional great opportunities that the market presents to you. But you do have to have the courage of your convictions and the willingness to act when everyone else is TERRIFIED and PARALYZED. The lesson is to strive to follow LOGIC rather than EMOTION some people can do this and others can't. When the opportunities do arise, you have to make sure that you can play out your hand under all conceivable circumstances, if you can and you have the right facts and you let the market serve you (not instruct you), you probably can't miss.
- Buffett: The recent swing in property values has been huge in some markets. In our residential brokerage business, we are seeing a slowdown in almost every market, but most dramatically in the formerly hottest markets. High end properties where there were a lot of people buying for investment and for speculation are doing the worst. When you have someone living in a house as their primary residence, they are likely to stay there and continue making mortgage payments, even if the market price of the house falls, but when investors and speculators are holding a property effectively day traders in real estate then you can see big downward moves when it starts to correct. First, the buying and selling stops. In Miami and surrounding areas, about a year or so ago, there were 3000 condos listed and about 3000 transactions each month. Now, there are 30,000 condo's listed and only 2,000 per month are selling. The supply and demand equation has changed. We've had a really bubble in housing and I would be surprised if there weren't some significant downward adjustments, especially in the high end of the housing market.
- Buffett: Related to the commodities markets today, I have observed that trends in investing and in markets often start out with some fundamental merit such as a legitimate supply and demand imbalance, but that there is usually a point at which speculators take over and begin to dominate the price movements. Speculation usually takes over once the positive price history and upward movement start to become clearer and establish a long enough history which attracts a much wider following. Certain commodity markets like copper and silver might be in such a speculative phase today. If you play during these times (which most people do), you are playing with fire and risking disaster when the party ends. My general advice would be to stay away because "What the wise man does in the beginning, the fool does in the end."
At The Ridgewood Group, we share many of the philosophies and principles of long-term investing and patience that are shared by Buffett. If you are serious about using intelligent investing as a way to secure your financial freedom, it is a great idea to read Buffett's writings and maybe even attend the annual meeting in person. It is an investment in time that will surely pay many personal, intellectual, and perhaps even monetary dividends in the years to come.
Kaushal Majmudar is the Chief Investment Officer of The Ridgewood Group (www.ridgewoodgrp.com), a Short Hills, NJ based money management firm focusing on value-oriented investing. Mr. Majmudar, a Harvard graduate and Charted Financial Analyst, is also a noted expert on the investment techniques of great investors like Warren Buffett, the second richest man in the world. You can learn more about Warren Buffett and Berkshire Hathaway, the topic of this article, by visiting www.valueinvesting.info.