Berkshire Hathaway Annual Meeting Notes from a Padawan Learner
Disclaimer: Any omission/commission errors are my own. Any interpretations/comments I have are tagged as (Cmts: within parentheses).
1) Q: While Warren has described the newspaper business as being in terminal decline, how does he expect subscribers to buy the Omaha Herald?
*Buffett: Newspapers suffer from two/three problems:
** They used to be great vehicles of information that catered to a diverse populace and set of interests. However, over time with Internet, no one is interested in checking stocks, game results from the previous day when they can have live results through Google, social networks and other niche sources for free. Also they are expensive to distribute.
** Newspapers are losing the game in being useful to more people. So, what is the most common denominator that would appeal and still have some protection? There is one good news. In a town/city with a sense of community a newspaper reporting on the local issues, local institutions has some value. Checking obituaries and primarily local events is easier over the local newspaper than on the Internet. (Not sure if this is true with mobile access.) This sense of community may not be there in a city like NYC but in Omaha it is okay.
** However, there is another problem. Whatever the newspapers offer, they offer the same thing online for free. So, they compete against themselves and "free" wins.
* Munger: World Book got destroyed by Microsoft (MSFT). However, it is still selling profitably at lower levels. (Cmts: I happened to find the World Books stall at the exhibition hall mostly empty. To me it sounded like both Buffett and Munger were resigned to this terminal decline but still fond of the paper businesses they hold.)
2) On being asked about the effect of Amazon (AMZN) on some of the retail businesses that Berkshire holds (Cmts: Nebraska Furniture Mart was in my mind especially the electronics section)
* Warren: Amazon is a powerhouse and could affect a lot of businesses that do not expect to be affected. Gave examples of Geico being affected by such changes. Initially, Geico did its business through mail before the advent of television when it promptly switched. With Internet, Buffett only expected young people to go for online quotes. However, that was not the case.
* Munger: It is terrible for retailers. He re-emphasized saying it was really terrible for most retailers. Ouch.
(Cmts: I don't really have the exact expression but it sounded very ominous. He seems to expect a lot of destruction in the retail sector. Suddenly brought to my mind the travails of Borders, Best Buy, Circuit city and also the recent move by Target to not sell Kindle from their stores. Looking at the Borders shop on Farnam street on my drive to NFM, it was all the more ominous.)
3) A 26-year-old guy working for private equity asked if he were to start over how would he do it to be successful?
* Warren: Pretty much the same. He suggested that people start as soon as possible with as large a scale as possible to generate sufficient capital. He also suggested maintaining an audited track record.
* With enough capital his favorite way would be to start buying companies and hold forever as he has done. (Cmts: And relax)
4) Both Whitney Tilson and Glen Tongue asked questions (two from the T2). Both questions were about share buybacks and why Berkshire wasn't proactive about it.
4a) Tilson: Warren announced that 1.1x book value is where he would start buying. Warren seems to have placed a floor but by saying that did he put in a ceiling as well? Why not buy shares at 1.5x instead of investing in some other businesses creating value?
4b) Tongue: (Cmts: I do not clearly recall what the question was, but it was something like:) The ratio of price book value has been lowered over time in the market. Why not buy back?
4c) Others: Provide dividends and we prefer that. Or some version of why not buy back stock?
(Cmts: There were so many shareholders — mostly fund managers — who wanted a catalyst for Berkshire stock to go up and their questions reflected the same. In short, I felt Buffet and Munger's answers were not to the point. I had a feeling that they felt conflicted at least a bit about purchasing at any levels above 1.1x and they didn't care much either. The reasoning seemed to be that it is in the nature of markets. However, Munger quipped in the end saying, "If short term performance turns you on, you should not be in the room." Ouch again.)
5) On being asked whether he has changed his opinion on Walmart (WMT) since the Mexico scandal:
* Warren: Walmart may have made mistakes on not having acted fast enough, there may have been slippages, but Buffett still has the same opinion on the fundamental dynamics of Walmart. Walmart has the lowest gross margins leading to the lowest prices. Huge value.
* Munger: Interesting issues. Problems will arise because of size. In an organization with thousands of employees (for instance Berkshire itself) such things are bound to happen. If something is wrong and material, what is important is whether the firm acts promptly.
(Cmts: A large organization primarily will end up reflecting the kind of people that it can recruit from the society in which it operates.)
6) Question on European and American banks.
Both Buffett and Munger believe that American banks are a class apart and above the European ones. Partly because of the way their deposits are received and partly because American banks have cleaned up their balance sheets and are well-capitalized post 2008.
7) Asked about coal and natural gas:
Buffett never believed that the natural gas to oil ratio would be of the order of 1:50. He would have laughed at such suggestions a few years ago. But here we are. Natural gas is a great wealth for the U.S.
Munger was very forthcoming and believes that we should not use up the natural gas especially since it is so cheap. Doesn't believe classical economics is correct or has the right answer for energy needs in this case. His motto: Suffer now, so we can leave the natural gas deposits to future generations. (Cmts: This theme of his repeated again in the post noon Q&A session.) He believes that he is very correct and that during oil boom times, U.S. would have done well to use imported oil to home-sourced ones so now we would be more independent. The conventional idea of energy independence is stupid because it involves exploiting every last barrel that we have and run out of it and eventually be dependent on others. Be dependent first till others run out. So, ours can be saved for the future. (Cmts: This looks like a solution that U.S. could benefit from, but doesn't really help the world.)
8) Will Geico use Telematics for gauging insurance performance? (Cmts: This question was of much interest to me personally working for a company that is interested in M2M communication markets.)
Buffett: Referred to progressive using this method. If proven to be a better predictor of driver behavior then yes. (Cmts: Said something to the effect of using non-intrusive ways of monitoring behavior where the driver is free to drive as he pleases to get good data.) He also said that, though not allowed, credit scores are a good indicator of required insurance premiums.
9) Are there any macro-climate related changes that are affecting the insurance business?
Buffet: It is really hard to separate new trends that have just diverged from the base set of data from a one-time random deviation. They usually use 100-year figures for making decisions. Hard to say.
10) On being asked about solar and wind,
From what I gathered Berkshire has a nice advantage in terms of using the tax credits that come with starting solar and wind projects. Since Berkshire pays significant taxes this is valuable. Other companies have optimized over tax payments and are not incentivized by these programs. Solar and wind depend on government subsidies.
11) Never look at macro (as they have stated before). Focus on individual businesses.
11a) When asked on why $20 billion is a magic number for requirements for Berkshire businesses:
Buffet said there was no magic number but sufficient margin/cushion way beyond what probability models predict (like Fed being bombed and wiped out and other unthinkable things) is needed. (Cmts: Sounded similar to Taleb's admonishment on the uselessness of low-probability estimates especially when there is no scientific way to assign tail probabilities). Also there was sufficient admonishment of VaR and Sigma/Gaussian-based computations. The firms have become smarter and started using skewed distributions/fat tails but the philosophy is flawed. Both Munger and Buffett said the reality in business and economic life has nothing whatsoever to do with nicely measurable sigmas. Buffett doesn't hold business schools as too responsible for economic ills but mentioned that they are teaching a lot of wrong things, while Munger believes that they have committed considerable sin.
Second Half (again in no particular order)
1) On being asked about BYD, Munger said BYD has good future in China and probably in the U.S. through EV fleets. Had a very good opinion about the founder.
2) On being asked about Berkshire starting 2% dividends:
Buffett: Long-term shareholders would do better to sell 2% of their shares than get dividends to raise cash. Why? Buffett has been able to get more than $1 value for every $1 retained and believes that is possible even now. (Cmts: This is the kind of answer that gets me excited for it reveals how a true owner should think.)
Munger: Hopes that evil day never shows up.
3) On being asked whether Buffett would do better than himself from 60 years ago if he had only $1 million:
The answer was an emphatic yes. Munger was quite generous in crediting Buffett as being a continuous learning machine. Continuous learning was needed to get the great returns that Berkshire has achieved over decades and alluded to this as pretty much being the human condition.
4) A 26-year-old San Francisco-based SW firm founder asked about minimizing errors:
Buffett: Don't expose yourself to mistakes that will kill your ability to play tomorrow. Doing anything really big with terrible consequences. He doesn't worry about mistakes that have happened. Going from one mistake to another. Learned one at age 19 (Cmts: Probably referring to introduction to Benjamin Graham's ideas). He has made mistakes about people. He does not go through life sitting and consciously thinking about the mistakes.
Munger: Learning from others' mistakes is the pleasant way to learn. Learn history. Follies in financial histories a good place to start. There are other places to look for follies as well.
5) Is it possible to build barriers to entry in an industry that doesn't have any?
Buffett/Munger: We do not create barriers to entry. We only buy them.
Buffet: Richard Branson introduced Virgin Cola. Hundreds of colas introduced. But none has stayed. Lipitor has been great for Pfizer (PFE) but... Also buying at a huge discount to assets that companies have whose replacement cost is much higher is a huge advantage. He was probably referring to BNSF. (Cmts: Wonder if that is applicable to a company like Level3?)
6) Contributions to Super PAC - No way
7) Buffett/Munger: 4% GDP growth is not possible. One percent growth over the next 20 years is plenty good. With such rate each new generation would have a 25% better standard of living.
8) On compensation policies, keep it simple. Check incentives. Not a complex science. Compensation committees are useless. Buffett is responsible for the compensation of 60 (?) people. He is not over-worked. (Munger had some really bad things to say about such committees that I'll skip.)
9) Does Buffett co-ordinate resource allocation across the various businesses esp (if they have synergies like selling a Clayton home buyer from other retail businesses)?
Buffett: The key dynamic here is the feeling of ownership that he wants his managers to have. Before and after acquisition of a business is simply an exchange of stock certificates and cash. We don't want to dictate/tell the owners/managers the way they should run businesses. It is up to individual managers and Buffett and Munger really want them to act as owners. What makes Buffett tick? (Cmts: Here I heard Daniel Pinkish talk.) Essentially that joy of work and passion cannot be given to a manager but can easily be taken away especially if they feel they are being taken for granted. Similar dynamics in the pay structure for Todd and Ted.
Munger: We are trying to fail at what you want us to succeed in. (Cmts: or something to that effect.)
10) How to value declining businesses?
Munger/Buffett: Don't. It is worth a lot less than a growing business! Buffett said he had been masochistic before buying such businesses. Munger refined it calling it ignorance. (Cmts: Both seem to believe it is a pointless job to figure out what a declining business is worth. One of the filters to save time. Some very prominent phone vendors?)
11) What businesses to avoid?
Buffett: Business we don't understand. Understanding refers to the ability to make reasonable judgments about earnings and competitive position five years hence. If price is crazy, no. Promoted and IPO stocks are not great. It is ridiculous to think that of all the thousands of businesses available, the one that is a bargain or with great returns is one where the seller has the ability to time when it is offered. Just one or two good things once in a while without a big mistake. Will do well.
Munger: Avoid anything where the appraiser is being paid commission. Since he is not working for you, he is not appraising for you. Look at what other smart ones are looking at. Not a bad idea.
12) Google, Apple, IBM
IBM (IBM): Understandable. Buffett: Apple (AAPL) and Google (GOOG) are extraordinary and fantastic companies. Tough to dislodge and probably worth a lot more. But 10 years ago he would not have been able to judge Apple's performance. Same now. So they'll stay away.
Munger: Doesn't understand these companies as well as others. We have reverse of a true edge. So, skip.
13) There was an interesting question on how to value insurance companies:
The key take away I got was it depends on the insurance business. Geico is statistical. They have data on driver performance across ages, demographics, etc. Tony Nicely has done a great job. Past data is good and reliable estimates on cash flow can be made.
But Ajit's business is way different. Things being insured are mostly one time. No cohort of events/outcomes to study/rely on. Each one is unique. Ajit is fantastic at this. This is the only business they have built from scratch and all kudos to Ajit.
14) Both considered questions related to fiscal prudence hard to answer. Keynesian ideas work if there is complete belief in the market about the fiscal virtue of the nation. Otherwise, it won’t. Also, any fiscal deficit is akin to a stimulus, but simply not called so.
There were also other questions on effect of politics on some of the businesses (Buffett: Railroads will have to play the game), on Fannie Mae and Freddie Mac being in conservatorship (Buffett/Munger: Great folly up to 2008, but no choice other than nationalizing) and Berkshire being able to get great deals like GE and Goldman after Buffet is gone (Buffett: Not material to business) etc.
The questions came from a panel of journalists (Andrew Sorkin, Becky Quick and Carol Loomis), a panel of three analysts and from the audience. To me it looked like this meeting had more business and valuation-related discussions because of this structure (based on my reading of Jeff Mathews).
Overall it was a great learning experience. The live presence of the stalwarts on stage added some gravity to what was being taught and what I learned.
I am an engineer working in the Bay Area.