Question: In a 1987 letter to shareholders, you comment on the type of companies Berkshire (BRK.A, Financial)(BRK.B, Financial) likes to buy. Today the company has changed the strategy. Now it invests in companies with tons of capital expenditures and lower returns on equity. Why?
Buffett: The ideal business is the kind that takes no capital and grows. We own some. It does hurt us in terms of compounding earnings growth.
Charlie: When circumstances change we change our minds. We are working with $1 billion as well.
Buffett: The alternative would be to go back to investing very small sums of money.
On the price of crude oil
Question: Over the past year we’ve learned that Berkshire’s results are more influenced by oil markets than I previously appreciated. Revenues at the railway company and some of Berkshire’s manufacturing businesses were negatively impacted, and arguably low gas prices hurt Geico’s loss ratio. Yet earlier this year, Berkshire invested in Phillips 66 (PSX, Financial), Kinder Morgan (KMI, Financial) and even Precision Castparts, which has revenues associated with the oil and gas industries. And I know Berkshire wouldn’t make a bet on a commodity like oil, but is Berkshire making a statement about the long-term outlook for oil?Â
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Buffett: No, we haven’t the faintest idea what the long term price of oil was. And there’s always a better system available. You can actually buy oil for delivery a year from now or two years from now or three years from now. We actually did that, Charlie, didn’t we a few years back?
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Munger: We did it too soon too.Ă‚
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Buffett: We made some money, but we could have made a lot more money. But we don’t think we can predict commodity prices. We don’t hedge cocoa or sugar at any rate. We do some forward buying of chocolate coating or something. But basically we are not two fellows who think we can predict the price of soybeans or corn or oil or anything else. So anything you have seen in our investment transactions — some of the securities you mention there were bought by Todd or Ted and one was bought by me. But neither they nor I bought those or if we sell them sell them based on commodity price predictions. We don’t know how to do it. And we’re thinking about other things when we make those decisions.Â
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Charlie: I’m even more ignorant than you are.Â
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Buffett: That’s hard to beat.Â
Buffett: A year or so ago, the manager [of Ruane Cunniff] took an unusually large position in Valeant and despite the objection of some people on the board, not only maintained that position but actually increased it after a fair amount of doubt had been expressed by the board about the advisability of doing that. The record like I said to date from when they started is significantly better than average. My understanding is that the manager who made the decision on Valeant it no longer running the operation and that other people at Ruane Cunniff are doing so, and I have every reason to believe —Â I know that they’re very smart, decent people who are good, probably way better than average analysts in terms of Wall Street so I think it was a very unfortunate period when the manager got overly entrenched with a business model which, if you — I watched the Senate hearings a couple of days ago when Sen. Collins and Sen. McCaskill interrogated three people from Valeant and it was not a pretty picture. In my view the business model of Valeant was enormously flawed. It had been touted to us. We had several people who urged us strongly to buy Valeant, wanted us to meet Pearson, but it illustrated a principle that … said many, many years ago: If you’re looking for a manager, find someone who is intelligent, energetic and has integrity. And if they don’t have the last be sure they don’t have the first two. If you have someone who lacks integrity you want them to be dumb and lazy, and if you get an intelligent, energetic guy or woman who is pursuing a course of action that if you put on the front page, would make you very unhappy, you can get in a lot of trouble. It may take a while. But Charlie and I have seen —Â we’re not remotely perfect at this —Â but we’ve seen patterns. Pattern recognition gets very important in evaluating humans and businesses. And the pattern recognition isn’t 100% and none of the patterns exactly repeat themselves, but there are certain things in business and securities markets we’ve seen over and over that frequently have a bad end but frequently look extremely good in the short run.Â
On the price paid for acquisition of Precision CastpartsÂ
Question: On Precision Castparts, you had confidence in the CEO. But what else did you like that made you pay an extraordinarily high multiple?
Munger: In the early days, we used to make wise-ass remarks and we would say we buy a business an idiot can manage because sooner or later an idiot will. We did buy some of those in the early days, when they were available, but it got harder and we had to find a new way of operating. PCP-like businesses require superior management. Gradually we have done more and more of that. It’s simply a lot of work.
Buffett: We won’t be able to find them; they’re more rare. We find three-four like PCP that are forever going to make something important, with contracts that extend over years. It’s very important that you have someone with enough skill running a business, and their reputation among manufacturing is absolutely unparalleled.
On looking back
Question: Looking back, what would have you have done differently in life in search for companies?
Buffett: I’m sitting here eating exactly what I want to eat, doing what I love with people I love to be around. It doesn’t get any better than that.
I did decide my favorite employer was myself early in life. Managed to avoid aggravation of any sort… Charlie and I are blessed in that every day we do something we find fascinating. At 92, I find it as rewarding and socially productive as any period in my life. I’m lucky to be doing it. In my business life, I wouldn’t have started with a textile company.
Munger: Looking back, I don’t regret making more money or owning other businesses, but that I didn’t wise up as fast as I could have. I’m blessed in that too. At 92 I still have a lot of ignorance left to work on.
On reinsurance
Question: Why did Berkshire sell down its holdings in Munich Re while sticking with operations in Berkshire Re? Would you reduce exposure to it if Berkshire didn’t own it?
Buffett: We said that the reinsurance business would not be as profitable in the last 10 years as in the next 10 years… We sold our entire holding of that and Swiss RE (XSWX:SREN). They are fine companies, managed well, we like them. The business of reinsurance is less attractive in the next 10 years in part because of what happened to interest rates. A significant portion of earnings comes from investment of float. But the reinsurance companies are more restricted in what they can do with float because they don’t have the huge capital. Berkshire has more that it can do. It also has earnings power from unrelated insurance areas, so it was not a negative judgment in any way on those two companies or management, but was a mild negative judgment on the reinsurance businesses. The ability at Berkshire to… to a degree, it's flexible to modify its business models and operate in a way that over the years in insurance and reinsurance at Munich Re, Swiss Re, all except for us. They don’t have as many options as how capital gets employed. They will do fine, just not as well in 10 years. I think if we played the same game, we wouldn’t do as well. But we’re more flexible in how we conduct our insurance operations. We have an amount of capital that has come into reinsurance, but it’s not fun running a reinsurance business because we have money coming in and look around for choices to invest and find nowhere to invest with negative interest rates. It’s unattractive but not terrible.
On investing in unhealthy Coca-Cola
Question: With the health problems it causes, why should shareholders be proud to own Coke?
Buffett: I consume 700 calories a day from Coke (KO, Financial), so I’m about one-quarter Coke. But I think if you decide that sugar is something the human race should have, they consume 125 pounds a year. What’s in the calories comes from sugar. I get calories from things that make me feel good when I eat them. That is my sole test. There are over 1.9 billion 8-ounce servings of Coke, and they have a range of products, 1.9 billion of the 693 billion 8-ounce servings per year, except leap year, that’s almost 100 8-ounce per capita for 7 billion people in the world, and it’s been going up since 1986. Find it curious the fact that you eat 3500 calories a day and consume 3500 but any portion of obesity related-illness on Coke you drink. You have the choice of consuming more per day than you use and I make a choice if I have 700 from peanut brittle, I like fudge a lot. I’m a very very happy guy, and I’m serious if you were happy all day you’d live longer as well. So it may be a compensating factor. I wish I had a twin and that twin had eaten properly and we both consumed the same carloies, I know I would be happier. I think Coke is a marvelous product. If you consume many calories something can go wrong with your body at some point. I’m not seeing evidence that convinces me that I’d be a more than average guy if I lived of broccoli. I friend of mine, RJ Miller… the president of Ford Motor Co., had his 100th birthday on March 4. I saw him and RJ told me that 40,000 men in the U.S. live to be 100 or better and 45,000 women. I checked the internet and sure enough, that is the statistic. If you want to improve your longevity prospects, have a sex change. Just a matter of facts, folks.
Munger: I like peanut brittle, but I drink a lot of Coke. People who ask questions like that one make one error: They measure the depths and don’t consider the advantage. Like air travel: because 100 people die a year from aircraft, but it’s worth the risk… it’s immature and stupid.
On choosing stocks
Question about how children should look at companies when every day they see in the media IPOs, short-term stances and the business cycle getting shorter and shorter:
Buffett: You don’t have to really worry what’s going on in IPOs. People win lotteries all the time. You shouldn’t be jealous. If they want to do unsound things, it’s nothing to worry about. All you have to do is worry about what makes sense. When you buy a stock you get yourself in a mental frame of mind that you’re owning a businesses. If you don’t get a quote on it right away, it’s fine. You want to look at stocks as businesses and think about performance as a business. Think about what you pay as if buying a business. Let the rest of the world go its own way. You don’t want to get into a stupid game just because it’s available.
No consultant in the world is going to tell you just buy an S&P fund and hold it for 50 years. So they come in and talk for hours and they always suggest something other than just sitting on your rear end and investing in American businesses at no cost.
Consultants always change their recommendations a little from year to year. So they tweak them from year to year and have lots of charts and power points and recommendation and people that will in turn take their money. The the flow of money from hyperactives while this group that sits here absolutely gets the benefit of American businesses. American businesses have done wonderful and the net return of hiring professional management is a huge minus. Look at the book “Where Are the Customer’s Yachts?” It’s a book we are selling. That lesson is told in that book from 1940. It’s so obvious yet all companies tell you to do something today different from yesterday. Just sit back and let U.S. businesses do it for you.
On share buybacks
Buffett: We will buy at 1.25 times or less. We would do it in a manner where we’re not popping the stock at any given level. It if’s true we will and are eager even from a financial standpoint to buy at that price. It’s like you get a dollar, and you leave it in you almost guarantee to get $1.20. It acts as a backstop. It’s ensuring that no… results in greater returns that if you paid a dollar, you got a dollar. If they leave money in they get $1.20. Not a guarantee. If we run out of ideas, not day by day, but if it really becomes apparent that we can’t use capital that in companies in quantities at which generate returns then at some point the threshold might be moved ups little. I don’t want capital to accumulate so much that it burns a hole in my pocket. Been so full so long it’s something like a full bladder: I might get the urge quick to move yet away. So far it hasn’t happened. If it ever gets to be… billion or something like that, we might have to increase the price. It should be by a.. margin. Intrinsic value can’t be that finely calculated.
Munger: … It’s common to buy back stock at high prices. It’s fashionable.
Buffett: They’re being sold no it by advisers. Imagine someone saying we’re going to go out and buy a business. And they don’t attach some kind of metric. They should say we’re going to buy back stock and it’s not even advantageous to buy it back. It’s nothing to do with preventing dilution. Dilution is a negative. Buying at too high a price is another negative It has to be related to valuation.
Munger: It’s like the Episcopal prayer: Thank you that we’re not like these other religions who are inferior.
On Precision Castparts
Question: Buffett hasn’t discussed [Precision Castparts'] performance since the acquisition five years ago. How has it done?
Buffett: It’s a very good business. We’re the leader. It has performed almost as anticipated. Other speciality companies have growth but it’s small. It made one large acquisition which was a big mistake. It was in the oil field, specialty chemical area, around the time oil took a nosedive. It was the biggest and should not have been made. We still have fundamental earning power of the additive company, but it’s not a growth company.
Question: You are famous for making deals over a day or two or over a handshake. Do you do due diligence yourselves? Others have teams of bankers.
Buffett: We have made plenty of mistakes in acquisitions. The mistake is not making a company mistake but always about making improper assessment of industries. Not about the specific labor contract, not a question of patents, not things you can find on a checklist for acquisitions.
What counts is what you’re wrong about. What you really have to fix. Whether the industry’s likely to develop or Amazon (AMZN, Financial) is likely to kill them. Due diligence list doesn’t get to the risk we see. We’ve made half a dozen mistakes, but none could be cure by doing more due diligence. They’re cured by us being a little smarter. Assessing whether managers who I hand a billion dollars to, and he hands me a stock certificate, assessing whether he will behave differently in the future than in the past. It’s incredibly important. But no checklist in the world is going to tell us that. If we thought items of due diligence we thought things we were missing on the economic prospects in the future of the future of the business then by all means we would have done those. When we bought See’s, they had probably 150 leases. When we bought Precision Castparts it had 170 plants. There are going to be problems someplace. But it doesn’t determine whether a $32 billion acquisition will look good 10 years from now. We try to focus on these things.
Munger: Business quality is more than leases. Human quality of the people who are going to stay is very important. How are you going to check that? I don’t know anyone with a record generally better than Berkshire to find the quality of people that lead the business after they thought.
Buffett: Negotiations that drag out have a tendency to blow up. People can get obstinate over very small points .It’s silly, but people get silly sometimes. Human trust comes back to you. The truth is there are bad apples out there. Spotting them doesn’t come from looking at documents. You have to size up whether th person getting a lot of cash from you is going to behave the same way in the future.
On interest rates
Buffett: A bird in the hand is worth about nine-tenths of one in the bush in Europe. If you ask me whether I paid a little more for PCP because of interest rates around 0, the answer is yes. It has an effect. If rates remain that way for a long time, that will have an enormous effect on asset values.
Munger: Nobody really knows much about negative interest rates. We’ve never had them before. We’ve never had states except in the Great Depression. We didn’t have things like very modern nations having all monetary… none of the great economists who have studied this don’t understand it, but we’re doing the best we can.
Buffett: It’s an interest movie to watch and it does modestly affect what we pay for businesses. I don’t know whether anyone expected it to last this long.
Munger: Everyone who’s not confused hasn’t thought about it.
On renewable energy
Buffett: We would not have the renewable generation that we have if it hadn't been for the fact that the building of those projects is subsized by the federal govenrment, because the benefits of reducing carbon emissions are worldwide and therefore it’s deemed proper that the citizenry as a whole should participate in subsidizing the cost of reducing those emissions and that is encourages, in fact it’s allowed, things like have happened in Iowa, but the degree to which the renewables replace primarily coal although there’s plenty of emissions connected to natural gas, will depend on governmental policy and I think it’s been quite sensible in encouraging, having the cost borne by society as a whole as opposed to reduced tax revenues and having the benefits of less CO2 into the atmosphere. They’re not just limited to the people of Iowa; it’s a benefit that accrues to the world. I think you’ll see continued change, it will vary by jurisdiction. We would hope — we’ve got the capital, we’ve got lots of taxes paid in our consolidated returns so we’re in an advantageous position to take advantage of massive investments that companies with limited tax appetites couldn’t handle. But I think you’ll see us be a very big player, but governmental policy is going to be the major player.Â
Charlie: I think we’re doing way more tan our share in shifting to renewable energy, and we’re charging way lower energy energy prices to our utility customers than other people. If the whole rest of the world were behaving as we are, it’d be a much better world.Â
On effect of low crude oil prices
Buffett: Decline in oil is good for consumers and bad for some companies like Lubrizol and others to a degree. Net it should be good for the U.S. overall. We’re a net oil importer. If we have low margins for bananas, it’s good for bananas when prices fall. Oil is big enough and extends to so many areas that it hurts plenty when it falls. It hurts capital value. The consumer gets the benefit, goes to the filling stations every few weeks, it has a small influence. If has a capital value contraction if you project out lower prices for oil for a while. An oil field worth x is suddenly worth one-half of x or no x overnight. There are certain big factors, in terms of our chemical operations, where people just stop ordering. It has a big impact on capital values and have benefits move in over time. But net, the U.S. is better off than Saudi Arabia when prices are lower. Oil is a big part of our economy, but our economy is continuing to make progress overall during the oil price decline. His regions suffer disproportionately.
On humor
Buffett on his sense of humor: It’s the way I see the world. It’s a very interesting and sometimes humorous place. If you see the world accurately it’s bound to be more humorous than predictable.
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