Apple and the Airlines in Buffett and Munger's Own Words

Earlier this year Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) made some big news by announcing huge investments in Apple (AAPL) and the airline stocks.

Since then there has been quite a bit of speculation why Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) made these seemingly controversial decisions (they are controversial because it’s contradictory to what Buffett and Munger said over a few decades).

From my observations and conversations with some smart investors, it is clear to me that Buffett and Munger know a lot about Apple and the airlines, especially Buffett. In fact, I’d bet that he knows more about the airlines than 99% of the investors out there. So instead of speculating, I thought it might be helpful to put together an article on Buffett and Munger’s thoughts on Apple and the airline stocks in their own words. These words only represent a tiny bit of what they actually know about them, but it’s a good starting point.

Here you can find the full transcript of Buffett's interview with CNBC.

Munger on Apple and airlines during the 2017 Daily Journal Corp. (DJCO, Financial) meeting

“The nice thing about the game we’re in is that you can keep learning, and we’re still doing it. Imagine, we’re in the press all of the sudden for airline stocks. What have we said about the airline business? It was a joke; it was such a terrible business. And now if you put all those stocks together, we own one minor airline. We did the same thing on railroads.

“We said railroads were no damn good. There were too many of them; they had truck competition. And we were right; it was a terrible business for about 80 years. Finally they get down to four big railroads, and it was a better business. Something similar is happening in the airline business. On the other hand, this very morning, I sat down in my library with my daughter-in-law, and she showed me a round-trip ticket to Europe. Including taxes, it was like $400 or $500. And I’m like, ‘We’re buying into the airline business?’

“Now it may work out to be a good idea for the same reason that our railroad business turned out to be a good idea, but there’s some chance that it might not. He’s changed, and I think he’s changed when he buys his airlines, and he’s changed when he buys Apple. Think of the hooting we’ve done over the years about high tech – we just don’t understand it. It’s not in our circle of competency. The worst business in the world is airlines. What do we appear in the press with? Apple and a bunch of airlines. I don’t think we’ve gone crazy; I think the answer is we’re adapting reasonably to a business that has gotten very much more difficult. I don’t think we have a cinch in either of those positions. I think we have the odds a little bit in our favor. And if that’s the best advantage we can get, we’ll just have to live on the advantage we can get. I used to say you have to marry the best person that will have you. And I’m afraid that’s a rule of life and you have to get by in life with the best advantage you can get. And things have gotten so difficult in the investment world that we have to be satisfied with the type of advantage that we didn’t used to get. On the other hand, the thing that caused it to be so difficult was we got so enormously rich. That’s not a bad trade off.”

Munger’s comments on the airlines after the 2017 DJCO meeting

Can you talk more about the airlines and what’s changed from a couple decades ago to now?

Munger: Well I don’t know that much about it, but I do know that it’s more concentrated now. There’s no real substitute for it. Isn’t like we have a substitute for air travel. It’s down to relatively few players. In the old days they could always start a new airline. They hire nothing but young people, they pay the pilots less, they don’t have a union. They could just start hitting the prices. They kept ruining the business over and over again. Even now, Southwest is just starting to go to Hawaii, so the vicious competition is continuing, including people doing it for – the government owns these airlines, doing it to show off how strong they are. I don’t regard it as a perfect model, and I don’t think it’s the greatest idea we ever had, it’s just something, considering how pounded they were, and how the world has changed a little, we thought, as I say, we had a little advantage by that particular gamble. It’s not a cinch.

Is there an outlook on oil prices in that investment?

Munger: I don’t think oil prices will make that much difference over the long term. It’s not that if the kerosene doubles over time, I don’t think it matters that much to the airlines. You put 100 people in an airliner and fly somewhere, it’s pretty efficient, and you can do a lot of flights per day. That’s worth a lot of money, the people who take the trip. Not going to be a new airport in Shanghai, you know. A lot of the airports are fixed. A lot of them are out of capacity. It’s obviously better than it was in the past. Whether it’s good enough so it will do well, I don’t know. Also,if it starts working, you get paid in advance for the tickets, so there’s no credit. A lot of people lease the airplanes. You make money; it can pile up pretty rapidly in cash.

When industries like airlines or railroads rationalize and turn around, how do you and Warren know?

Munger:Â We don’t know. It was easy to say with railroads, it was all over and then we went in. In the airlines, it’s not over. It’s a little bit the same story.Years of consolidation and bankruptcies. Three, four, five, six big bankrupts already in the airlines. Anyway, the young men make some contributions. They cause us to think about things we wouldn’t have thought about before. We would not have bought the airlines or the Apple if the young men hadn’t come up with the idea, but once they did, Warren ran with it. It was hard to buy that much airline stock. Doesn’t sound like much airline stock by Berkshire standards, but we had to be a hell of a percentage of the market, and those stocks for a pretty long time. It’s very hard to manage a lot of money.

Buffett’s comments on Apple during an interview with Becky Quick from CNBC

Becky Quick: So you say you're not a technology investor, but you're buying shares of Apple, which is now Berkshire's fifth or maybe even larger than that based on how many that you've put in since then, how many you've bought since Dec. 31. IBM (IBM, Financial) is your third-biggest holding, too?

Buffett: Well, I would say Apple is very, very, very tech-involved, but it's a consumer product to a great extent too. And I mean, it has consumer aspects to it. And one of the great books on investing, which I've touted before, is one that Phil Fisher wrote back around 1960 or thereabouts, called "Common Stocks and Uncommon Profits." It had an effect on me. I went out to meet Phil Fisher after reading the book, I found him in this little office in San Francisco. And I recommend any investor read that book. And it's still in print. And he talks about something called the scuttlebutt method, which made a big impression on me at the time. But I used it a lot, which is essentially going out and finding out as much as you can about how people feel about the products. It's just asking questions, basically. And Apple strikes me as having quite a sticky product and enormously useful product that people would use, and not that I do. Tim Cook's always kidding me about that. But again, it gets down to the future earning power of Apple when you get right down to it. And I think Tim has done a terrific job, I think he's been very intelligent about capital deployment. And I don't know what goes on inside their research labs or anything of the sort. I do know what goes on in their customers' minds because I spend a lot of time talking to them.

Becky Quick: Stock was up after the earnings report.

Buffett: Yeah, yeah. It did jump, and that's why we couldn't buy. We probably would've bought more. But the stock, they tell you every quarter what they expect in sales and in gross margins and they've been pretty accurate on that. So I don't think the fourth quarter, well, in the fourth, fifth – I mean, the December quarter, they're on a fiscal year. I don't think that was that big or should've been that big a surprise. But they've got an extraordinary business. Yeah, there's always people trying to knock you off. And the market system, one of the things it does is, if you've got something good you've got a lot of people who are gunning for you. And you've got some very smart people that are gunning for them.

Becky Quick: Warren, we were talking a little bit about how you came about to this decision and I, you know, I assumed you had people who would go out and do some of these channel checks for you and do some of these things. But you just mentioned to me you've done some of the research yourself right here in this building.

Buffett: Well, I've, yeah, I had learned that from a fellah named Phil Fisher who wrote this great book called "Common Stocks and Uncommon Profits." And he calls it the scuttlebutt method. And Phil was a remarkable guy. And I first used it back in 1963 when American Express (AXP, Financial) had this great salad oil scandal that people were worried about it bankrupting the company. So I went out to restaurants and saw what people were doing with the American Express card, and I went to banks to see what they were doing with travelers' checks and everything. And clearly American Express had lost some money from this scandal, but it hadn't affected their consumer franchise. So I ask people about products all the time. When I take my great-grandchildren to Dairy Queen they bring along friends sometimes. They've all got an iPhone and, you know, I ask them what they do with it and whether they could live without it, and when they trade it in what they're gonna do with it. And of course, I see when they come to the furniture mart that people have this incredible stickiness with the product. I mean, if they bring in an iPhone, they buy a new iPhone. I mean, it just has that quality. It gets built into their lives. Now, that doesn't mean something can't come along that will disrupt it. But the continuity of the product is huge, and the degree to which their lives center around it is huge. And it's a pretty nice, it's a pretty nice franchise to have with a consumer product.

Joe Kernen: You're not worried about the law of large numbers. Because it's the most valuable company in the world right now at something like $720 billion. So you have no problem thinking that it's gonna go, be the first company to go over $1 trillion in market cap?

Buffett: I won't make any prediction of that, Joe. But what I do know is when I take a dozen kids, as I do on Sundays, out to Dairy Queen they're all holding their Apple, they barely can talk to me except if I'm ordering ice cream or something like that. And then I ask them how they live their lives. And the stickiness really is something. I mean, they do build their lives around it, just like you were describing. And the interesting thing is, when they come in to get a new one, they're gonna get, they overwhelmingly get the same product. I mean, they got their photos on it and, I mean, yeah, I know you can make some shifts and all that. But they love it.

Joe Kernen: That's my point. I mean, you see what I mean about the law of large numbers? It will be a $1 trillion company even it's only gotta go up 40% from where it is now. So I mean, I don't think you'd buy it if you thought it was gonna peak at $800 billion.

Buffett: Well, or they could, Joe, which they, you know, they've bought shares quite aggressively. You could have a lot fewer shares outstanding at some time and still do very well on a per share basis. They bought in about 4% of the company last year. And they've been pretty, pretty aggressive on that. So my guess is they've got about 5.25 billion shares out now, but my guess is that 10 years from now they'll have substantially fewer.

Buffett’s comments on airlines during an interview he had with Becky Quick from CNBC

Becky Quick: Walking around with that. Right. All right, let's talk about another thing that you've been buying a lot of, and that is the airlines. We just found out, at least at the end of the year, how much you owned in each of them, and they were pretty significant stakes for the four majors. That would be American (AAL, Financial), Delta (DAL, Financial), United Continental (UAL, Financial) and Southwest (LUV, Financial). At the end of the year we were reporting that you had stakes of about 7%Â to 8.5% for some of these airlines. Where are you now?

Buffett: It's about the same. They may have been tweaked just a shade. They're, again, one of the fellows in the office has essentially one of those positions. While he was building that position he owned a couple of the others, just 'because he wanted to get the money invested and then he was going to shift over. So, but one of them has, he has the American Airlines position and I have the other three.

Becky Quick: All right, let me read a couple of things back to you. In the past you've said things like, "I have an 800 number that I can call if I get the urge to buy an airline stock. 'My name is Warren and I'm an air-aholic,' and then they talk me down." You also said that, "If a capitalist had been present at Kitty Hawk back in the early 1900s he should've shot Orville Wright; he would have saved his progeny money."

Buffett: That's so true. He'd have saved him a lot of money. If you look at the last 30 years you can look it up on the internet, I think there have been almost 100 airline bankruptcies. I mean, that is a lot. So it's true that the airlines had a bad first century. I mean, they're kinda like the Chicago Cubs, you know, everybody has a bad century now and then. And they got that century out of the way, I hope. But it's been a disaster for capital. I mean, it's got glamour to it so you can always get guys to put some money up for an airline. And you can go to the internet and look at 100 of them that failed then, and all of them now that are operating, you know, with the exception, Southwest, I mean, they – they've been through bankruptcy. And I bought into one called U.S. Air. That was my previous investment in the late 1980s. Ed Colodny, who was the CEO, came out here. We had dinner at Garazzo and I gave him $358 million, and it disappeared almost before we finished dinner. I mean, U.S. Air had some favored routes, but Southwest was coming at 'em over time. And I tried to sell that stock at 50 cents on the dollar. It was a preferred stock. Fortunately, I wasn't able to do it, and then they had this blip so we actually made quite a bit of money. I mean, we're one for one on airlines, actually, but not because we were smart. And then it went bankrupt twice afterwards, U.S. Air did. It's part of American Air now.

Becky Quick: So why in the world do you buy back in now? I'm sure that this was a horrible business; what's changed?

Buffett: It's a very tough business because it's got the marginal cost of a seat that is practically nothing. You have these huge fixed costs, and yet if you take one more person on there's virtually no cost to it. So you're very tempted to sell that last seat too cheap, and if you sell the last seat too cheap it becomes the first seat for, in a way, so it has, it has this dynamic to it. And unless the airlines operate in the well over 80% capacity. What kills you is when they really have too many airplanes around. I mean, they do what anybody else does. If they've got too many airplanes around they just think it down to marginal cost, and marginal costs cause you to go broke over time in the airline business. The hope is that they will keep orders in reasonable relationship to potential demand. And lately they've been operating in the 80s now for awhile. But it's a business you can always mess up.

Becky Quick: You know, Warren, it does occur to me, though, if you're building up such a significant stake in all the major players, is that anything that's, like, monopolistic behavior? Is there any concern to think that you would say something to the airlines to make them make sure that they're not competing on prices quite the same? What would keep somebody from worrying about that?

Buffett: Yeah, I've never met the CEOs of any of the four airlines. I may have met one down in a Texas business Hall of Fame thing, shake his hand. I mean, Herb Kelleher was down there for sure. But I have no communication with them. And index funds own a significant percent of each one. And we'll see how it turns out. I mean, it's the orders that they have now would not look excessive. I mean they usually take options, and they can delay deliveries, and so on. But it can be brutal. And I mean, ever you've got lower cost airlines, you've got startups that can come at them. And historically the pricing has been a very tough game. I do like the fact that they used lots of money to repurchase shares; most of them have these huge tax carry-forwards, too. So they had a lot of cash coming in for awhile. They've used up the carry-forwards in general. But they the idea that you're buying something that had a huge carry tax loss carry-forward is not the best signal in the world. Getting into a wonderful business. But they bought in a lot of stock, I like that. And we'll see how they do. We bought them at lower prices and we're not buying them now. And I don't wanna run out and buy airlines.

Becky Quick: You told us earlier in the program you've put probably $20 billion to work just since around the time of the election because you've liked two areas. One of those areas is Apple, one is the airlines. And we do have a question that came in from a viewer, James Lee, it's T51, folks, who says, "Why do you believe that managements in boom and bust industries like the airlines will act prudently and rationally for a long time?"

Buffett: Well, that's the question. But hey, it's certainly easier to act rationally when you're doing 80% plus loan factors than if it was a lot less. So the big problem if they get too many airplanes around you know, you can be sure that it'll be a lousy business for a while.

Becky Quick: Does that mean that's a number you watch, kind of like the canary in the coal mine – is the loan factor itself?

Buffett:Â Well, you can see what the orders are and all of that and delivery's expected to be. And airline usage will go up over time. You know, not necessarily dramatically, but that will increase. So it isn't like demand is ever going to go away. If you get too much supply, you got a problem.

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