Featured in this article are a McDonald's Corporation, The Coca-Cola Company, The Procter & Gamble Company and several of Berkshire Hathaway Inc’s wholly owned subsidiaries that Warren was so kind as to discuss them.
Part 1 can be found here,
Part 2 can be found here
Part 3 can be found here
Q-13: Please talk about diversification in general?
A: If you are not a professional investor and the goal is not to beat the markets, you should massively diversify. This is 99% of all people that invest. Most people should be invested in index funds and not trade.
Only if you are evaluating businesses and bringing effort, intensity and time would diversification be a mistake. And if you do your homework, you should only need 6 “best ideas”. Very few people got rich because of their 7th best idea. Buffett would put 50% in his single best idea (that probably means BRK, KO of WFC from other comments he has made in the past) and thinks that people that really do their homework should have a similar amount of diversification.
Buffett does not diversify in his personal account.
Q-14: How do you differentiate the Coca-Colas of the world form the Proctor and gambles of the world?
A: Proctor and Gamble is a very strong business. Good brands, good distribution system. It has more diversification than Coke. Buffet says that he would be happy to hold Proctor and Gamble if he were told he had to hold it for 20 years. He even lets it slip that Proctor and Gamble is in his top 5 companies (in 1998). He would be happier to be forced to hold Coke for 20 years though, primarily due to pricing power and unit growth. With a billion servings a day (in 1998), Coke only has to raise the price by a penny to make another $10 million. And people will pay it. P&G does not have the same pricing power of Coke. There are some other companies he’d prefer over P&G but there are not 100 of them.
He also talks about his like for Gillette. He sleeps well at night knowing that hair is growing on people’s faces while they sleep. And women have two legs so it is even better with women. Since the MBA talk, Proctor and Gamble has since bought Gillette.
Q-15: Any comments on how to think about McDonalds over 20 years?
A: McDonalds is not a company that people eat at every day. Adults don’t want it that often. McDonalds does not win taste tests with adults. Not kids tough, kids love it. With Coke though, even adults drink it on a daily basis. If people drink 5 today, they’ll drink 5 tomorrow. Buffett emphasizes that Coke is simply a better company.
McDonalds has recently gotten into the pricing and promotion game. A lot of McDonalds is tied into advertising and product deals. If Burger King gets a big Disney deal which McDonalds misses out on, that can be a problem. McDonalds is simply selling more than just their product these days. Happy meals and the toy that comes with them are part of the business. With Coke though, it is simply the product that makes it sell.
Buffet likes products that do not rely on pricing or promotional deals. This is also why he bought Dairy Queen. Dairy Queen, Inc. a wholly-owned subsidiary of Berkshire-Hathaway, Inc.
McDonalds is a terrific business, but not as good as Coke. If you bet on one business in the restaurant arena, it’s not a bad idea. He jokingly says that it is the best restaurant business, aside from Dairy Queen which BRK recently bought. So, as of 1998, Buffett viewed McDonalds as the best publicly traded company to buy.
Q-16: What do you think of the Electric Utility Industry?
A: He doesn’t understand where the industry is going to go with deregulation in the future. He can’t see things out 10 years out. If he can figure out with certainty where things are going, he would invest in electric utilities in the future. But he simply can not figure out who is going to be making the money 10 years from now.
Q-17: Large caps or small caps and why do large caps outperform over the long term?
A: There are several things BRK looks at. He does not care about market cap. He cares about understanding the business, if it has good people running the business and whether or not it sells at a price that is attractive.
If you are investing $100,000 market cap does not matter. Berkshire does not share this luxury however. But even with the size of BRK, he said if another See’s Candy comes by for $25 million, he would buy it.
In terms of large companies, there are a lot of large companies that are returning 20% on invested capital. Buffett is skeptical about how long this can continue.
Q-18: What are your insights on securitization of mortgage debt?
A: Regarding equities and real estate, there is a big problem. Corporations get taxed and the shareholder gets taxed in a business that anyone can easily run on their own with a single tax. Corporations also have overhead, so he’s never been excited about real estate corporations.
But REITS remove the problem with double taxation even though they still have management (an intermediary). If you have $1,000, REITS might be your only option but if you have a million dollars, you are better off owning the real estate on your own. Berkshire has found very little in the real estate field that he likes.
Regarding the valuation of real estate Buffett goes on to say that people get confused and look at real estate incorrectly. Pacific Land Trust in Texas has a couple of million acres and sell each acre for an amount, you can’t price the company based on the amount of land and price per acre. That’s nonsense if you can only sell 1% of the land each year. It’s one thing to think this but if you own the company, you know that you can’t sell all the land at once. Some silly valuations exist because people that don’t know what it is like to run a real estate company are the ones placing prices on them.
Part 5 can be found here.