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The Science of Hitting
The Science of Hitting
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Berkshire Hathaway Meeting: 1994 Morning Session

Highlights from the morning session of the 1994 shareholder meeting

June 08, 2020 | About:

In 2018, CNBC launched the Warren Buffett Archive, which they described as “the digital home to the world’s largest video collection of Warren Buffett (Trades, Portfolio)”. The website includes complete video footage from every Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) shareholder meeting since 1994, in addition to video clips from Buffett’s appearances on CNBC dating back to 2005.

Over the next few months, I’m going to share key takeaways from the old meetings. I’m going to select a handful of answers from each session that I think are most interesting and insightful for investors. So, with that behind us, let’s start with the 1994 morning session.

Discount rates and valuation

Early on in the session, Buffett and Charlie Munger (Trades, Portfolio) were asked about the minimum free cash flow yield they would demand in order to invest in a company (stock). Buffett answered (bold added for emphasis):

We could conceivably buy a business - I don’t think we would be likely to - but we could conceivably buy a business that had no current after-tax cash flow - but we would have to think it had a tremendous future. The current figures, particularly in the kind of businesses we buy, tend to be representative, we think, of what’s going to happen in the future. But that would not necessarily have to be the case. You can argue, for example, in buying stocks, we bought Geico at a time when it was losing significant money. We didn’t expect it to continue to lose significant money. But if we think the present value of the future earning power is attractive compared to the purchase price, we would not be overwhelmed by what the first year’s figures.”

He expanded on his answer when asked about discount rates:

“In a world of 7% long-term bond rates, we would certainly want to think we were discounting future after-tax streams of cash at at least a 10% rate. But that will depend on the certainty we feel about the business. The more certain we feel about a business, the closer we are willing to play it. We have to feel pretty certain about any business before we’re interested at all. But there are still degrees of certainty. If we thought we were getting a stream of cash over the next 30 years that we felt extremely certain about, we would use a discount rate that would be somewhat less than one where we thought we might get some surprises in five or 10 years.”

I think the combination of those answers points us in the right direction. In recent decades, Buffett and Munger have primarily invested in businesses where the current figures tend to be representative of what’s going to happen in the future. On the other hand, they’ve been less interested in securities where the valuation assumes (prices in) future improvement in the underlying economics – most likely because they rarely believe they are offered an adequate premium (in terms of expected rates of return) to assume that risk with an acceptable level of certainty. Arguably, this could be considered a matter of preference as opposed to a matter of right or wrong (one approach being better than the other). Thankfully for Berkshire shareholders, they’ve periodically found attractive opportunities in the past that fall within the first bucket.

Management and judgement

Later in the meeting, Buffett and Munger were asked how they determine whether a manager is best-in-class. Buffett spoke about the two factors he focuses on: how well they the business and how well they treat shareholders. But in his response, he also said the following:

“You don’t have to make 100 correct judgments in this business or 50 correct judgments. You only have to make a few. And that’s all we try to do.”

The decision to invest in a company should be dependent upon a handful of key considerations. As it relates to management, I think there’s a corollary to his point that I’ve personally found useful: once you find an honest and able individual, don’t spend your time incessantly questioning them or nitpicking every decision they make. Instead, get out of the way and let them run the business. Buffett discussed this in more detail when asked about identifying and retaining good managers:

“We look at what they do the same way we look at what we do… Before I ran this, I had a partnership. I had a great group of partners. And essentially, I liked to be left alone to do what I did. I like to be judged on the scorecard at the end of the year rather than on every stroke - not second guessed in a way that was inappropriate. I liked to have people who understood the environment in which I was operating. The important thing we do with managers, generally, is to find the .400 hitters and then not tell them how to swing.”

In short, stay focused on the big picture and have realistic expectations. That’s not to suggest irrational or ill-advised decisions should simply be accepted. It’s to say that you should not expect perfection (spoiler alert, it doesn’t exist), particularly if your assessment of others is being made with the benefit of hindsight. With time, even the best manager will make mistakes. The best you can do is to try and find people who, when they do make mistakes, are honestly with themselves and their stakeholders, and quickly move to correct the issue and limit the damage.

Different approaches to investing

Towards the end of the meeting, the dynamic duo were asked about Peter Lynch. At the time, Lynch was the recently retired portfolio manager of the Magellan Fund at Fidelity, which had produced astounding returns under his leadership. Warren said the following about Lynch:

“I like him personally and obviously he has an outstanding record. And he has written two books, which have been bestsellers, about his investment philosophy… There’s certainly a fair amount of overlap. There’s some difference. Peter likes to diversify a lot more than I do. He owns more stocks than the names of companies I can remember. But that’s Peter. And, I’ve said in the past, in investing, that there’s more than one way to get to heaven. There isn’t a true religion in this, but there’s some very useful religions. And Peter’s got one, and I think we’ve got one that’s useful, too. And there is a lot of overlap. But I would not do as well if I tried to do it the way Peter does it, and he probably wouldn’t do as well if he tried to do it exactly the way I’d do it.

Watch the video and decide for yourself, but I do not sense that Buffett is perturbed, jealous or anything of the sort by the fact that Lynch and others have found success in his world (investments) using an approach that does not suit him. That’s an important lesson for the rest of us: it’s foolish to assume others are mistaken or wrong if their approach to investing isn’t exactly the same as our own. While the basic tenants of value investing – buying a business for less than it’s worth – apply across the board to someone like Lynch, that does not mean those truths must be executed identically. As with many things in life, different people bring different skills and preferences to the table, which may influence the way that’s most effective for them as they play the game (in terms of position sizing, turnover, etc.). It’s also foolish to lose sleep over the fact that others are making money in ways that are either uncomfortable or illogical to you. All that matters is finding an approach that suits you (and works over time).

Disclosure: Long Berkshire Hathaway's Class B stock.

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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