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The Science of Hitting
The Science of Hitting
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Berkshire Hathaway Meeting: 1995 Morning Session

Highlights from the morning session of the 1995 shareholder meeting

June 11, 2020 | About:

In 2018, CNBC launched the Warren Buffett (Trades, Portfolio) Archive, “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 (BRK.A, BRK.B) shareholder meeting since 1994, in addition to video clips from Buffett’s appearances on CNBC dating back to 2005.

My goal in this series is to share key takeaways from the meetings. In these articles, I will select a handful of answers that I think are most interesting and insightful for investors. For readers, hopefully this will provide the highlights from each session. With that, let’s look at the 1995 morning session.

Preferred issuance

At the beginning of the meeting, Buffett discussed a shareholder proposal related to authorization of preferred shares. In his explanation for why Berkshire wanted to have this option at their disposal, Buffett said the following:

“It’s an authorization. It’s not a command to issue shares. It’s not a directive. It simply gives the directors of the company the ability, in a situation where it makes sense for the company to issue preferred shares, to do so. Now, when we acquire businesses, sometimes the seller of the business wants cash, sometimes they would like common stock, and it’s certainly possible, as one potential seller did last year, that they want a convertible preferred stock. Now, from our standpoint, as long as the value of the consideration that we give equates, we really don’t care - aside from a question of tax basis we might obtain - but in other economic respects, we don’t care what form of consideration we use, because we will equate the value of cash, versus a straight preferred, versus a convertible preferred, versus common stock, whatever it may be. So, if the worry is that we will do something dumb in issuing the preferred stock, that’s a perfectly valid worry. But you should worry just as much we’ll do something dumb in terms of using cash or common stock. I mean, if we’re going to do something unintelligent, we can do it with a variety of instruments.”

I think this point is one that is often misunderstood by investors. At the end of the day, the currency used in an acquisition – whether stock or cash – is irrelevant. The only thing that matters is the value surrendered to the seller relative to the value gained by the buyer. As Buffett goes on to note, issuing $200 million of preferred to buy a business that’s only worth $150 million would leave shareholders worse off than before. That same logic applies if Berkshire were to issue $200 million of common stock or pay $200 million in cash as well.

Succession planning

Later in the meeting, Warren and Charlie were asked a question that would become a recurring focal point for investors for years to come: "what happens to Berkshire Hathaway when the two of you are no longer with us?" Their answers should provide some comfort for shareholders. Buffett responded:

“Well, I appreciate that question. And the answer is, obviously, we do care enormously about that because, in addition to a lot of other reasons, we both have a very significant percentage of our net worth in Berkshire… Our continuing financial interest will go well beyond our deaths. And in terms of foundations or something like that, it will go to organizations that we care very much about having maximum resources available to. So, we do have some plans. We don’t name names or anything of the sort. It’s not quite as tough as you might think because we have a collection of fabulous businesses. Some of them owned totally, some of them owned in part. And I don’t think razor blade sales or Coca-Cola (KO) sales are going to fall off dramatically the day Charlie or I die. We’ve got some great businesses. And then same is true of the wholly-owned businesses. So, the question is more that of allocating capital in the future… We think we will have some very smart people working on that. And we don’t think it will be the end of the world if they don’t find anything the first year, because the businesses will run very well. We have a big advantage in that, as contrasted to virtually almost every other company, we, now and in the future, are willing - eager - to buy parts of wonderful businesses or all of them. I mean, most investors are limited to buying parts of businesses, and most managers, psychologically, are geared to owning all of something that they can run themselves. It’s like, I think Woody Allen said some years ago: the advantage of being bisexual is it doubles your chances of a date on Saturday night. And we can go either direction, in that respect. And our successors will also.”

Afterwards, Munger added the following:

I think few business operations have ever been constructed to require so little continuing intelligence in corporate headquarters. An idiot who was willing just to sit here would have a very good record long after the present incumbents were dead.”

I wrote about this back in 2013, concluding with the following thoughts that mirror Charlie’s:

“The collection of competitively advantaged business – both wholly owned and public traded entities – that underlie this corporate juggernaut are truly one of a kind, along with the individuals that run them. Berkshire has a bright future, with a culture that will endure.”

After 25 years, shareholders are (thankfully!) still asking Warren and Charlie about Berkshire once they’re no longer with us. Since that time, Berkshire has continued to add wholly-owned businesses like Burlington Northern Santa Fe, Berkshire Hathaway Energy and others. From my perspective, it has never been clearer that Berkshire is well positioned for continued success when it inevitably falls into the hands of new leadership.

Moats and sustainable competitive advantages

Towards the end of the session, Warren and Charlie were asked about their investment process. Specifically, the shareholder wanted to know the attributes that they look for when analyzing a business. Buffett said the following:

“What we’re trying to do is we’re trying to find a business with a wide and long-lasting moat around it, protecting a terrific economic castle with an honest lord in charge of the castle. And in essence, that’s what business is all about… We’re trying to find is a business that, for one reason or another - it can be because it’s the low-cost producer in some area, it can be because it has a natural franchise because of surface capabilities, it could be because of its position in the consumers’ mind, it can be because of a technological advantage, or any kind of reason at all - that has this moat around it. All moats are subject to attack in a capitalistic system - if you’ve got a big castle in there, people are going to be trying to figure out how to get to it. And most moats aren’t worth a damn in capitalism. I mean, that’s the nature of it. And it’s a constructive thing that that’s the case. We are trying to figure out why that castle is still standing. What’s going to keep it standing or cause it not to be standing 5, 10, or 20 years from now? What are the key factors? And how permanent are they? How much do they depend on the genius of the lord in the castle? And then if we feel good about the moat, then we try to figure out whether the lord is going to try to take it all for himself, whether he’s likely to do something stupid with the proceeds, et cetera. But that’s the way we look at businesses."

Next, Munger said:

“I think he wants it translated into the ordinary terms of economics. The honest lord is low agency cost. That’s the word in economics. And the microeconomic business advantages are, by and large, advantages of scale - scale of market dominance, which can be a retailer that just has huge advantages in terms of buying cheaper and enjoying higher sales per square foot. So by and large, you’re talking economies of scale. You can have scale of intelligence. In other words, you can have a lord with enough extra intelligence that he has a big advantage. So, by and large, you’re talking scale advantages and low agency costs."

Buffett then went on to add:

To some extent, Charlie and I try and distinguish between businesses where you have to have been smart once and businesses where you have to stay smart. Retailing is a good case of a business where you have to stay smart. You are under attack all of the time. People are in your store. If you’re doing something successful, they’re in your store the next day trying to figure out what it is about your success that they can transplant and maybe add a little something on in their own situation. So, you cannot coast in retailing. There are other businesses where you only have to be smart once, at least for a very long time. There was once a southern publisher who was doing very well with his newspaper. And someone asked him the secret of his success. And he said monopoly and nepotism. And he wasn’t so dumb. I mean, he didn’t have any illusions about himself. And if you had a big network of television affiliates station 30 years ago, there’s still a major difference between good management and bad management. A major difference. But you could be a terrible manager and make a fortune, basically. Because the one decision to own the network TV affiliate overcame almost any deficiency that existed from that point forward. And that would not be true if you were the first one to come up with some concept in retailing. You would have to be out there defending it every day. Ideally, you want terrific management at a terrific business. And that’s what we look for. But as we pointed out in the past, if you have to choose between the two, get a terrific business.”

Three months after the 1995 shareholder meeting, Berkshire Hathaway announced a $2.3 billion offer to acquire the remaining 49% of GEICO (they already owned the other 51%, a level that had been reached through a combination of open market buys at Berkshire and significant repurchases at GEICO). In Buffett’s eyes, the insurer offered that rare combination of a terrific management team and a terrific business. A quarter century later, with year after year of significant underwriting profits and market share gains (growing from roughly 2% of the U.S. private passenger auto insurance market in the late 1990’s to 13% or 14% today), it’s clear that Buffett and Munger were correct in that assessment. When you get those two things right, with enough time, you can end up with an acquisition price that looks silly in hindsight. GEICO is worth many more multiples of the roughly $4.6 billion price tag that was applied to the business in 1995.

Disclosure: Long BRK.B

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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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