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The Science of Hitting
The Science of Hitting
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Berkshire Hathaway Meeting: 1999 Morning Session

Highlights from a past annual meeting

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 (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.

As discussed previously, my goal in this series is to share key takeaways from the meetings. I will select a handful of quotes from each section that I think are most insightful for investors. With that, let's take a look at the 1999 morning session.

Market valuations

Early in the session, Buffett and Charlie Munger were asked about the current state of the stock market. Did they think that it was a good time to invest? Buffett responded:

"Charlie and I don't think about the market. And Ben Graham didn't very much. I think he made a mistake to occasionally try and place a value on it. We look at individual businesses. And we don't think of stocks as little items that wiggle around in the newspaper and that have charts attached to them. We think of them as parts of businesses. And it is true that currently we have great trouble finding businesses that we both like and where we like the management and find them at an attractive price. So, we do not find bargains in this market among the larger companies that are in our universe. That is not a stock market forecast in any way, shape, or form. We have no idea whether the market is going to go up today, or next week, or next month, or next year. We do know that we will only buy things that we think make sense, in terms of the value that we receive for Berkshire. And when we can't find things, the money piles up. When we do find things, we pile in. But I know of no one that has been successful and really made a lot of money predicting the actions of the market itself. I know a lot of people who have done well picking businesses and buying them at sensible prices. And that's what we're hoping to do."

Munger simply replied, "How could you say it any better?"

I think the nuance of this answer is insightful. Specifically, while Buffett and Munger don't spend their time worrying about the overall stock market, they did not that they were having trouble finding businesses that they wanted at attractive prices – and given that the market is nothing more than a collection of many individual businesses, I think that indirectly gives the questioner what he was looking for. The reason why I think Buffett and Munger are reticent to comment on the market directly is because they (rightly) have a sense that the information will be misinterpreted - used as a justification for being bullish or bearish in the short term. That said, I think the message is pretty clear: In May 1999, the two gurus were finding it increasingly difficult to find investment opportunities that met their criteria. Primarily, they were struggling to find equities in their investable universe being offered in public markets a reasonable price.

Wholly-owned businesses or minority interests?

Later in the meeting, Buffett and Munger were asked if they preferred buying wholly-owned businesses as opposed to "nibbling" on minority interests in the stock market.

Buffett said:

"Well, we don't want to nibble, we would like to take big gulps in the stock market from time to time. But we've always wanted to acquire entire businesses. People never seemed to really believe that back when we were buying See's Candy or the Buffalo News or National Indemnity. But that's been our number one preference right along. It's just that we've found that much of the time we could get far for more our money, in terms of wonderful businesses, by buying pieces in the stock market, than we could by negotiated purchase. There may be some movement, in terms of the availability of the two, toward the negotiated purchase, although it's almost impossible to make a wonderful buy in a negotiated purchase. You will never make the kind of buy in a negotiated purchase that you can in a weak stock market. It just isn't going to happen. The person on the other side cares too much. Whereas, in the stock market, in a 1973 or 1974, you were dealing with the marginal seller. And whatever price they establish for the business, you could buy it. I couldn't have bought the entire Washington Post Company for $80 million in 1974. But I could buy 10% of it from a bunch of people who were just operating, based on calculating betas or doing something of the sort. And they were in a terrible market. And it was possible to buy a piece of it on that valuation. You never get that kind of buy in a negotiated purchase. We always are more interested in large negotiated deals than we are in stock purchases. But we are not going to find a way, probably, to use all the money that way. And we occasionally may get chances to put big chunks of money into attractive businesses through the stock market – to buy 5% or 10% of a company, something of that sort."

Munger added, "My guess is over the next five years we'll do some of both. Both the entire businesses and big gulps in the stock market."

Buffett then continued:

"Yeah, I agree with that. We'll keep working at both. We're not finding a lot in either arena. We might be a little more likely to find it in the negotiated business. It won't be any huge bargain. We're not going to get any huge bargain in a negotiated purchase. We are more likely to find what I would call a fair deal there under today's circumstances than we will in the market. But I agree with Charlie. Over the next five years, I think you'll see us do both."

I've written about this in the past, but I don't think its importance can be overstated: the flexibility that Buffett and Munger have at Berkshire to allocate capital is a huge competitive advantage. Berkshire can utilize funds through reinvestment in its current operating businesses, through the acquisition of additional wholly-owned businesses (either bolt-on deals or in new arenas), through minority investments in the stock market or negotiated deals like we saw during the financial crisis, or through the repurchase of its own shares. For most companies, those options are much more limited – and more importantly, the ability of shareholders to trust management to intelligently pursue those avenues is much more limited as well in my opinion. This flexibility is one of the huge advantages that an entity like Berkshire holds over the average company; it's been a major contributor to Berkshire's attractive growth in intrinsic value over the past five decades.

Insurance reputation – "Stronger today than it's ever been"

Towards the end of the session, Buffett and Munger were asked about Berkshire's insurance and reinsurance operations. The questioner quoted Buffett in the 1994 shareholder letter, when he wrote about the assurance that insurers rely upon when they buy reinsurance. As he noted in that year's shareholder letter, "the certainty that Berkshire will be both solvent and liquid after a catastrophe of unthinkable proportions is a major competitive advantage for us." The shareholder wanted to know if that statement was still true five years later. Here's what Buffett said:

"I would say that the reputation is stronger than ever. Berkshire's preeminent position as the reinsurer most certain to pay after any conceivable natural disaster - that reputation is stronger today than it's ever been, and GenRe's reputation is right along with it. I would say the commercial advantage inherent in that reputation is very important. I can't tell you exactly how it rates compared to 1994 but I can tell you that it's important. It tends to be more important when we're reinsuring other very large entities, either primary insurers or large reinsurers, than it is with the smaller company. The smaller company probably focuses on that less. But we are writing, probably this week, a very large cover for a very important reinsurer. I don't think they'd want to buy that from almost anyone else. A couple people maybe. They could decide not to buy it from us because they might not feel they wanted to buy it. But I don't think they would have a list of 10 people from whom they'd buy it. They're too smart for that. Because it's a very high-level cover. And if that is called upon, there will be a number of people whose checks will not clear. Berkshire's check, undoubtedly, will clear. So, the reputation has never been better. The commercial advantage is significant. How much it translates into can vary from year to year. But I think it's a permanent advantage that Berkshire will have. I think five years and 10 years from now, and particularly after there has been a huge super-cat, it will be a great asset to Berkshire to be thought of as, essentially, as I've described it, as Fort Knox. We will pay under any circumstances. And there aren't many people in the insurance or reinsurance business that can truly say that. And when the very big [cat to] cover comes along, we should have very few competitors."

With the benefit of hindsight, I think we can confidently say that Buffett's prediction from 20 years ago came true. As we've seen in recent years in transactions with Lloyds (LSE:LLOY), AIG (NYSE:AIG) and Insurance Australia Group (ASX:IAG), Berkshire's fortress balance sheet can be used as a source of capital flexibility for others when needed (and at the right price). In addition, as Buffett noted in the 2018 shareholder letter that Berkshire is in a position to continue playing offense:

"A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. "The Big One" may come from a traditional source, such as a hurricane or earthquake, or it may be a total surprise involving, say, a cyber-attack having disastrous consequences beyond anything insurers now contemplate. When such a mega catastrophe strikes, we will get our share of the losses and they will be big – very big. Unlike many other insurers, however, we will be looking to add business the next day."

Disclosure: Long Berkshire'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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