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Buffett and Munger on Discount Rates and How They Read Annual Reports

Notes from the June 1993 Outstanding Investor Digest issue

March 12, 2018

As some of you can probably tell, I’ve been going through the old issues of Outstanding Investor Digest lately and have found plenty of gems. Today I read the June 1993 issue and was delighted to find the editor’s notes from the 1993 Berkshire annual meeting, which according to the editor, around 2,200 or so Berkshire shareholders attended. The editor took a great deal of notes. I think what may interest our readers the most are the parts on how Buffett and Munger read annual reports and how they think about discount rates.

On how to read annual reports and proxy statements (they like thick annual reports and think proxy statements):

Buffett: How do we go about reading annual reports and proxy statements? Frist, we read a lot of them. It’s very helpful to read a lot of annual reports and trade publications to get a better fix on certain businesses. A good many I just skim. But if I’m really interested in a company, I probably read every word – although some of the general descriptions lose me a little bit. But we start at the front and read to the back if we’re really interested in it. And we will be interested not only in any business that we own or are thinking of owning, but we’ll be interested in reading their competitors’. I get the Bic annual report. I get the Warner Lambert annual report to read about Schick. I get the PepsiCo annual report. I get the Cott Beverage report. Cott Beverage makes more of the generic colas than anybody – at least in this hemisphere. I want to know what competitors are doing and talking about, what results they are getting and what strategies seem logical to them. So I spend a lot of time reading annual reports.

Proxy statements don’t usually take as much time, but they give you some clues as to the management. They tell you about ownership and give you some other clues. We like think annual reports and thin proxy statements.

Munger: If you just started reading annual reports at random, you wouldn’t learn as much. You have to have some body of theory in your head before you approach such a mass of data.

Buffett: That’s a very good point. Unless you have an investment framework from which you are coming at the report, it will be essentially gibberish. If you are fitting in what you see to find out whether it is in your circle of competency, and whether it’s interesting if it is within it, it becomes a terribly useful document. I’ve learned a lot over the years just reading annual reports. Aside from this general body of knowledge that we may have – this is our main source material in terms of making investments. We don’t buy that many securities. But among the securities we buy, we often have made our decisions just by reading annual reports – not by visiting management. We usually do that afterwards. And some reports have been terribly helpful to us.

On discount rates (it’s no secret that Buffett has explicitly said that long-term government rate is an appropriate rate to use as a discount rate for most assets, but what’s likely less known is the exception to the rule – low-rate environment):

Buffett: And once you’ve estimated future cash inflows and outflows, what interest rate do you use to discount that number back to arrive at a present value? My own feeling is that the long-term government rate is probably the most appropriate figure for most assets. And when Charlie and I felt subjectively that interest rates were on the low side – we’d probably be less inclined to be willing to sign up for that long-term government rate. We might add a point or two just generally. But the logic would drive you to use the long-term government rate. If you do that, there is no difference in economic reality between a stock and a bond. The difference is that the bond may tell you what the future cash flows are going to be in the future – whereas with a stock, you have to estimate it. That’s a harder job, but it’s potentially a much more rewarding job. Logically, if you leave out psychic income,that should be the way you evaluate a farm, an apartment house or whatever. And in a general way, Charlie and I do that.

About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 5.0/5 (14 votes)



Praveen Chawla
Praveen Chawla premium member - 1 year ago

Wonder what he meant by "psychic income"?

Grahamites - 1 year ago    Report SPAM

Praveen - Great question. My guess is that psychic income is basically over optimistically estimated future income. In other words, estimated future income that will nenver be realized.

Rrurban - 1 year ago    Report SPAM

psy·chic in·come



  1. the nonmonetary or nonmaterial satisfactions that accompany an occupation or economic activity.

Ryan Harding
Ryan Harding - 1 year ago    Report SPAM

I read this phrase before and he meant the sort of feel-good return on owning something such as a piece of art or a sports team or a newspaper, which may give someone a sense of importance or a warm feeling, an enhancement to your psyche, even if it isn't lucrative financially.

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

Interesting on discount rates - basically a moving absolute hurdle with a floor.

BTW, are these old OID copies available publicly? Thanks Grahamites!

Extramiler - 1 year ago    Report SPAM

I think he means the satisfaction of being an owner, or the prestige, etc. outside of monetary considerations. For example owning a pro sports team or a newspaper (back when that was prestigious), or a farm if you like to be a farmer (like his son apparently Howard apparently does).

Grahamites - 1 year ago    Report SPAM

All - You guys are right. I was wrong in my guess of psychic income. Thanks for the correction.

Stephenbaker - 1 year ago    Report SPAM

Hmmm, I got the feeling he meant income on gains from any future sale of the underlying asset.

Rajeev_agr - 1 year ago    Report SPAM

Any suggestions on how one can get access to old OID?

Luker - 1 year ago    Report SPAM

Hi all,

Personally when I invest in the market I look through things in the lens of corporate bonds. My reasoning is this, a corporate bond has a higher risk of default than a government bond.

This means that a stock and a corporate bond both have a small but real risk of going to zero.

Government bonds on the other hand, assuming that the US government does it's job, have zero; or near zero risk of default barring a global calamity. In this thinking corporate bonds have more a closer risk to the market than government bonds.

With that said, this is a big difference. A corporate bond rate of 4 percent theoretically justifies a PE of 25 (though you could say higher since earnings in general grow over time). An interest rate of 2.5 percent could justifiy PEs of 40. Investing in these low interest rate environments is tricky. This is why one should just follow Buffett's advice continue to try to find great companies at a reasonable price.

Looking to see if anyone else has a different opinion and can present a case for why US Treasuries should be used. I know modern portfolio theory uses zero risk bonds as it's baseline, but as a value investor who is focused more on alpha than beta corporate bonds seem to make more sense.

Jegan17 - 1 year ago    Report SPAM

Where can you get access to old issues of OID?

Mikesplan - 1 year ago    Report SPAM

I love this simple advice which motivates me to just cut away the noise and stay inside of the 10Ks for Cos I'm interested in! Thanks for posting.

Praveen - Buffett uses that ironic term to mean the only return is psychic, rather than economic. Ego driven M&A as an example.

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