A while ago a friend of mine sent me a great gift – an electronic file that has all the transcripts of Berkshire Hathaway BRK.ABRK.B’s annual meetings between 1994 and 2018. I was ecstatic when I received the file and became even more so when I found out that there are 3,057 pages of wisdom of Warren Buffett and Charlie Munger.
Evidently a good portion of the transcripts is repetitive questions and answers. Therefore, a project I’m taking on is to take notes on the questions and answers that are more insightful or valuable (not saying the rest is not insightful). Today’s article is a compilation of the questions and answers that I think are the most interesting from the 1994 meeting.
1. Question on why insurance business intrinsic value is well above the book value of the business.
Warren Buffett (Trades, Portfolio): Well, it’s very hard to quantify. But I think that it’s clear that even taking fairly pessimistic assumptions, that the excess of intrinsic value over carrying value is higher, by some margin, for the insurance business. And I think that the table in the report that shows you what our cost to float has been over the years, and also what the trend of float has been over the years, would, unless you thought that table had no validity for the future, I think that table would tend to point you in the right direction of saying the insurance business does have a very significant excess of intrinsic value over carrying value.
It’s very hard to put something on. But – and you don’t want to extrapolate that table out. But I think that table shows that we started with maybe 20 million of float and that we’re up to something close to $3 billion of float. And that float has come to us at a cost that’s extremely attractive, on average, over the years.
2. Question on how to find out what good management is.
Warren Buffett (Trades, Portfolio): Well, I think you should judge management by two yardsticks. One is how well they run the business, and I think you can learn a lot about that by reading about what they’ve accomplished and what their competitors have accomplished, and seeing how they have allocated capital over time.
You have to have some understanding of the hand they were dealt when they themselves got a chance to play the hand.
But if you understand the business, then you simply want to look at how well they have been doing in playing the hand, essentially, that’s been dealt with them.
And the second thing you want to figure out is how well that they treat their owners. And I think you can get a handle of that, oftentimes.
It’s interesting how often the ones that are the poor managers also turn out to be the ones that really don’t think much about the shareholders too. The two often go hand in hand.
And generally speaking, the conclusions I’ve come to about managers have really come about the same way you can make yours. I mean they come about by reading reports rather than any intimate personal knowledge or – and knowing them personally at all.
3. Question on how to look at the usefulness of the product when acquiring a business.
Warren Buffett (Trades, Portfolio): Obviously we look at what the market says is the utility. And the market has voted very heavily for Dexter Shoes, just to be an example.
I don’t know how many pairs of shoes they were turning out back in 1958 or thereabouts, but year after year, people have essentially voted for the utility of that product. There are 750 million or so eight-ounce servings of one product or another from the Coca-Cola Company (KO) consumed every day around the world. And there are those of us who think the utility is very high. Essentially, people are going to get thirsty and if this is the way they take care of their thirst better than other forms, then I would rate the utility high of the product. But I think it’s hard to argue with the market on that. I don’t think we would come to an independent decision that there was some great utility residing in some product that had been available to the public for a long time, but that the public had not endorsed in any way.
4. Question on how to define risk.
Warren Buffett (Trades, Portfolio): Well, we do define risk as the possibility of harm or injury. And in that respect we think it’s inextricably wound up in your time horizon for holding an asset. I mean, if your risk is that you’re going – if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, that is a very risky transaction. Because we think 50% of the time you’re going to suffer some harm or injury.
If you have a time horizon on business, we think the risk of buying something like Coca-Cola at the price we bought it a few years ago is essentially, is close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction. Now, as I pointed out in the annual report, it became very fashionable in the academic world, and then that spilled over into the financial markets, to define risk in terms of volatility, of which beta became a measure. But that is no measure of risk to us.
The risk, in terms of our super-cat business, is not that we lose money in any given year. We know we’re going to lose money in some given day. That is for certain. And we’re extremely likely to lose money in a given year. Our time horizon of writing that business, you know, would be at least a decade. And we think the probability of losing money over a decade is low. So we feel that, in terms of our horizon of investment, that that is not a risky business.
And it’s a whole lot less risky than writing something that’s much more predictable. Interesting thing is that using conventional measures of risk, something whose return varies from year to year between plus-20% and plus-80% is riskier, as defined, than something whose return is 5% a year every year. We just think the financial world has gone haywire in terms of measures of risk. We look at what we do — we are perfectly willing to lose money on a given transaction, arbitrage being an example, any given insurance policy being another example. We are perfectly willing to lose money on any given transaction. We are not willing to enter into transactions in which we think the probability of doing a number of mutually independent events, but of a similar type, has an expectancy of loss. And we hope that we are entering into our transactions where our calculations of those probabilities have validity. And to do so, we try to narrow it down.
There are a whole bunch of things we just won’t do because we don’t think we can write the equation on them. But we, basically, Charlie and I by nature are pretty risk-averse. But we are very willing to enter into transactions — we, if we knew it was an honest coin, and someone wanted to give us seven-to-five or something of the sort on one flip, how much of Berkshire’s net worth would we put on that flip? Well we would — it would sound like a big number to you. It would not be a huge percentage of the net worth, but it would be a significant number. We will do things when probabilities favor us. Charlie?
Charlie Munger (Trades, Portfolio): Yeah, we, I would say we try and think like Fermat and Pascal as if they’d never heard of modern finance theory. I really think that a lot of modern finance theory can only be described as disgusting.
5. Question on whether speed of information has caused Berkshire to miss opportunities.
Warren Buffett (Trades, Portfolio): The speed of information really doesn’t make any difference to us but getting good information does. And it’s the processing and finally coming to some judgment that actually has some utility. And I would say that, virtually everything we’ve done has been reading public reports, and then maybe asking questions around to ascertain trade positions or product strengths or something of that sort.
6. Question on growth rate of a predictable business that Berkshire’s willing to stab at.
Warren Buffett (Trades, Portfolio): If you are going to put a million dollars in a savings account, would you rather have something that paid you 10% a year and never changed, or would you rather have something that paid you 2% a year and increased at 10% a year? Well, you can work out the math to answer those questions.
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