WealthEffect — Berkshire Hathaway Annual Meeting

Berkshire Hathaway Annual Meeting

Berkshire Hathaway Annual Stockholder Meeting
Saturday, April 29, 2000
Transcript by Laura Beal
Finance & Banking Instructor
University of Nebraska at Omaha

For an analysis of the meeting, click here

Valuation

Question: How much do you worry about the market?

Warren Buffett: It gets sorted out eventually. We've seen companies sell for 20-25% of what they're worth and companies that are worthless sell for much more. The market creates wild things. We don't see any straight cases of under-valuation. There's so much money sloshing around, if something is undervalued, it's likely to be bought up.

Charles Munger: The present time is a very unusual period.

WB:

You can have a private business selling for $10 billion where it could not borrow $100 million, but public companies can borrow billions.

CM:

Most extreme time in modern capitalism: this is almost as extreme as the '30s, but in reverse.

WB:

It's not easy to predict the outcome.

I have a question about a company with a P/E ratio of 4 — is this a growth vs. value stock? Also, I know a company that sells recreational vehicles — would this be a good opportunity for Berkshire?

WB:

Every business has worth or value. There is no distinction in our minds between growth and value. The potential for growth and likelihood of good economic growth are part of the valuation process. It's very simple. The first investment primer that I know of was developed in 600 BC by Aesop: "A bird in hand is worth more than two in the bush." This is an investment equation. He forgot to say when the two in the bush would be received and what interest rates were; you have to evaluate when those two birds in the bush will arrive. Investing is a value decision based on interest rates. When we buy a company, we consider the whole enterprise.

CM:

I'd like to know what the name of the company is.

National RV, based in California.

CM:

I agree that all intelligent investing is value investing... If you stick with stocks that are underpriced, you must keep moving or switching them around as they move closer to their true value.

Do you have a P/E ratio cutoff?

WB:

No cutoff whatsoever, no absolutes. In 1976, one of the best buys was GEICO. When the company was losing a lot of money, we thought we saw a future significantly different than the current situation. It would not bother us to buy a company currently losing money. There is no P/E ratio we have in mind; it's the future that's important. We focus on how much cash this business will deliver 20 years out, discounted at a proper rate.

CM:

A great company disguised with terrible numbers is a great investment for us.

Do you think price-to-book value multiple is more effective for valuing intrinsic value of a stock?

WB:

Really wonderful businesses require no book value. Prices of securities are a useful proxy, but not a substitute. In early 1965, our intrinsic value was less than book value. Now our businesses are worth much more. We don't look at book value.

CM:

Obviously correct.

About intrinsic value as defined in annual report: judging risk is as important as calculating net present value. Comments about risk?

WB:

Business risk in terms of 5, 10, 15 years from now that will destroy current conditions is impossible to calculate. We are extremely risk-averse. In terms of doing a group of transactions in insurance, we want a mathematical edge so that over time we're ok. We don't intentionally go into situations where we perceive business conditions are risky.

What kind of moat around the castle of the business is there to protect it? We look for moats around the castle. We think in terms of moats and the impossibility of crossing it — we want it widened every year. If it's too narrow, we leave it alone.

CM:

How could you say it better?

What are your views on EVA [economic value-added] compared to the more traditional valuation methods, such as price-to-earnings, price-to-book value or price-to-sales?

CM:

There's an awful lot of twaddle and b.s. in EVA. The game is to turn retained dollars into more dollars. EVA incorporates a cost of capital that makes no sense. But it's very fashionable now.

Technology

Are we asking too much as shareholders for you men to possibly speculate on technology and electronics?

WB:

We will never buy anything we don't understand. The only way we make money is if we can evaluate it. It's a big mistake to make money on those companies through us — do it through those who know the companies. We look at the businesses, not the stock price, to determine their net worth. We look at it as if there's no quote on the stock.

CM:

If there's someone else down the street that can make more money, don't feel miserable about it. There are worse things in life than being left behind in the possession of great wealth.

WB:

Name a couple. It's just not our game.

I can't imagine you not understanding anything — how can you not understand tech stocks?

WB:

I don't know the economics of it ten years from now; the predictability of the economics of the situation isn't there — we don't know what it will look like... I'd be skeptical of about anyone knowing what it will be like in the future.

With the speculation in high-tech stocks, could you share your views on the fallout and on the economy?

WB:

I don't want to speculate about high-tech. Anytime there have been real bursts of speculation, it gets eventually corrected. The amount of cash [a company] gorges in the future governs the value the stock commands in the market today... In the end, creation comes from the company itself. We can't be richer as a group unless it comes from the company. Similar to chain letters and Ponzi schemes, the manias that periodically take place are called momentum investing. In the end, valuation does count. This happens when there are a huge number of investors — it doesn't go on forever.

CM:

The reason we use the phrase, "wretched excess," is because it produces wretched consequences. It's irrational. If you mix raisins with turds, they're still turds.

WB:

That's why they have me write the annual report.

I know you don't invest in technology companies — are you afraid the Internet will hurt the companies you do invest in?

WB:

We have no religious belief against it, [but] we've never found one we think we know enough about to make a rational decision. You're absolutely right that we should be thinking about the potential threat to our companies. I've talked to publisher Stan Lipsey from the Buffalo News — newspapers are very threatened by the Internet.

Print encyclopedias used to be a great source of information. But it requires chopping down trees, delivery costs, transaction costs. We've seen first hand the business consequences of the Internet on existing businesses. It eliminates delivery costs, raw materials, printing presses.

Now we have the Internet — there are no incremental costs. Newspapers will look very different in the future. All of our businesses will be affected: Coca-Cola not significantly, GEICO will be very affected [but] this might be advantageous. Retailing will be affected, might be an opportunity there.

CM:

He asked if we were afraid. The answer is, "yes."

WB:

We appreciate the short answer, Charlie.

Will the Internet change the low cost of float?

WB:

This will change the insurance industry — it will increase our cost, but our competitive advantage "net net" will not be hurt. Our cost in the future will be higher, but for other reasons than because of the Internet. The Internet, if you analyze it, will reduce profitability, but improve efficiency — and this will increase the monetized value of American business.

CM:

Perfectly obvious, little understood.

WB:

So there.

Berkshire Businesses

How many insurance companies do you own and what [are] the criteria used for selling a business?

WB:

A great number, perhaps twenty. The three biggest are General RE, GEICO and National Indemnity.

The criteria used for selling a company, we have set forth ground rules as written in the annual report. Even though we might be offered a price far above economic value, we don't break off relationships. This actually helps us when we buy businesses. The primacy of loving a business is very important to us when we buy. There will never be a takeover of Berkshire. We won't be selling our operating businesses. We love buying solid businesses we can ride with forever.

CM:

I think you were better off when you had 50 years ahead of you.

WB:

I still do.

Can you describe the activities before and after the Gen Re acquisition? How come the company didn't see it?

WB:

The Unicover situation was discovered in February 1999. There was a $275 million reserve set up when the mistake was discovered. Big mistake, but we've made bigger ones... In insurance, you'll get surprises. We had fraud in Texas, an agent using our paper, National Indemnity. General RE has a terrific [business] — last year was not good.

The ratio of mistakes are fairly equal. I think insurance will turn out to be a good business for Berkshire — we announced another small acquisition last week. The average company will do poorly. Over time, we will acquire... at a cost that's very attractive. One of our surprises worked to our incredible benefit: GEICO made a mistake in early 70's, where it almost went bankrupt — we were able to capitalize on that.

CM:

The most irritating way to lose money is by a lie. I don't think it's likely to happen again.

WB:

Fraud will spring up again; there are crooked people in insurance, people who give others a piece of paper and they give you money. That intrigues people. (You don't even have to give them a Dilly Bar.) It's a field that attracts chicanery. We will get a surprise over a 10-year period [but] we try to minimize it. I think we could screen out the crooks if we could meet everyone face to face.

Regarding the consecutive gains year after year in growth, do you think you could've ended the millenium with a bigger bang?

WB:

There's nothing magical about the numbers. It's a fluke to some degree that we've had no down years. We have to report every year our numbers. The capital allocation job I did in '99 was very poor. Coke and Gillette had poor years. Both companies are selling more units than ever before. The business is inevitable: Gillette has over 70% of the razor blade business in the world; Coke has 50% of the soft-drink business. This economic benefit comes to Berkshire — I don't worry about the businesses.

CM:

It's an interesting stretch, the whole period. [Berkshire has] marketable securities in excess of net worth — the extra liquidity, that advantage has been augmented. Give us reasonable opportunities and we're prepared.

You mentioned love for the business, not the money. I want to hear more about how you pick people.

WB:

I can do it quite well, but I don't know how to tell others how to pick managers — it's very important, very crucial. We tell people we're the Metropolitan Museum of companies. Some people just want to auction off their businesses — we have no interest in being on the other side. We have a good home for these companies that love the business. I can tell what people's motivations are. Any thoughts, Charlie?

CM:

Our culture is very old fashioned: Ben Franklin, Andrew Carnegie. These ideas still work. Can you imagine Andrew Carnegie bringing in a compensation consultant? We don't get imitated much. A lot of our businesses are cranky and grouchy like us. WB: They're sitting out there, Charlie.

CM:

See's Candies has standards and integrity.

WB:

We want management as well as the business.

What justifies Doug Ivester's severance package, considering his short tenure? How did you vote on this — did you support it?

WB:

Yeah, I supported it — I pay more severance pay than anyone in the world. Doug Ivester did wonderful things for Coke. He was a huge asset — he conceived and carried out a lot of things I'm sure others got credit for. The deal was contractually in place when he left. He had devotion and knowledge. He was not the right man at the time when Roberto died; we made a decision within a couple of years that Doug Daft would be better in charge. The Coke shareholders will be many billions of dollars ahead.

CM:

I think it's a mistake for corporate America to create a sense of hostility toward this.

WB:

It's maddening for a CEO to show up with a lawyer with a 20-page contract. CEO compensation is not a market system. We will run Berkshire in a rational manner.

What is your view on American Express — is this a business which is inevitable such as Gillette and Coke?

WB:

The dominance of the business is inevitable. When a company with a wonderful business gets into a mediocre business, the reputation of the mediocre business sometimes spoils the wonderful business. With American Express, the job is to have the product favorable in people's minds. American Express has financial integrity; there's worldwide acceptance of its name. It holds 2/3 of the market while charging more for its product. You have something special in people's minds.

The credit-card business was a defensive move because of the Diner's Club. American Express backed into the credit-card business and started charging more and took business away from Diner's Club. This showed the power of American Express — their dominance prevailed. In 1964, we bought 5% of the company. The company got into other businesses, to some extent, let the Visas of the world get in and erode market share, but it still had the cache.

There will be $300 billion in charges put on American Express this year. I would say, if nourished properly, the American Express name has great value. It tells you something about the company's ability to withstand adversity. An example: AOL signed up more customers even though they had customers mad at them. Coke had problems in Europe, but came back. You see that underlying strength.

We now own 11% of American Express — it's growing very substantially; it becomes more valuable over time.

How do you avoid being average in the newspaper industry?

WB:

The industry is growing — this is terrific for consumers. The Internet accentuates this process. The newspaper industry will try to be a very important information source in a new medium. But the economics might still be bad.

"Average" is poor business, especially in insurance. We do not have average businesses. We have special things we bring to the party to make us better than average. Average is not good and will not go away.

Not buying the Omaha World-Herald?

WB:

That's a fair assumption — they're not selling; it's not offered to me. There's no plus in life owning the World-Herald now.

Can you elaborate on the long-term competitive advantage of Mid-American. Will it be the lowest cost provider of energy?

WB:

It is relatively well positioned; we cannot dramatically change the cost. Dave Sokol has demonstrated ability — his batting average is high. He'll produce more ideas over time. It's a big field, not the jelly bean business. There are a lot of rules in the business. We've got the right management and are very likely to get a decent return.

Are you interested in investing in energy and transportation companies which have environmentally friendly products, such as fuel cells? Would you ever sell Mid-American Energy?

WB:

Those fields are big in terms of capital investment. We are capable of evaluating them; I would consider these. I doubt if technology changes dramatically in the near term, but I believe managers can take advantage of this.

CM:

Historically, we've done well in both fields.

WB:

Look at rail transportation in Value Line: the revenues are not high relative to the capital investment; acquisitions and mergers are the only thing moving the top line. Most fields don't turn out well that require heavy capital — there are a few exceptions.

Could you comment on the investing outline of the book, Buffettology?

WB:

The most representative book is written by Larry Cunningham [The Essays of Warren Buffett]. He's done a very good job at taking annual reports and rearranging them by topic.

The original purchase of Berkshire was a terrible mistake. The textile mill was selling below net working capital. I sort of stumbled upon it, eventually took control by buying more shares.

CM:

Interestingly, a wrong decision made to work out so well — can turn lemons into lemonade.

[Editors Note: As reported by Roger Lowenstein in American Capitalist, the acquisition of the Buffalo News, though not a wrong decision, provided an initial return on investment well below its eventual return.]

WB:

Diversified Retailing, Blue-Chip and Berkshire — started out with 3 disasters and put them together. Don't follow our example of starting out. Start with a good business and build from there.

Economics

A lot of companies seem to be doing better when the dollar is weak and interest rates are low — any comments?

WB:

If we knew what the dollar would do or interest rates would do, we would engage in futures trading directly on currencies and interest rates. It's so much more efficient to pursue currency or interest rate plays — it's more direct than through companies.

In the end, we're more interested in how many people in Japan will drink Coke; we're interested in their purchasing power — we're better at predicting that. Currency moves aren't that important to us. Product acceptance is very important. Vending machines in Japan is something we understand. What's knowable and what's important. More and more people will consume Coke because it's inexpensive relative to the pleasure it brings.

Interest rates and foreign exchange rates won't matter in the short-run. The best time to buy stocks is when interest rates are sky high — it's better to buy equities at that time.

Do you see a deflationary trend in the global economy — any investment advice?

WB:

I'm not good on macro questions; my judgment is no better than yours. In my opinion, we're not going into deflationary times. We don't look into the macro factors — it doesn't enter into discussion. That's the way it will stay.

I've seen bank mergers — to cut costs, they'll cut out the economics department, which I never understood why they had in the first place. It's got nothing to do with running the business. If we ever get an economics department at Berkshire, sell the stock short.

If Alan Greenspan retired and the job was offered to you, would you take it?

WB:

No — in a hurry.

CM:

No — more quickly.

WB:

Our quick answers alone would disqualify us from the job. We can't find a job in public life to entice us. We've got the best job in the world. We should pay to have this job.

In reference to a Fortune Magazine article [regarding] corporate earnings and what people are paying. There is a strong trend in demographics regarding the retirement crisis. What is your opinion on this trend?

WB:

It doesn't mean a thing. The savings rate is not high now. The biggest thing going for nonproductive persons is that the pie is getting bigger. This will make the problem easier — there will be so much more in goods and services produced to take care of the aged. We will need no big boom in savings.

CM:

Stocks are valued in 2 ways: perceived practical utility is one way; the other way is like Rembrandts. It is valued highly. This element is fueled by massive retirement funds — stocks can go high for a long, long time. Nobody expects 3% interest rates to go on for a long time. We can't predict macroeconomic trends.

Miscellaneous

What is the best way to value stock option costs? What about the Black-Scholes model assumptions?

WB:

Companies try to use lowest cost. The most appropriate is to make educated guesses on average option issuance over time. What could the company sell them for in the market? What is their opportunity cost?

One-third of market value strike price for 10-year options is a good proxy for cost — that is what we would look at. I think you'll see a lot of option repricing. (We'll leave the [salary] raises out of this question regarding compensation.) Options subtract value the moment they're granted.

Is option-based compensation attacking the moat around the castle from within?

WB:

We look for a great knight in charge of the castle — how much do they get paid for that? We pay people fairly at Berkshire.

No compensation committee is going to recommend the lower quartile — if there's no bottom half, the median keeps going up; the compensation structure only ratchets up. I was on the compensation committee at Salomon with two other guys. I voted against an increase in compensation. That was the end of it. It's the only one I served on.

It's not so much money as ego. That's understandable: people care about where their name is in relation to others, and their [place] in compensation. I don't know how it will reverse.

CM:

We have an advantage that, to some businesses, we're the only acceptable buyer.

WB:

We try to run Berkshire in a way we find admirable.

Many academics agree that sustainable growth is affected by the threat of new entrants and substitution. How deep is the moat around Moody's?

WB:

Moody's [name] is a strong franchise, stronger than the operating

What are your views on Michael Porter and can you recommend other sources of information?

WB:

I've never read Porter, but have only seen references regarding sustainable competitive advantage. That's exactly what we strive for. What gives you this over time? People, good management — look at Mrs. B and what she did with Nebraska Furniture Mart. We try to spot it where others can't; we focus on that.

CM:

It's hard for me to see how Microsoft is sinful.

Can you share with us your relationship with Bill Gates? How vigorously do you expect him to defend his company against the government? Will it be split into 2 companies? Can you give us an update on your silver position?

WB:

I don't want to speak for Bill [Gates] or Steve Ballmer — I can't tell you anything about Microsoft. I know Bill, met with him several times.

CM:

I happen to be quite sympathetic to the Microsoft side. Regarding silver, it's been a dull ride.

WB:

About Microsoft: twenty years ago, this country had an inferiority complex about how we fit into the economy of the world — we were very depressed. Then the Information Age and technology came along and we just swept the world aside. This contributed to a change in the national mood; that development will fuel much of what occurs in the future. It's difficult to see who #2 is. It doesn't make sense to tinker with the success that's pulling the country along [which] might pull down returns on capital, but make it more efficient.

CM:

Having lost position in radio, stereo and TV to the Japanese, here we have software — and someone in government gets the bright idea to dramatically weaken the thing we're good at?

When would you tell a single mother to exchange her shares of Berkshire for gold?

WB:

I would rather trust good companies run by good management. I'm not excited about gold — I never understood its intrinsic value. (I can sell you some at Borsheim's.) The idea of exchanging a producing asset for a non-producing asset is foreign to me.

CM:

I suppose if she faced conditions similar to a Jew in Vienna in 1939, a transportable good might be useful. Now silver...

You once stated that if you know a person's role model, you can tell a lot about that person. Well, Warren Buffett is my role model — do I have a chance?

WB:

It does pay to have good models — it has a huge impact on children. The initial models are parents. As [you get] older, and pick up more, it influences your behavior, no doubt about it. I tell students to pick out someone they admire and figure out why they can't emulate the same things. Or they can follow Charlie's philosophy and do the reverse, figure out who you don't like and avoid those behaviors.

CM:

There's no reason to look only for living models. If that's all you want, don't limit yourself. Some of the best models have been dead a long time.

Was anyone dumb enough to offer you shares at $45,000?

WB:

We did not repurchase any shares.

What is your philosophy on paying dividends?

WB:

I think we paid 10 cents a share in 1969 — Charlie? We will very likely pay either a large amount or none at all. On a present value basis, if we can keep it and use it to earn more, then it's worth more reinvested, regardless of taxes.

Any given decision is subjective, and it becomes more objective over time when it can be measured. If the situation changes, we will pay dividends. If it's worth only 90 cents kept, but worth $1.00 paid out, we would change. We will never have a conventional dividend policy, where you pay 20, 25, 30 percent of earnings every year. That's nuts. There's no logic to it, other than building up expectations in people's minds.

CM:

What's interesting about our dividend policy is that, in all leading business schools, it wouldn't be taught this way. We're right; they're wrong.

For an analysis of the meeting, click here