The Return of
by John Price
A friend told me that on a recent exam she
was asked to explain why Warren Buffett says that diversification
is a protection against ignorance and that it makes very
little sense for those who know what they are doing. Based
on a discussion she had with a stock analyst a few days
prior to the exam, she answered roughly as follows. Buffett
could buy in such large amounts and had such a following
that what ever he bought would go up in price. Then he would
sell and take a huge profit. What grade would you give that
None of the 11,000 people crowding into the
Aksarben Stadium in Omaha Nebraska on May 4, 1998, for the
annual meeting of Berkshire Hathaway, the company led by
Warren Buffett, would have committed such a blunder. To
a person, they knew that Buffett patiently waits until Mr.
Market offers to sell a great company with predictable earnings
growth at a discount price. Then Buffett buys all that he
can afford with the assumption that he will hold it for
Can such a simple-minded strategy really give
worthwhile returns? Once again, ask those who attended the
meeting. Many would know that when Buffett took over Berkshire
Hathaway in 1965, it was trading at $18 per share. Using
it as a vehicle for purchasing and investing in other companies,
he has guided it to the level where it is now trading at
$70,000 per share, an annual return of 28 percent. Others
would know simply that since they bought stock in this former
New England textile company, it has been going up like clockwork
in both share price and equity per share.
No one else comes close to Buffett’s
record over such an extended period covering every type
of bull and bear market. He is also unique in that this
has been accomplished without the use of derivatives, hostile
takeovers and leveraged buyouts.
After dealing with the business in five minutes,
Buffett opened the meeting to questions. For almost six
hours he told stories, joked and munched on See’s
Candies, while answering question after question with care,
relevance and wisdom. Many questions were also dealt with
by Charlie Munger, the Vice Chairman of Berkshire Hathaway.
The following is a selection of the answers given by this
twosome fairly much taken straight from my notes. Enjoy!
- Avoid stocks with low returns on equity
- Time is the enemy of poor businesses, the
friend of good businesses.
- With a poor business you may be lucky
in that you pick the time that it gets taken over. However,
it is no fun to own stock in a company in which you hope
it liquidates before it goes bankrupt.
- Avoid "cigar butts," but we have
a had a lot of soggy butts in our time.
- When presented with a new company, we can
say "no" within 10 seconds. Technology does
not get through our filter.
- Our central role is (1) to motivate the
chairmen of our companies to keep working even though
they are already very rich, and (2) to allocate capital.
- Buy stocks that you never want to sell;
when you get a good business, buy for life.
- Ideal purchase: buy more of what you already
like and have because the price is right.
- Insurance is the most important business
at Berkshire Hathaway.
Political campaign spending is an under priced commodity,
it needs legislation to limit it.
- Berkshire Hathaway gets a 20 to 30% return
- Jack Welch (CEO of General Electric) gave
his secret of life—go where the competition is weak.
- How do you beat Bobby Fischer? Play him
at anything but chess.
- Fannie Mae and Freddie Mac could be hurt
by rising interest rates but not nearly as much as people
- Q. What keeps you awake at night? I don’t
worry. We do the best we can. We don’t predict currents—just
how different fish will swim in different currents.
- Coca Cola is the best large business in
the world; amongst other things, it set the trend for
a company to buy back its own stock.
- Is there a danger of Japan selling the
U.S. Treasuries that it owns? When you ask such questions,
always follow up with "and then what?" If Japan
sold a billion dollars of U.S. Treasuries, what would
they do with the money? They would have to invest in other
- There are two questions managers of public
companies must ask. (1) Do you keep the earnings or return
them to the shareholders. (2) With the portion that you
keep, what do you do with it?
- Not many analysts recommend Berkshire Hathaway—perhaps
because it is not the stock for them to get rich on.
- Steps to selecting companies. (1) We start
by only looking at companies we understand. (2) We observe
whether or not the management is telling us the truth
in the Annual Report and other publications. Are they
the things we would want to know if we were buying 100%
of the company. We avoid companies with annual reports
full of PR gobbledygook. We want to be able to read the
report and know the company better at the end.
- The Annual Report of Coca Cola is an enormously
informative document. We first bought Coca Cola on the
basis of its Reports and had no discussions with its management.
- Look for candid, clear, coherent prose.
If a business has a problem, we would like to know about
it. Honesty and openness is the best policy. We would
like to see announcements at board meetings along the
lines of "this is a very serious problem and we have
no idea how to solve it."
- Because of the use of options and warrants,
we estimate earnings for many companies could be 10% or
more lower than what they state.
- Benjamin Graham was a wonderful teacher
and said that you don’t have to be right about every
company. If I [Munger] taught a course on company evaluation,
I would ask the following question on the exam, "Evaluate
the following internet company." Anyone who gave
an answer would be flunked.
- Current factors influencing market prices:
(1) return on equity, (2) low interest rates, (3) market
- A valid criticism is that we should have
bought more shares of the companies we already own; perhaps
we missed the boat in some cases. Also probably we have
issued shares that we shouldn’t have.
- Definitely think that the demand for silver
exceeds the supply by approximately 150 million ounces
- Intrinsic value: present value of future
cash that can be taken out of the business. It easy to
calculate for Coca Cola, but very difficult for Intel.
- Need various internal models to deal with
reality. One model is not enough: "To a man with
a hammer, every problem looks like a nail." [Munger]
- We try to assess managers as to whether
they love the business or the money.
- Do not mind paying a manager a lot of money
for good performance but I am bothered by mediocre managers
getting large sums of money. Unfortunately the system
feeds on itself and there is not much that you can do
to correct this problem. The original Vanderbilt didn’t
take any salary. These high management salaries have a
- Can have a circle of competence for a particular
industry, but not a circle of competence for individual
companies within the industry. It's easy to say that the
manufacturing of PCs will grow enormously over the next
decade, but hard to say which company will dominate.
- We have decentralized Berkshire Hathaway
to the point of abdication. The only thing we have centralized
- Discount future cash flows at the long
treasury rate. Businesses get credit for free cash. With
the best businesses, you don’t need to keep putting
- Investing is the art of putting in cash
now to get more cash later on.
- EBITDA [earnings before interest, taxes,
depreciation and amortization] is a nonsense figure; it
is absolute folly to take any notice of it.
- To understand a company, understand its
products, its competition, and its earning power.
The best way to teach finance is to focus on easy cases.
For example, in 1904 anyone could see that NCR was a wonderful
- We like homey, Norman Rockwell types of
- Learn all the accounting you can.
- The best book on my investment methods
is by Larry Cunningham. He has done a first class job
of organizing my letters to shareholders. If I had to
pick a single book, this would probably be the one.
I would be worried if I sold a stock at the top of the
market because it would mean that I would be practicing
the "greater fool" theory.
- It is instructive to do postmortems, but
don’t get too carried away.
- My principle is to leave enough money for
your children that they can do anything they want, but
not enough so that they can do nothing.
- Volume, price actions, RSI have no place
in our calculations.
- Deprecation charges are a good indication
of the required capital expenditures. Avoid companies
that have to spend like crazy just to stay in competition.
- Good businesses throw up easy questions
for the managers and the board, bad businesses throw up
- We are willing to wait indefinitely for
the right price for the right stock.
- Scuttlebutt—you can’t do too
much, but you should be interested in the company in the
first place. It might form the last 10-20 per cent of
the analysis. If it looks like a seven foot hurdle to
start with, don’t touch it.
- Don’t worry about risk the way it
is taught at Wharton. Risk is a go/no go signal for us—if
it has risk, we just don’t go ahead. We don’t
discount the future cash flows a 9% or 10%; we use the
U.S. treasury rate. We try to deal with things about which
we are quite certain. You can’t compensate for risk
by using a high discount rate.
- We don’t worry about volatility,
if we are confident about the business. For example, Washington
Post went down by 50% after we bought it; it was a volatile
stock, but not a volatile business.
The best criterion is to buy businesses on the assumption
that you will hold them for life.
- Dairy Queen [recently purchased by Berkshire
Hathaway] is a lot different than McDonalds. For example,
it employs a lot less capital. Nevertheless, McDonald’s
still gets a good return on its capital.
- I don’t mind paying taxes. It is
much better on this side than to be on the other side
receiving government assistance.
The Mousketeers was never this much
fun, even though back then we got to wear big ears.
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