“When people talk, listen completely. Most people never listen.” ― Ernest Hemingway
Yesterday night I encountered the transcript of the comments made by Warren Buffett and Charlie Munger at the 2014 Berkshire Hathaway Annual meeting. Go here to read the transcript.
The notes were a great read and I picked out some interesting parts which are shown below. All markings in the quotes below made by me.
Intrinsic value vs book value
“Q5: Jay Gelb (JG): Intrinsic value, you signal undervalued versus intrinsic value. What can you do about it? Would you consider an IPO of the operating units?
WB: No on the second part of that. We try to explain intrinsic value (and I’ve never seen an annual which uses that term) where there is a difference between carrying value and real value. GEICO is carried at $1bil over tangible, but it is really worth $20bil over. We are eager to buy stock at 120% of book value. Book is $230bil. And obviously I think that $45bil over that figure we are getting a bargain over intrinsic. It changes from day to day, but not a lot, but changes over the quarters and years. If you ask Charlie and me to write down a figure as to intrinsic value, I think we’d be within 5% of each other, but not 1%. We will continue to try to give information to shareholders on the important units at Berkshire. Some of our small businesses may be worth $1bil or even $2bil, but the small ones don’t have a big impact. Railroad, utility and insurance are big, and we try to use the words and numbers that we use when thinking about those businesses ourselves. We only believe in repurchasing shares when we can buy at a discount to intrinsic value. The 120% is a loud shout out as to a figure that we think is significantly below intrinsic. Some companies buy in shares to cover options. You shouldn’t buy it in if shares are overvalued. Negating dilution isn’t right when shares are expensive. If management can buy a dollar bill for 90 cents, they are doing shareholders a good job. If spend $1.10, not helping.”
About Marmon and Iscar: “WB: Those were two important acquisitions, partly due to accounting peculiarities. Carry value is much lower than intrinsic.“
“WB: … Our goal is to buy big businesses. We are about building earning power. We are looking to add earning power to Berkshire. We don’t get opportunities that often. If opportunity is large enough, we can dip into huge reservoir of securities.”
“CM: … At Berkshire not many long term bonds are being bought.”
Risk of technology change
“WB: … All businesses should think about what can mess up their position. We look at all of our businesses as subject to change. GEICO set out in 1936 to operate with low costs and pass on those prices to the customer, on a necessity being auto insurance. They originally did it with mail offerings to government employees. They’ve adapted over the years, to widening classifications, to US mail, to telephone, to internet and social media. And in there they stumbled, when they left government employees and got too aggressive about expanding, and they really did go broke. We want managers who are thinking about change, and what is needed for the business model in the future. We know it won’t look the same. BNSF is looking at LNG for locomotives. Our businesses are strong and are generally not subject to rapid change, but sometimes slow change can be harder to see and lull you to sleep easier versus rapid change which you can see. I will make mistakes in future, that is guaranteed. We never make bet‐the‐company decisions that cause real anguish. Occasionally they work out very well. In 1966, we bought a department store in Baltimore. There was nothing dumber. The $6mil in that store became $45bil over time in Berkshire. You have to be very alert, and Charlie and I and our directors think about it.”
CM: I spoke earlier about the desirability of removing ignorance piece by piece. Another trick is scrambling out of your mistakes, it is enormously useful. We had a sure to fail department store, a trading stamp business sure to fold and a textile mill. Out of that comes Berkshire. Think about how we would have done if we had better start! [laughter]
WB: My uncle wrote a letter in 1942 that the day of the chain store was over. Our grocery store went out of business in 1969. The wish being father to the thought.”
“WB: It was a reasonably run food company with 15% pretax margins for many years, not an unusual operating margin in food business. I think the margins will significantly improved from historical figures, have to watch quarter to quarter. What Bernardo has done is restructure the business model and the brands are as strong as ever, and they will have structurally lower costs. I don’t want to name a number, you will find it out soon enough.”
What to do and where to look if 23 years old
“Q39: Station 2, New Jersey. Tech and entrepreneurship, if you were 23 year old, in what non‐tech industry would you start a business and why?
WB: I’d probably do what I did when I was 23. I would look at lots of companies, and talk to lots of people, and learn about lots of industries. I would see CEOs of 8 or 10 coal companies. I often didn’t make appointments, but they almost always would see me. I would ask them, if they had to put all of their money into any coal company except their own, and go away for 10 years, which one would it be? And which would they sell short over 10 years and why? If I did that, I would know more about the coal companies than any manager would. But you wouldn’t learn about how to start Google or Facebook that way. You need real curiosity about it, it has to turn you on. Asking questions about coal companies? I mean really, you have to be a little odd too. I might find an industry that particularly interested you, and you might become very well equipped, and can start or go to work for someone good. If you are open to things and keep learning things you’ll find something.
But it is not a bad system to use. You really learn a lot by asking. I sound like a Yogi Berra quote perhaps. But if you talk to enough people about something they know a lot about, people like to talk. Here we are talking ourselves. You will find your spot. I was very lucky, I found what fascinated me when I was 7 or 8 years old. If you are lucky you will find it early.
WB: I have everything in life I wanted. Standard of living does not equate with cost of living. There is point where you get inverse correlation. My life would be worse if I had 6 or 8 houses. It doesn’t correlate. You can’t have more than that. It makes a difference up to a point. You can start thinking differently at x dollars. But it doesn’t make a difference at 10x or 1000x.”
“…How does management factor into valuing instrinsic value. Which company do you fear the most, as even Coca‐Cola has their Pepsi?
WB: Actually Ben Graham didn’t get too specific about intrinsic value in terms of calculations. Now it is equated rightly with private business value. Aesop was the first who came up with it. It is intrinsic value if you can foresee the future, the present value of all cash that will be distributed between now and Judgment Day. You put money in and you take money out. One in hand is worth two in bush. The question is how sure are you that two are in the bush, how far away is bush, what are the interest rates ‐‐ Aesop wanted to leave us something to play with over next two thousand years so he didn’t spell it all out. In calculating it, Ben would say he wanted two dollars of cash in the bush and pay a dollar. Fischer would use qualitative factors to estimate the number of birds in the bush. I started out very influenced by Graham, so more quantitative, but Charlie came along and said look more at qualitative. If you buy McDonald’s franchise, you think about the cash in, the cash out, when, and at what discount.“
CM: There is nothing in business school that teaches people to do what we do at Berkshire.”
“WB: Inflation would hurt us, but other businesses more. Some assets would do better under inflation. If drones set off and drop $1mil in every household, would everyone be better off? Berkshire would be worse off. Trick is to find out you have $1m before anyone else does. You don’t create wealth with inflation, but you can move it around. You don’t with a firm like Berkshire, our earnings per share up, intrinsic value per share would be up but, unless we leveraged the businesses, the value per share in real terms would go down.”
“CM: Sum total of all acquisitions in America has been lousy. It is the nature of successful companies that they will be talked into dumb deals. It has been path to wealth for us, but luckily many don’t want to be peculiar in our way.
WB: When we read that a company we own but don’t control is going to make an acquisition, I’m more likely to cry than smile. But we love them ourselves. I have sat in on hundreds of acquisition discussions conducted by people I didn’t control. Most have been disasters…
CM: Some are mediocre.
WB: Look at GEICO ‐ it had been an incredible business until the 1970s. They made acquisitions after getting back on track and then took their eyes off the ball. Accounting cost of those two acquisitions was poor but not disastrous. But secondary effects were huge. It was a dozen years there that they couldn’t get back. We bought half the company, so it was wonderful for Berkshire. It is human nature, CEOs have animal spirits and supporting staff senses that they like to do things. They keep coming in with deals. Investment bankers are calling them daily. All these forces push towards deals. We’ve tried very hard to not be eager to do deals, just to be eager to do deals that make sense. That would be harder if we had strategy departments pushing us. The setting in which you operate can be very important.“
Worst case scenarios and BP
“CM: Big surprise was British Petroleum. No one thought loss from one well would be many billions of dollars. After that I would have less enthusiasm for drilling in Gulf. Such a big loss can offset any possible gain. The biggest rail accident cost $200m.”
Returns and capital spending
“Q55: Station 8, New Hampshire. Looking at page 64 segment data for the energy business, when I take ebitda less capex, the result is negative operating cashflow. When I repeat exercise in each of last five years, in best years, $300m of operating cash flow. Divide by tangible assets, 0.8% return, why allocating capital to a business with such low returns?
WB: You were doing great until return on tangible assets. We love the math you describe, as long as we get return on capital investment. We are looking forward to putting more capital in, as long it is treated fairly, and we will get appropriate returns on that. It is not cash minus increased capex, it is operating earnings less depreciation. There are times when no net investment is required, but we prefer where net investment must be higher because we get more capital in and our bet is that regulators will treat us fairly in future. One reason we believe this is true is that we have done so much better than many at delivering electricity at lower rates than charged by most. In Iowa there is a public utility, and our rates are significantly below competitors. A friend with a farm who is served by two utilities tells me that rate from us is dramatically lower than the competitors. We have a deserved good reputation with regulators, including safety. They welcome us when we come to new states. If we can put new money into those projects, we will get good return. But you will get negative returns if you include adding to capital spending. This is somewhat similar at the railroad.
CM: if numbers you recited come from a declining department store, we would hate it. But we have confidence that the reinvested capital will give us a good return from a growing energy business. It is that simple.
WB: Greg, can you quote some rates?
Greg Abel: We are generally lowest quartile, if not cheapest. We recently took the first rate increase in Iowa in 16 years, and we don’t see one in near future. There is a 1000 megawatt project adding up to $1.9billion, and deploying over 2 years and we are earning an 11.6% return on it. We try to keep our capital close to depreciation. But the lion share of our capex is growth capital.”
“Habits are such a powerful force in everyone’s life.”