autodidact

From

http://blogs.rhsmith.umd.edu/davidkass/

(4) Looking back at the financial crisis, did you learn anything that you didn’t know before?

WB: Learned how bad things could get. Knew there was a housing bubble, but surprised by the speed at which it spread, the way the dominoes toppled, and the need for the government to act. In September, when Lehman went down, that Sunday, if Ken Lewis (Bank of America) had not bought Merrill Lynch (ML), ML would have gone down on Monday. Everyone was terrified. No one trusted anyone else or even placing their money under a mattress. Berkshire sold a $5 million Treasury Bill in December 2008, due in April 2009, for $5,000,070. The purchaser would get back $5 million at maturity and earn a negative return (losing $70). People didn’t trust each other. Banks didn’t trust each other. Bernanke, Paulson, and Geithner understood that speed was needed. President Bush said the most important 10 words in economic history: “If money doesn’t loosen up, this sucker is going down”. He backed up Paulson. There are certain chairmen, presidents, and Treasury secretaries that might have frozen. If anyone had frozen for a few weeks, it would have been too late. Congress did not get it at first. When they initially voted down TARP, the Dow Jones Industrial Average tumbled 750 points that day, coming close to a financial Armageddon. This was potentially a lot more serious than the 1930’s, although there was a worse social impact at that time. After Lehman failed, money market funds held $3.5 trillion which was equal to one-half domestic deposits at banks. In three days, $175 billion (or 5% of money market funds) was removed from money market accounts. To whom would these funds liquidate assets (commercial paper)? Only the government could have stepped in, which it did. At that time Berkshire had already committed to come up with $6.6 billion to assist Mars in its purchase of Wrigley. He has never seen a panic period like this one. One should buy what you can pay for. If you are smart you do not need to borrow. If you are dumb, you do not know what to do with the amount you borrow.

(5) Does the U.S. have a sustainable competitive advantage versus the emerging countries?

WB: In the 1920’s 32% of Americans worked on farms. Today, that number is 3%. In the 1980’s Americans thought that Germany and Japan would dominate the world’s economies. However, over the next decade the U.S. created 20 million jobs. We have a system that works and encourages creativity. Since 1995, the Internet has changed the world.

(7) In the past you have said your investment philosophy was 85% Graham and 15% Fisher. Has that changed?

WB: Started out looking for cigar butts with one puff left. There were lots available in the 1950’s. That approach does not work well with large amounts of money to invest. His philosophy has shifted slightly more toward Fisher. Berkshire currently has $150 billion in cash and investments. He met Charlie Munger in 1959 who argued for investing in wonderful businesses and sit with them as they get better over time. In 1951 WB picked up the Moody’s Manual for that year and found Western Insurance selling at ½ times earnings. A few years ago someone sent him a book entitled “Korean Stock Market”. He found 15 – 20 stocks selling for 2X earnings. It was like the old days. He has also made mistakes such as his 1968 purchase of Blue Chip Trading Stamps whose sales have dropped from $120 million at its peak to $18,000. Dexter Shoe was another bad business that he bought. You need to get on an 80 mph train that is speeding up.

(9) Question about WB’s ability to evaluate management in place of companies he acquires.WB: In terms of evaluating management, it is very hard to do for public companies. You can look at the record (like baseball). When we buy a business it is for keeps. When someone comes to me and wants to sell a business and I hand him $1 billion, I have to decide if he’s going to have the same energy when he’s working for us as he had when building the business. We do not have any contracts with our managers. In the Fall of 2006 I received a 1 ½ page letter from a guy in Israel. I had not heard of the guy or his company before. He offered to come meet with me. After we met, I handed him $4 billion (Iscar) and was counting on him to run the business the same as before we gave him the money. Want managers to be passionate about their business. You cannot put passion into someone. It’s worked out most of the time. Every now and then we make a mistake. We want people who are in love with their business, not the money. (People who would say: “I’d rather go to work than anything else in the world”.) Our batting average is good and has probably gotten better over time. We are looking for the guy who is still in love with his business and for one reason or another, needs to monetize it. With respect to stocks, we are not interested in meeting with management. We do not want to see their projections. We look into their products and “moats” around the business.

(10) Question about advice in finding a job.

WB: Find the job that you would do if you were independently rich and not getting paid for it. He loves the job he is in. He jumps out of bed and tap dances to work. Upon graduation from Columbia (MBA), he offered to work for Ben Graham for nothing. Ben Graham said he was overpriced. He started selling securities in Omaha for three years. Then he was offered a job with Ben Graham. He never asked what his pay was. He didn’t know until he received his first pay check. Do what makes you tap dance. Take a job until you find the right job. Work for the person you admire most. Don’t wait for the dream job either. You should be close to a dream job 5 years out of school.

(11) What do you do everyday?

WB: He reads a lot, so does Charlie. They have been close friends for 52 years. They disagree, but never have any arguments. He reads books and 10K’s and 10Q’s. He now plays bridge over the Internet 12 hours per week, so he has less time for reading. He also watches YouTube.

(12) Question about China’s policies and impact on its growth.

WB: China changed its system and started to unleash the potential of its 1.2 billion people. In the last 30 years it has built its infrastructure. When forces are working together as they are in China, amazing things happen. The success the Chinese have achieved has reinforced what they are doing. They have come a long way. They have a long way to go. In the U.S. system, the right people are in the right jobs.

(13) Question about the Financial Regulation Bill.WB: We need something that will keep leverage under control. There is a natural tendency in a capitalist system to use leverage. Leverage is dangerous. If the financial regulation bill controls derivatives, it will be good. We also have the wrong incentives. If CEO’s succeed, they get doubly rich. If they fail, they are still rich. If a CEO needs big assistance from the government, then the CEO should go broke. At Berkshire we want a system that if Berkshire goes broke, so do Warren and Charlie. Freddie Mac and Fannie Mae resulted in the greatest losses to taxpayers. They (Fannie and Freddie) were a big part of the problem.

(14) Earlier this month, Bill Gross was quoted as saying June 30 would be D-Day for investors with QE2 going away. What do you think Bernanke should do?

WB: No one could have done better than Bernanke. He (Buffett) would not be buying $20 billion of Treasuries every week as is being done now. In addition to government’s fiscal and monetary policy, capitalism has its own regenerative capacity. We have had 15 recessions in U.S. history. They were called “panics” in the 19^th Century. The regenerative capacity of capitalism was demonstrated before fiscal and monetary policy were introduced. Our current budget deficit represents 10% of GDP. It is the largest it has ever been except for World War II when it equaled 30% of GDP. This led to a vibrant economy and price controls. We are, therefore, experiencing the second greatest stimulus in the history of this country. Monetary policy (stimulus) is not needed now. It is dangerous. The Federal Reserve has its foot to the floor. Bernanke will quit monetary stimulus on June 30. The economy is fine. This expectation is baked in (built into the market).

(15) When you have made a mistake, what steps did you take to determine what went wrong?

WB: His circle of competence is growing over time. When investing in stocks, there are no called strikes. He waits for the pitch he wants. The mistakes he has made resulted from thinking he understood a business when he did not. He prefers to learn from other people’s mistakes (not from his own). On Dexter Shoe, he issued shares in Berkshire that are today worth $3 billion. Dexter Shoe went to zero. He is wrong from time to time, but overall has a good batting average. One should focus on the future. Don’t dwell on mistakes. Do not make a mistake with respect to the person you marry.

(18) Question about oil and the current situation in the Middle East.

WB: The Middle East has been and will continue to be an unstable place. If the supply of oil from Saudi Arabia is disrupted, it will have big consequences. The oil shocks of the 1970’s resulted in oil going from $3 per barrel to $30. We paid a huge tax to OPEC. He expects to see the usage of oil decline in our lifetime (although the current usage of 86 million barrels of oil a day may increase to 100-110 million barrels per day before the decline begins). There are 500,000 oil wells in the U.S., producing an average of only 11 barrels per day. If oil prices have a sustained increase, there will be a windfall profits tax in the U.S. Therefore, higher oil prices are not a signal to buy oil stocks.

(21) Question about income inequality in the U.S.

WB: During recent years of economic growth in the U.S., income inequality has grown. It’s going to exist in capitalism and it should. A society with equality and no production would not be good. You should think of output, providing incentives to people, an abundant society, a market system. In the U.S. per capita GDP equals $47,000. We want freedom from fear of not receiving health care and not starving to death. An abundant society will take care of people that get a lousy ticket. Inequality of the tickets is what you want to deal with. We are working toward that in this society. Social Security is an attempt at that in our society. In the last 20 years we have been moving in the wrong direction. According to the IRS, in 1992 the 400 highest incomes averaged $45 million. In 2009, they averaged $350 million. The rest of the U.S. went no place over these years. The average tax rate for the highest income earners has declined from 28% down to 16% over this time period. His average tax rate is 16% on $16 million of income, largely from dividends and capital gains which are taxed at 15%. He has no tax shelters and does not consult tax advisers. He credits George Bush and the U.S. Congress. We have moved away from equality to taking care of the rich. If you and a twin were competing for a ticket in the U.S. or Bangladesh (with no income tax), you might bid 70% – 80% (of future wealth) to get the U.S. ticket. He is lucky that he is alive now rather than thousands of years ago. Otherwise he would have been some animal’s lunch. It would not have done him any good then to say “I allocate capital”. We should have a society that will incentivize people to work hard and the ticket you pick doesn’t destine you for a poor outcome.

Highlights of Warren Buffett’s Interview on CNBC – March 2, 2011

Warren Buffett appeared for three hours this morning on CNBC (6 a.m. – 9 a.m. EST) and answered questions from both CNBC staff and viewers. His responses to these questions included:

(1) The recent rise in oil prices will have no impact on Berkshire Hathaway owned GEICO and its large investment in Coca-Cola five years from now. He does not know where oil prices will be in the near future. Demand for oil is inelastic, so small interruptions can lead to a big change in price. Markets anticipate this.

(2) The American economic system works. Once in awhile the economy falls off the track as is did in the Fall 2008. Berkshire’s businesses are now inching forward. Its TTI electronic components business is booming. Its railroad (Burlington Northern) has recovered 60% from its bottom and is improving each quarter. January was a record month for its Iscar machine tools. However, its businesses depending on residential construction are not moving. 2010 was a better year for Berkshire than 2009, with Berkshire doing some net new hiring. By election day in November 2012, the unemployment rate will be in the low 7% range (vs. 9% now). Housing will be better in one year. The demand for housing is increasing from new household formations, while the supply of new housing is slowly decreasing from current under building, which will help offset the previous oversupply.

(3) Buffett does not like short term or long term bonds as investments at current interest rates. The U.S. is currently running a budget deficit equalling 10% of GDP. This is providing a large fiscal stimulus. Commodities are for speculators who are betting that their prices will go up and hope that someone will pay them a higher price later. On the other hand, assets such as rental property or stocks can be expected to earn income over time. If the stock market were to close for 10 years, he would not worry about his investments in Coca-Cola or Wells Fargo since they will continue to produce over time. The current value of all of the gold in the world equals $7 trillion, which approximates 1/3 of the value of all stocks in the U.S., or equal in value to all of the farmland in the U.S. (1/2 of the land in the U.S.) and 7 ExxonMobils plus $1 trillion in walk around money. Buffett prefers the farmland and the 7 ExxonMobils to the gold.

(4) Stocks still look attractive vs. most assets, although they are not as cheap as they were. It is harder to make deals now. Buffett had an iron in the fire a couple of days ago, but someone else beat him out. There is nothing of high probability at the moment. The deal he lost out on was a “zebra”, not the “elephant” he referred to in his annual report. His “itchy finger” in his annual report was a free advertisement. Any acquisition he makes must be at a good price so he will get his moneysworth from earnings. He is more likely to pay a fair price for a privately owned business than he would after paying a 20% premium for a publicly traded company. Mars (candy company) is a wonderful business but Buffett is currently partners with Mars with respect to its Wrigley’s subsidiary. If private owners want to sell their business to Buffett (and he wants to buy it), he will advise them to keep it. The money the private owners will collect cannot be invested in better businesses. But sometimes there are tax or family issues that would lead to the sale. A good business should not be sold just to get money.

(6) When he bought Burlington Northern, he sold his shares in Union Pacific and Norfolk and Southern railroads. He did not have to sell — it was a mistake. He was planning to buy more of those shares prior to the acquisition. He prefers railroads in the west such as Burlington Northern and Union Pacific. Managers of Burlington Northern are now happy that they are owned by Berkshire, in part because they no longer have to spend 20% of their time talking to analysts.

(8) Berkshire’s investee BYD’s success depends on it succeeding in the field of battery technology. It is a tough competitive game, but Charlie Munger thinks BYD will be the winner. Buffett would not answer the question as to whether he would buy more shares (he owns 10%) at the current low price.

(9) Buffett likes to act fast on acquisitions. If a deal is offered to him on a Friday, he wants it done by Sunday. Burlington Northern underperformed the week before he agreed to acquire the 77% of shares he did not already own. Otherwise people talk and the share price runs up. (He was referring to the recent SEC charge against a Goldman Sachs director who is alleged to have leaked information about Berkshire’s planned investment in Goldman Sachs in October , 2008.)

(14) When Lou Simpson retired last year, Berkshire sold all of his stocks. Todd Combs will be selecting his own stocks. Neither Combs nor Buffett wish to inherit someone else’s investment decisions. Bank of America and Nike were Lou Simpson’s picks.

(17) The CEO of a company should be its chief risk officer and should go away poor if he/she has ruined his/her company and harmed the country. Instead, failed CEO’s have walked away with hundreds of millions. Incentives are very important. They can help set the right limits on leverage.

(19) With respect to “too big to fail”, shareholders of Citigroup and Wachovia lost a lot.

(20) Equities will outperform short term and long term fixed income securities over 10, 20, and 30 years. Investors should not buy stocks with borrowed money.

(1) A discussion of how he calculates intrinsic value. (He considers book value to be an “understated proxy for intrinsic value”.) There are three components to this calculation. The first component is the market value of Berkshire’s investments in stocks, bonds, and cash equivalents ($158 billion at yearend). Berkshire’s insurance float (premiums paid to Berkshire that have not yet been paid out to cover claims) funds $66 billion of its investments. Berkshire’s second component of intrinsic value is earnings that come from sources other than investments and insurance underwriting. These earnings are delivered by Berkshire’s 68 non-insurance companies. The third, and more subjective component to intrinsic value, is the efficacy with which retained earnings will be deployed in the future.

(5) Lou Simpson retired at yearend at age 74 — “an age Charlie and I regard as appropriate for trainees at Berkshire”. (Buffett is 80 years old, and Munger is 87.)

Buffett reported Berkshire’s largest common stock holdings (with a market value of over $1 billion) as of yearend as follows (in descending order by value):

(1) Coca-Cola ($13.2 billion) – 21.4% of common stock holdings
(2) Wells Fargo ($11.1 billion) – 18.1%
(3) American Express ($6.5 billion)– 10.6%
(4) Procter $ Gamble ($4.7 billion) – 7.6%
(5) Kraft Foods ($3.1 billion) – 5.0%
(6) Munich Re ($2.9 billion) – 4.8%
(7) Johnson & Johnson ($2.8 billion) — 4.5%
(8) U.S. Bancorp ($2.1 billion) – 3.4%
(9) Wal-Mart ($2.1 billion) – 3.4%
(10) ConocoPhillips ($2.0 billion) – 3.2%
(11) POSCO ($1.7 billion) – 2.8%
(12) Sanofi-Aventis ($1.7 billion)– 2.7%
(13) Tesco plc ($1.6 billion) – 2.6%
(14) BYD ($1.2 billion) – 1.9%
Others ($5.0 billion) – 8.1%
Total ($61.5 billion) – 100%

Buffett’s entire Letter to Shareholders is available at:

http://www.berkshirehathaway.com/letters/2010ltr.pdf