Buffett Nebraska

Q What exactly do you do all day?
A I spend an inordinate time reading. I probably read atleast six hours a day, maybe more.And I spend an hour or two on the telephone.And I think. Thats about it.

-I would say there is no hunch or intuitiveness or nothing of the sort. I try to sit and figure out what the future economic prospects of a business are. I try to figure out whether the management is someone or a group I both trust and admire, and I try to figure out whether the price is right. I mean that: Its the right business, the right people and the right price.

Buffett notredame, pricing power

Buffett Notredame

-I would say that the most important thing in business, and investments, which I regard as the same thing, from our standpoint, is being able to accurately define your circle of competence.

-You need very few good ideas in your lifetime. You have to be willing to have the discipline to say, “I’m not going to do something I don’t understand.”

-Why should I do something I don’t understand? That’s why I find it an advantage to be in Omaha instead of New York. I worked in New York for a few years, and people were coming up to me on the corner and whispering in my ear all the time. I was getting excited all the time. I was a wonderful customer for the brokers.

-But now you say “I don’t know how to evaluate the Washington Post.” It isn’t that hard to evaluate the Washington Post. You can look and see what newspapers and television stations sell for. If your fix is $400 and it’s selling for $390, so what? You can’t [invest safely with such a small margin of safety]. If your range is $300 to $500 and it’s selling for $80 you don’t need to be more accurate than that.

-[Question from audience about how many of his investment ideas are pitched to him by others.]

Practically none. The Wall Street Journal is my deal source. There are 1,700 or 1,800 of America’s companies that I’m generally familiar with

-We read hundreds and hundreds of annual reports every year. I own 100 shares of everything. I find this much more reliable than asking to be put on a mailing list

-Well, I would say this. If we were working with $25 million – so we could sort of look at the whole universe of stocks – I would guess that you could find 15 or 20 out of three or four thousand that you would find that were A) selling for substantially less than they’re worth, and B) that the intrinsic value of the business was going to grow at a compound rate which was very satisfactory.

-You don’t want to buy a dollar bill that’s sitting for 50 cents, and it demands positive capital, and it’s going to be a dollar bill ten years from now. You want a dollar bill that’s going to compound at 12% for [a long time].

-Incidentally, I would say that almost everybody I know in Wall Street has had as many good ideas as I have, they just had a lot of [bad] ideas too. And I’m serious about that. I mean when I bought Western Insurance Security selling at $16 and earning $20 per share, I put half my net worth into it. I checked it out first – I went down to the insurance commission and got out the convention statements, I read Best’s, and I did a lot of things first.

-A couple of fast tests about how good a business is. First question is “how long does the management have to think before they decide to raise prices?” You’re looking at marvelous business when you look in the mirror and say “mirror, mirror on the wall, how much should I charge for Coke this fall?” [And the mirror replies, “More.”] That’s a great business. When you say, like we used to in the textile business, when you get down on your knees, call in all the priests, rabbis, and everyone else, [and say] “just another half cent a yard.” Then you get up and they say “We won’t pay it.” It’s just night and day. I mean, if you walk into a drugstore, and you say “I’d like a Hershey bar” and the man says “I don’t have any Hershey bars, but I’ve got this unmarked chocolate bar, and it’s a nickel cheaper than a Hershey bar” you just go across the street and buy a Hershey bar. That is a good business.

-I’ll try this on the students later: What’s the highest price of a daily newspaper in the United States? [Pause] The highest priced daily newspaper in the United States is the Daily Racing Form. 150,000 copies a day, $2.25 a copy, they go up in 25 cent intervals, and it doesn’t affect circulation at all. Why? There is no substitute. If you go to the track, assuming you’re a forms player, you don’t want “Joe’s Little Green Sheet”, you want The Form. And it doesn’t make any difference what it costs! There is no substitute. And that’s why they’ve got a 65% pretax margin. It doesn’t take a genius to figure it out.
There are products like that, and there are products like sheet steel. And they’re night and day.

-Then [I said] “I’ve got only one other question: How do you figure out how much to charge people? You look like a man of awesome commercial instincts – you started with a $1,500 radio station, now you’re worth $4 or $5 billion dollars.”
He said “Well, that’s another good question. I just tell my US managers to try and make 45% pretax and figure that’s not gouging.”

-Lord Thompson, once he bought the paper in Council Bluffs, never put another dime in. They just mailed money every year.

- The idea was that, essentially, he raised prices and raised earnings there every year without having to put more capital into the business.

-The product was undifferentiated (berkshire lining). The candy product is differentiated (sees). (Garbled story of Hershey Bar and Coke versus unbranded but modestly cheaper products).

-You really want something where, if they don’t have it in stock, you want to go across the street to get it. Nobody cares what kind of steel goes into a car.

-someday, there’s going to be some business I understand selling for way less than the value I arrived at. It doesn’t have anything to do with book value, although it does have to do with earnings power over a period of time. It usually relates, fairly closely, to cash [flow]

-Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street.

-Western Insurance companies: I didn’t have any background in insurance. But I knew I could understand it if I worked at it for a while. And all I was really trying to do was disprove this thing. I was really trying to figure out something that was wrong with this. Only there wasn’t anything wrong. It was a perfectly good insurance company, a better than average underwriter, and you could buy it at one times earnings.

-think the Wall Street Journal is essential. I spend 45 minutes a day with the Wall Street Journal. Actually, I got up the night before, about 11:00... I frequently read it at night. But I’ll read anything. Actually, I probably spend five or six hours a day on reading

-Buried in rented suit

Mecham

Mecham:

-It’s really quite simple. I need to understand the business like anowner. The firm needs to have staying power; I want to be confident about thegeneral nature of the business and industry landscape on a longer term basis 

-In fact, I think very little about quarterly earnings and more aboutthe barriers to entry, competitive landscape/threats, the ongoing capital needsand overall economics, and most importantly, the durability of the business 

-Wealso stress test the business under various economic scenarios and look to anormalized earnings power. We passed up many seemingly attractive ideas overthe years as we would ask, “What happens under 7-10% unemployment (whenunemployment was in the 4-5% range) and 6-8% interest rates?

 
-“Is the business overly reliant on loose credit extension and frivolousspending?” Many names didn’t hold up under these stress test scenarios, so wepassed.

 
-We prefer cockroach-like businesses — very hardyand almost impossible to kill!

 
-Oftentimes a key cog of valueis in a form that’s difficult to measure — brands, mindshare/loyal customers,exclusive distribution rights, locations, management, etc. Sometimes it’s thelocation of assets that can be hugely valuable. Waste Management [WM] andUSG [USG] both have assets that are uniquely located and almost impossible toduplicate, which provides a low-cost advantage in certain geographies.

 
-Any time you arepaying a price today that’s dependent on heroics tomorrow — fantastic growthfar into the future, favorable macro environment, R&D breakthroughs, patentapproval, synergies/restructurings, dramatic margin improvements, large payofffrom capex, etc. — you run the risk of inviting pesky over-optimism(psychologists have shown overconfidence tends to infect most of us), whichcan result in skewed probabilities and payoffs. We want to see a return todayand not base our thesis on optimistic projections about the future. Investments based on projections that are disconnected from any historicalrecord make us leery. Investments dependent upon a continued frothy macroenvironment (housing, loose credit) are prone to over-optimism as well — howmany housing-related/consumer credit companies were trading at 6x multiplesgrowing 15%+ inviting IV estimates 5x the current quote?

-How do you generate investment ideas?

Mecham: Mainly by reading a lot. I don’t have a scientific model to generateideas. I’m weary of most screens. The one screen I’ve done in the past was bymarket cap, then I started alphabetically. Companies and industries that are outof favor tend to attract my interest. Over the past 13+ years, I’ve built up a baseof companies that I understand well and would like to own at the right price. Wetend to stay within this small circle of companies, owning the same namesmultiple times

-That’s the beauty of the public markets: If you can be patient, there’s a goodchance the volatility of the marketplace will give you the chance to owncompanies on your watch list. The average stock price fluctuates by roughly80% annually (when comparing 52-week high to 52-week low). Certainly, theunderlying value of a business doesn’t fluctuate that much on an annual basis, sothe public markets are a fantastic arena to buy businesses if you can sit stillwithout growing tired of sitting still

-We try andstick with companies we understand, where we have a high degree of confidencein the staying power of the firm. We spend considerable effort thinking criticallyabout competitive threats (Porter’s five forces, etc). We really stress long-termstaying power and management teams with proven track records that are focusedon building long-term value. Then we always “stress test” the thesis againstdifficult economic environments.

 

-If the financialcrisis taught nothing else, it showed how elegant financial models that calculaterisk to decimal point precision act like a sedative towards critical thinking andeven common sense

 
-Most investors are their own worst enemies — buying and sellingtoo often, ignoring the boundaries of their mental horsepower. I think ifinvestors adopted an ethos of not fooling themselves, and focused on reducingunforced errors as opposed to hitting the next home run, returns would improvedramatically

 

  

 

When to walk away

Scott doesn’t need predictions of US$60 iron ore to tell him to steer clear of the notoriously cyclical sector. If he can’t reasonably predict the future demand or supply for something — especially a commodity like iron ore — he simply walks away.

There are no penalties in the investing game for missing out on the next big winner.