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2 Lending Practices At Clayton Homes; Business Practices At 3G Capital 3 Berkshire Automotive 2015 Berkshire Hathaway Predicting Earnings IBM Annual Shareholder Insurance Businesses 4 Culture, Integrity and Future Returns at Meeting Berkshire Post Buffett And Munger The Berkshire Hathaway annual Changing Consumer Preferences meeting is an opportunity for Stock Market Levels shareholders and analysts to pose BY R. HUTCHINGS VERNON, CFA 5 Railroad Safety questions to Warren Buffett and Co-Portfolio Manager, U.S. Dollar and The Euro Charlie Munger in a five-hour Flexible Equity Strategy Using The Berkshire Name At Subsidiary session covering over 60 questions. Companies Utility Business and Renewable Power Sources Mistakes, Inflation, and Predictions 6 Incentives and Messages he 2015 annual meeting past decade compared to 7.7% for the S&P celebrated the 50th anniversary 500 Index as of Dec. 31, 2014. Too Big To Fail of Warren Buffett taking The format of the meeting was question Value Investing Outside The U.S. control of Berkshire Hathaway and answer, with shareholders and Optimism Despite Bad Things Sometimes T Happening and it drew a record crowd of over investment analysts posing questions to 7 Management Succession 40,000. In 50 years, Berkshire has grown Warren Buffett and his long-time business from an economically challenged New partner, Charlie Munger, in two, 2 ½-hour Ted Weschler and Todd Combs England textile company to one of the S&P 500 Index vs. Hedge Funds largest U.S. companies, with 340,000 The increase in 8 Good Businesses for Inflationary Times employees and the fifth-largest stock Berkshire Hathaway’s Global Warming Effect on Insurance market value after only Apple, Microsoft, Energy Investments Google and Exxon. Notable businesses share price has outpaced Investment Reading within Berkshire are GEICO Insurance, the market averages Geico Rates Burlington Northern Railroad and with gains of roughly Outlook For Reinsurance Businesses consumer products companies such as 9 Netjets Pickets Fruit of the Loom, Dairy Queen and 10% annualized in the Duracell Purchase From P&G See’s Candies. Berkshire also holds Activists, Spin Offs and Berkshire investments exceeding $10 billion in past decade compared Berkshire’s Housing-Related Businesses each of Wells Fargo (Berkshire owns to 7.7% for the S&P 500 Philanthropy 9.4% of the shares outstanding), Coca- Index. Cola (9.2%), American Express (14.8%), 10 American Express International Business Machines (7.8%) sessions covering 60 questions. Buffett and Use of Cash and H.J. Heinz (50%), among others. Munger are going strong at 84 and 91 years Minimum Wage Berkshire’s share price and young. They communicate in clear-thinking “How To?” Questions shareholders’ equity per share have ways that leave little doubt of their insight How To Become A Good Investor? compounded at more than twice the and accumulated wisdom. How To Attract Money To Manage? 9.9% annual rate of the S&P 500 I was fortunate to attend my first Berkshire How To Build A Network Of Business Contacts stock market index since Buffett took Hathaway meeting in 1986. I was a tyke in If You Haven’t Gone To Business School? control in 1965. Even after Berkshire investing, hoping to learn from the masters. How To Get People To Like You (From A Seven- Year-Old)? became a large enterprise, its growth in I have returned with the same idea to all 11 How To Encourage Thrift In Young People shareholders’ equity and share price has but one meeting since then. Thirty years on outpaced the market averages with gains and roughly the same age now as they were What Matters Most To Buffett and Munger? of roughly 10% annualized during the then, I have as much admiration for the pace 2016 Annual Shareholders Meeting
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they continue to keep as the wisdom there room for compassion within scores for its borrowers because they they impart. For further information, capitalism and at Berkshire? [Clayton were in homes with loans they could readers are encouraged to study is the largest builder of manufactured afford. Buffett’s annual letters to shareholders homes in the U.S. and finances many On 3G’s employment cuts, Buffett available at www.berkshirehathaway. of the homes it sells. 3G Capital is said he had never seen a policy at any com and the book, Poor Charlie’s the investment firm that Berkshire company that it should run with more Almanack, a collection of Munger partnered with in acquiring its interest employees than it needs, but many speeches and presentations. The latest in Heinz. 3G’s partners have also been companies do so anyway. 3G on the annual report includes special sections the driving force behind AB Inbev, the other hand has been very good at from both Buffett and Munger on the owner of Anheuser-Busch Brewing.] getting employment down to what is past and future of Berkshire Hathaway. Buffett, who must have anticipated actually needed. Efficiency is required Buffett and Munger are great this question, responded with a over time in capitalism. Buffett cited thinkers and entertaining teachers. rebuttal of several material inaccuracies the railroad industry, which had 1.6 They celebrate good business and in the Seattle Times report and praised million employees after World War II investment practices, the potential for both Clayton’s lending practices and and now carries far more freight with human achievement, high ethics and its business results. Buffett explained less than 200,000 workers. Munger decency to one’s fellow man. Listening that Clayton retains the mortgages cited the Russian system under to Buffett and Munger, you get a course it writes so that both the borrower communism as an opposite example. in business, investing and decision and Clayton lose when a loan gets in Everyone had a job but there was no making with material reaching across trouble resulting in a foreclosure. Most productivity, resulting in a system eight decades of experience. The course Clayton borrowers have low incomes where the government pretended to is more how to think than what to and low credit scores, but only about pay the employees and the employees think, but in my experience, if you 3% of the loans Clayton makes default pretended to work. disagree strongly with Buffett or each year. The other 97% enable Later, there was a question about Munger, you’ll likely come around to customers to purchase their homes over the leanness with which 3G operates their views if you think about it more. time. Seventy percent of homes that compared with Berkshire, citing that The meeting also serves to ingrain the sell for less than $150,000 in the U.S. it took Berkshire over a decade to exit culture of Berkshire with shareholders are manufactured homes. its textile mills. Buffett explained that and employees. Home lending is regulated in every there was no incongruence. Berkshire These are my notes and recollections state where Clayton lends. In 91 had cut well back in textiles before it rather than a transcript, as recording inspections over the last three years, eventually closed the operations when isn’t allowed. Related subjects are Clayton had an exemplary record, it could no longer make any profit. It grouped together. My thoughts and having paid a total of only $5,500 is not in its economic principles to lose comments are bracketed to distinguish in fines and refunded $110,000 of money even if it is not maximizing them from the comments by Buffett loans made. Munger added that return in every operation. There are and Munger. Clayton has about a 50% share of the some businesses at Berkshire that likely manufactured housing industry. It have some extra people employed. They LENDING PRACTICES AT CLAYTON would not be running its business right tolerate this rather than encourage HOMES; BUSINESS PRACTICES AT 3G at a zero-percent foreclosure rate and it. If 3G ran these operations, there CAPITAL it wouldn’t have survived and earned would probably be some tightening. The first question of the day, a two- a 50% share with a high foreclosure However, Berkshire keeps its promises parter, inquired about a report in the rate either. In the 2008-09 recession, when it acquires companies and Seattle Times of predatory lending at mortgage defaults soared for all types doesn’t force that decision centrally. Clayton Homes and steep reductions in of borrowers on securitized loans. [Decentralization has other benefits employment at Heinz once Berkshire Clayton’s loans performed far better partner 3G Capital took control. Is despite lower incomes and lower credit
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to Berkshire that don’t show up in the employee count and IBM employment costs.] Noting that Munger helped break Buffett of the habit of Buffett cited GEICO and Berkshire’s corporate offices as buying “cigar butt” businesses like the original Berkshire examples of highly efficient operations. Munger added that textile operation, a questioner asked if IBM is a modern-day a job is an important part of people’s lives that requires some equivalent of the textile business and do they agree on the sensitivity, but asked rhetorically where we’d be if we had investment in it. Munger answered that he didn’t try to stop all stayed on the farm 100 years ago. We’d all be pitching Buffett and said IBM is a very creditable company. Berkshire hay by hand instead of sitting at the Berkshire Hathaway has invested in a lot of companies that have had temporary meeting. problems or that were once mightier than they are today. [Their decision boils down to what they expect to get in BERKSHIRE AUTOMOTIVE future cash relative to what they would pay in cash today.] Berkshire entered the car retailing business with the Buffett pointed out that IBM and many other Berkshire acquisition of Van Tuyl Automotive Group in 2015. The investment holdings are regular buyers of their own stocks, purchase prompted several questions. How might changing so a lower stock price doesn’t necessarily hurt them. If buying preferences for cars affect the business, from Buffett was talking his own book he would say pessimistic negotiated to fixed-price sales, for example? Buffett said things to drive the stocks lower so the companies could buy that Berkshire’s businesses adapt to changes of many types more. Munger added the quip of the day: “If people weren’t as needed. While he doesn’t expect buying preferences to so often wrong, we wouldn’t be so rich.” change, he wouldn’t be surprised if they did. Still, people seem to want to negotiate over large purchases like cars and INSURANCE BUSINESSES real estate. A questioner asked if Buffett agreed with Munger’s comments Does Berkshire have a scale advantage in automotive in the annual report that Berkshire’s extraordinary success retailing? Automotive dealerships are local businesses in the insurance industry would be hard to repeat. Buffett without real scale advantages, but they are a good business explained that Berkshire had benefited from three big pieces if run well. Berkshire owns 81 out of about 17,000 auto of luck in insurance. First, Lorimer Davidson, a future dealerships in the U.S., so Buffett expects to buy more CEO of GEICO, spent four hours explaining the insurance dealerships through Van Tuyl (name now changed to business to Buffett when Buffett was 20 years old. Second, Berkshire Automotive Group.) Their success will be based Berkshire was able to buy an outstanding insurance company, on the Van Tuyl culture of ownership and incentives rather National Indemnity, from Jack Ringwalt in 1967 during the than trying to improve margins through scale effects. five minutes each year that Jack would contemplate a sale. Will the price [$4.1 billion] Berkshire paid for Van Tuyl Third, the remarkably talented Ajit Jain came to work for become a yardstick for other automotive acquisitions? Berkshire’s insurance operations in the mid-1980s. Buffett Berkshire paid a full but fair price for Van Tuyl. Profits are said you couldn’t expect that to happen again in insurance, good this year, and it’s a cyclical business so that might argue but it might happen again in another field if starting over for a lower multiple in good times, though that’s likely not from scratch. You have to be open to good ideas as they how the sellers think. come along in business. Buffett was asked why Berkshire was re-insuring across PREDICTING EARNINGS its own insurance subsidiaries. He said the biggest chunk When Buffett and Munger make investment decisions, of capital in Berkshire’s insurance businesses is at National are there specific characteristics that give confidence in the Indemnity. Moving risks originating in other insurance future of a business 10 years in the future? Munger said subsidiaries makes the business easier to manage for Berkshire there is no one-size-fits-all answer, since all businesses are without changing the high likelihood of repayment for the different. Buffett added that various filters help him to rule insured. They are moving the insurance exposure from many things out, more so than in, and it’s not just the business and small pockets to one bigger pocket. price but the people he is looking at too. Another questioner wondered about Berkshire beginning to offer workers’ compensation insurance online. Buffett
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said they were experimenting a bit still be huge [which would be true Buffett joked that he is one quarter to see what the customer wants. He under the current leadership as well]. Coca-Cola based on the number of noted that GEICO insurance began To a subsequent question on culture, calories he has consumed from their as a direct mail offering of insurance Buffett said it was easier to build a good products. He said he is sure he wouldn’t in 1936, then moved to television and culture than to rebuild one, easier to live as long on Brussel sprouts and telephone. Now the company connects build in a small organization instead of broccoli, and folks shopping at Whole with customers primarily through the a large one, and that occasionally you Foods don’t smile as much as the ones Internet. The key for GEICO is saving have to change some things as issues he sees drinking Coke. Munger, who people money on insurance no matter arise. He cited an elder policy that ate See’s peanut brittle constantly how the method of reaching them was put in at Kirby vacuum cleaners during the meeting, is sure that sugar changes. to discourage excessively aggressive has prevented premature “softening of sales practices by providing a money- his arteries.” CULTURE, INTEGRITY AND FUTURE back guarantee for any reason for one More seriously, Buffett pointed out RETURNS AT BERKSHIRE POST year to customers over age 65. With that successful consumer product BUFFETT AND MUNGER companies adapt to the preferences of Asked about the outlook for Berkshire’s their consumers over time. Coca-Cola culture and stockholder returns after Brands like Coca- goes back to 1886 and Heinz to 1869. the current leadership steps down, Brands like these are very durable if Buffett responded that the culture Cola and Heinz are they adapt to change and don’t stand at Berkshire is institutionalized and still. It’s a pretty good bet that people not dependent on personalities. very durable if they will still like these same things in the [Hallmarks of Berkshire’s culture are adapt to change future. decentralized operating management, centralized capital allocation, and don’t stand STOCK MARKET LEVELS appropriate incentives, operating with Is the U.S. stock market valuation high ethics and integrity, keeping your still. too high given that measures such as promises and thinking long term.] corporate profits to gross domestic The board recognizes the culture as a product and stock market capitalization huge advantage and vital to maintain. more than 300,000 employees, Buffett to GDP are near record levels? Buffett Moreover, the board of directors at can almost guarantee that someone is agreed that these ratios are as high as Berkshire is serving for stewardship doing something wrong, so Berkshire they were in 1999 when he wrote about reasons rather than for director’s fees. has an 800 number to encourage people them in Fortune expressing caution [The highest paid directors, those to contact them if something isn’t right about future returns (“Mr. Buffett on serving on the audit committee, or they are worried about something. the Market”). earned $6,700 in 2014 at Berkshire. Munger added that the key is to keep American business has done very In comparison, directors at other large learning and not get stuck in time. well as shown by the corporate-profit- companies typically make $200,000 to to-GDP percentage. Buffett said the $400,000 per year.] At Berkshire, most CHANGING CONSUMER PREFERENCES stock-market-cap-to-GDP ratio is employees are more concerned about Do changing consumer tastes and health affected greatly by low interest rates. doing a good job for the company than consciousness regarding sugar affectProfits are worth more when interest about anything for themselves. On Berkshire’s investments in See’s Candies, rates are 1% than when they are 5%. future returns, Munger said that future Coca-Cola or Heinz? Sugar is less popular If interest rates stay low for a long time, returns for Berkshire shareholders today with consumers but the same idea stock market valuation doesn’t look would not match the historic returns in was current years ago too. Buffett expects out of line. But if interest rates go back percentage terms but the dollars would more, not less Coca-Cola products to be to what was previously thought to be consumed 20 years from now. normal, current valuations will look
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high. Munger asked why anyone would the amount of monetary expansion. Munger said renewables are bound ask them to predict the future since they There are times when governments have to grow in usage because fossil fuels failed to predict the present. Buffett, to print a lot of money for economic won’t last forever. He said he loves that referring to the 3G discussion, added stimulus, but Munger is more of a Berkshire owns MidAmerican Energy that any company with an economist fan of infrastructure spending than and thinks renewables will be a great trying to predict interest rates certainly “throwing money from helicopters.” benefit to mankind and to Berkshire. has one employee too many. Asked if the euro has had a positive There will be some disruption, too, or a negative effect on Europe, Buffett but there is more opportunity than RAILROAD SAFETY joked that the question was too easy for disruption so they embrace it. Wind There were two questions about him, so Munger could take it. Munger and solar are dependent on tax credits railroad safety, particularly related to said the euro had a noble motivation to be competitive with other generation risks and fixes for carrying crude oil by and has done some good, but it is a sources. Berkshire has the capital to rail. Buffett mentioned that new federal flawed system. There are countries invest and the ability to utilize the regulations had just come out two days in it that shouldn’t be there, he said. tax credits, so Berkshire is by far the before the meeting—about 300 pages You can’t form a business partnership biggest developer of wind and solar of new requirements—but he hadn’t with a “frivolous, drunken brother-in- power within the utility industry. had a chance to review them. Berkshire law” and expect it to succeed, he said. certainly has an interest in rail safety Buffett added that the system is flawed MISTAKES, INFLATION, AND and safer railroad cars. As a common but could be amended over time, like PREDICTIONS carrier, railroads are required to carry the U.S. Constitution has changed. Asked to comment on his mistakes, certain dangerous products that other He went on to say that the U.S. and Buffett said Berkshire has had several carriers can refuse. Railroad safety has Canada could probably have a currency companies that went to zero. He improved dramatically over the years union, but you couldn’t put the whole wasn’t misled about any of those. He and will continue to do so. Munger hemisphere into it. just simply got the wrong answer in said Burlington Northern has the best buying them, not fully anticipating safety record among railroads and the USING THE BERKSHIRE NAME AT the changes that occurred. The worst same is true for Berkshire Energy. It SUBSIDIARY COMPANIES of these is Dexter Shoe, not because it would be crazy for any large company Berkshire allows its residential real failed but because Berkshire bought it not to worry a lot about safety, and estate brokerage to use the Berkshire with its valuable stock and ultimately Berkshire invests a lot to improve it. The name. This came about when it bought got very little in return. Though some two pipelines that Berkshire Energy two-thirds of the Prudential Homes companies within Berkshire have owns went from worst to best in safety business but could not use Prudential’s folded, Berkshire itself would not. They after Berkshire bought them. As to name afterward. Buffett said he would are very cautious and wouldn’t even potential liabilities from a rail disaster, yank the Berkshire name if he heard take a 1% chance of that happening in Berkshire has offered reinsurance to about shoddy practices. any circumstance—too many people the railroad industry of $5 billion in depend on Berkshire. excess above the $1 billion retained by UTILITY BUSINESS AND RENEWABLE How might Berkshire fare if so much the railroad. The insurance had a high POWER SOURCES monetary easing around the world price reflecting the exposure, but there Asked what impact the move toward ultimately accelerated inflation? Buffett were no takers. distributed power generation, thinks Berkshire is better positioned renewables and battery storage of than any other large company should U.S. DOLLAR AND THE EURO power would have on Berkshire’s bad things happen. And if you have a Will the U.S. dollar remain the world’s utility operations, Buffett said the long career, you will see a lot of strange reserve currency? Buffett thinks it will best defense against such changes things happen that you would not still be among the reserve currencies in is having a low-cost position and have predicted, for example, negative 50 years. Munger is more nervous about Berkshire’s power business has that. interest rates in Europe. Munger added
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that the trouble with predictions is that people start to think like the Fed who can say that it will do whatever it takes they know something. to stop it. The Fed did that when it stopped the run on the money market funds. He added that in the days before the INCENTIVES AND MESSAGES Fed, the only way to stop a run on the bank was to pile When asked about incentives for managers, Munger physical gold in front of the bank doors! referred to Henry Singleton, the long-time force behind the conglomerate Teledyne, as someone who created very clever VALUE INVESTING OUTSIDE THE U.S. incentive programs for Teledyne’s managers. However, Does value investing work around the globe or just in the the incentives went too far and actually caused problems. U.S.? Buffett replied that value principles don’t stop at Basing incentives on short-term factors, or even just making borders. He uses the principles he learned from Benjamin short-term forecasts, can encourage the wrong behavior, Graham wherever he looks at an investment. He thinks like inflating results or acting in short-term ways that are about buying businesses rather than stocks. He aims to detrimental to long-term success. [Berkshire keeps its take advantage of price fluctuations. He said he looks at incentive programs simple and focused on the long term.] competitive advantages to understand where a business Buffett said one needs to understand human behavior to will be in five, 10 and 20 years. He sticks to his circle of run businesses. CEOs have to be careful of the messages they competence—what he really understands. He thinks about send, even those sent inadvertently. He told a story about what can go wrong and the price he is paying for what he is Jack Ringwalt, who continued to run National Indemnity getting, i.e., his margin of safety. Insurance after he had sold it to Berkshire. Ringwalt berated Munger said “investors” in some emerging markets like his claims manager for the size of new insurance claims that China, are behaving in wildly speculative ways. They’d came in. The manager eventually hid some claims just to likely be better served with more value principles. Buffett avoid being the bearer of bad news. This led to substantial said Berkshire benefits from volatility in markets. Investors losses as delay in dealing with the claims allowed them to who control their emotions to buy when things are selling grow in size and caused mispricing of future business since cheaply and perhaps sell when others get excited can do the estimates of past losses were understated. very well. Munger said value investing will never go out of style, to which Buffett noted that it never seems to get very TOO BIG TO FAIL popular either. Munger replied that is because people want Could Berkshire be classified as a Systemically Important something easy. Investing well may look easy but it isn’t, he Financial Institution (SIFI), i.e., too big to fail, and subject said. to additional regulation? Buffett explained that the SIFI regulation pertains to large financial institutions and OPTIMISM DESPITE BAD THINGS SOMETIMES has been applied to the largest banks, General Electric, HAPPENING Metropolitan Life and Prudential. Being a SIFI is about How worried should people be about the potential use of more than size, and Berkshire is nowhere close to these weapons of mass destruction (chemical, nuclear, biologic other parameters. Any problems at Berkshire would not and cyber weapons)? Evil or crazy people aren’t going away endanger the financial system, so there is no reason to expect and given their potential to do mass harm, the U.S. needs a Berkshire to be designated a SIFI, though competitors don’t very vigilant security operation, Buffett said. like that Berkshire isn’t one and that could pose a risk. In Despite bad things that happen from time to time, the the last financial crisis, Berkshire was a provider of capital to U.S. is a great place with a great system for advancing institutions and the market. human welfare. Even at the slower rates of improvement of Munger said there is still too much risk in high finance, a highly developed country, the U.S. per-capita standard of specifically in derivatives. The Dodd-Frank regulatory living will advance 20% in 20 years. The baby born in the overhaul doesn’t solve the too-big-to-fail problem. The U.S. today is statistically the luckiest person ever in history, Dodd-Frank Act actually weakens some of the necessary Buffett said. powers of the Fed to stop a crisis. When there is a panic, a Munger added that we shouldn’t get too smug—the run on the bank, you have to have someone with credibility U.S. has a lot of competition. The U.S. found a system that
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unleashes human potential 200 years an investor. It isn’t inconceivable that it the right temperaments for investments ago. China didn’t find that until 40 could be one person but is more likely and are helpful in non-investment areas years ago and has come an amazing to be two people working together but too, he said. way since. The U.S. and China are the focused in different areas. People learn two most important countries for the by doing, so having both experiences S&P 500 INDEX VS. HEDGE FUNDS future, and he hopes the two will work is important. [Buffett has often said Buffett has a wager with Protégé together and develop mutual trust. the combination of his business and Partners, a hedge fund-of-funds They “need to find the virtues in each investment experience has made him manager, that the return of the S&P other instead of the flaws,” he said. better at both.] 500 will exceed that of the hedge Later, on the subject of China, funds selected by Protégé over a Munger said he is a big fan of China TED WESCHLER AND TODD COMBS 10-year period. [Buffett, who began and how it’s followed the model Lee A few years back, Buffett hired his career as a hedge fund manager, Kuan Yew used in Singapore. Stopping Ted Weschler and Todd Combs to sees two disadvantages with modern corruption in a country is a big deal— manage investment portfolios at hedge funds that go beyond the skills nobody wants to be governed by a den Berkshire. Since then, Buffett has of the managers: 1) high fees reduce of thieves. China is cracking down on increased the capital they manage to net returns to the investor, and 2) corruption—it even shot a few people, about $7 billion each. Both had run excessive growth in the assets managed and that gets people’s attention on the successful investment funds previously. by successful managers reduces their issue. Buffett described them as smart ability to produce high returns in the about businesses and investments, future.] MANAGEMENT SUCCESSION understanding of competitive strengths The progress of the bet is reported at Is Buffett’s successor likely to be and the realities of business and, most each annual meeting at the end of the one person or two? Buffett said his important, possessing qualities of good morning session. After falling behind successor needs both the skills and character. They are people who do in the bear market during the first experience of running businesses as more than their share and don’t claim year of the wager in 2008, Buffett’s well as the capital allocation skills of credit for more than they do. They have S&P 500 Index side of the bet surged
CALENDAR YEAR S&P 500 INDEX PROTEGE HEDGE FUNDS 2008 -37% -24% 2009 +26% +16% 2010 +15% +8% 2011 +2% -2% 2012 +16% +6% 2013 +32% +12% 2014 +14% +6% Cumulative 63.5% 19.6%
Source: Berkshire Hathaway
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ahead through 2014 as shown in the preceding table. The share in 2015. As for investments like Exxon and Conoco, winner of the bet, which runs through 2017, will donate the Buffett said he won’t buy many energy stocks but he hasn’t $1-million-plus proceeds to charity. bought his last one either, even though energy isn’t an area in which he has distinguished himself. GOOD BUSINESSES FOR INFLATIONARY TIMES Asked what businesses do well in inflationary times, Buffett INVESTMENT READING likened inflation to a giant tapeworm for businesses that For those interested in learning more about investing, causes them to consume more capital without producing Buffett recommends four books, two by Benjamin Graham more in results. Businesses that can do well amid inflation [“The Intelligent Investor” (focus on chapters 8 and 20) and are those that have one-time outlays which don’t require “Security Analysis”], along with “Where are the Customer’s much subsequent reinvestment, or those whose past outlays Yachts?” by Fred Schwed, Jr., first published in 1940, and continue to produce real value in the future. If the asset Adam Smith’s “Wealth of Nations” from 1776 that teaches created with the outlay is of value to others, it will tend to the basics of economics and the division of labor. Munger hold its value in real terms because the cost to replace it is said Adam Smith’s work had really worn well over time— rising with inflation. Businesses requiring high reinvestment its lessons being taught again with the rapid rise of China to maintain their competitive position tend to suffer during following the demise of communism. inflation because the asset costs more to maintain without producing any more real income. Strong consumer brands GEICO RATES increase in value with inflation. For example, Gillette A questioner wondered why GEICO did not have the lowest bought the broadcast rights to the 1939 World Series for auto insurance rate in his particular case—age 78 with a $100,000. The place in the consumers’ mind made with good driving record. Buffett replied that GEICO has the those advertising impressions paid off not just in 1939 but lowest rate about 40% of the time but not in every case. Each for the next 40 years, but had been paid for in 1939 dollars. insurance company weighs variables differently, so no one will be the lowest in every instance. No sizeable company GLOBAL WARMING EFFECT ON INSURANCE has a higher success rate than GEICO on bids, and with only A questioner, noting that some insurance companies 11% of the market, the company still has a lot of potential had mentioned global warming as a risk factor in their customers. Munger, 91, said an elderly driver who hasn’t risk disclosures, asked if it had an effect on Berkshire’s deteriorated as fast as his peers may be paying a bit more for insurance operations. Buffett said there was no impact insurance, but it isn’t a bad tradeoff. because the company prices its insurance every year for a To a question on possible synergies of selling GEICO one-year period. That would be different if he were pricing insurance through the Van Tuyl auto dealerships, Buffett insurance today for risks some years in the future, but that explained that selling insurance through dealerships hasn’t isn’t how Berkshire’s property and casualty business works. been effective. Moreover, GEICO’s model is based on low Munger, while not saying global warming isn’t happening, costs. Adding people in the distribution system can only add espoused the view that some people get carried away with costs. Munger said it’s a dumb idea, and they aren’t going extrapolations, predictions and worries of its effects. to do it.
ENERGY INVESTMENTS OUTLOOK FOR REINSURANCE BUSINESS Buffett was asked if he was now leaving energy investments The reinsurance industry is likely to be less profitable in to Greg Abel at Berkshire Energy (MidAmerican Energy). the next 10 years because of more capital in the industry Noting that Berkshire had sold its investments in Exxon and and more competition from inventive finance vehicles such Conoco, Buffett answered that he is looking to spend big as catastrophe bonds, Buffett said. Berkshire has a very money in the energy field through Berkshire Energy under strong position in big risks with big premiums. Buffett said Greg Abel’s leadership. Berkshire bought the majority of Berkshire has written eight contracts with more than $1 MidAmerican in 1999 for $35.05 per share (it got the last billion premiums and no one else has written any. nickel out of him) and the operation will likely earn $30 per
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NETJETS PICKETS to running Berkshire as a consolidated Asked if Berkshire could spin out Why are NetJets pilots picketing the entity versus breaking it up. [These some of its investment holdings to Berkshire annual meeting? Is Berkshire are detailed in the 2014 annual report shareholders, Munger said it’s not anti-union? Berkshire is negotiating beginning on page 29.] possible under tax laws. Berkshire wages with the pilots and is not anti- Activist investing has grown in could spin off whole businesses to union, Buffett said. Berkshire has good popularity and attracted lots of money shareholders and did spin out a relations with its unions and employees. in recent years. Berkshire is quite large bank years ago due to a regulatory In 50 years and across many businesses, and will be larger still in the future, so requirement. But spin outs are not its Berkshire has experienced only three it might take all the activists combined game plan, he said. strikes, one at its textile mill, one at the to acquire much of a stake in it, Buffett Buffalo News and one at See’s Candy. said. BERKSHIRE’S HOUSING-RELATED The dispute at NetJets is a difference Munger commented that share BUSINESSES of opinion over wages. Pilots currently repurchasing wasn’t as popular when Berkshire has several businesses that make $145,000 per year on average stocks generally were selling for less benefit from housing construction and and work seven days on and seven off. improvement (Acme Brick, Benjamin NetJets has great pilots, and Buffett Moore Paint, Johns Manville and his family fly on the same planes Buffett’s extra Insulation, Shaw Carpets, Clayton with the same pilots as other NetJets wealth doesn’t have Homes and various home furnishing customers. retailers). There was a question much utility for about the subdued rate of household DURACELL PURCHASE FROM P&G formation since the last recession Berkshire has agreed to buy the Duracell him so he wants it affecting housing construction. Buffett business from Proctor & Gamble to go where it can can’t fully explain the slowness in through a stock exchange. A questioner, new family formation, but he expects citing that Duracell is a declining do the most good. it to eventually recover. Munger business, asked whether the purchase He believes more added humorously that he has some is driven by tax considerations. Buffett grandchildren who he hopes will soon said both companies have an after-tax in individual giving find suitable partners. It’s not healthy price advantage in the structure of the to keep looking for pie in the sky, he transfer similar to that of a real estate than corporate said. exchange. Yes, the battery business is giving. declining, but it will be around a long PHILANTHROPY time. This transaction is expected to Buffett is a philanthropist. His extra close in late 2015. than their worth. Now that prices wealth doesn’t have much utility for are higher, repurchasing has lots of him, so he wants it to go where it can ACTIVISTS, SPIN-OFFS AND advocates. Buffett said he has seen do the most good. He believes more in BERKSHIRE lots of contorted, silly discussions of individual giving than corporate giving. Noting the increasing influence of buybacks. If you look at the history of Berkshire’s subsidiaries participate in activist investors on Wall Street, an them, you’ll see that buybacks increase their communities and continue with attendee asked whether activists could when stocks are high and drop off when the giving practices that existed prior someday influence Berkshire, either by they are low. Price matters greatly in to Berkshire’s ownership. Berkshire, forcing a breakup or by forcing large assessing the benefit to shareholders of unlike other companies, doesn’t write share repurchases at premium prices. buybacks, he said. [Berkshire has done checks with shareholders’ money for Buffett said if Berkshire is run right, some small buybacks in the past and is the personal interest of Berkshire’s an activist-driven breakup would not disciplined on price.] managers or directors. Munger said make sense. There are lots of benefits
BROWN ADVISORY BERKSHIRE HATHAWAY ANNUAL SHAREHOLDER MEETING NOTES 9 MAY 2, 2015 MEETING
his personal interest in giving away someone else’s money is HOW TO BECOME A GOOD INVESTOR? quite restrained. Buffett said you have to know your limitations and look for situations that you feel comfortable with for years into AMERICAN EXPRESS the future. Keep reading and thinking. Compare A to B American Express has been in the news recently for not and what you hold to everything else. Be conscious of the renewing a long-term relationship with Costco. A question downside. Munger said they were lucky in some cases but was asked about the strength of AmEx’s defenses against they made their own luck by their curiosity and energy. competition. Buffett said there had been lots of innova- Nothing teaches you as fast as getting knocked on the nose tion and competitive attacks in the payments industry. by some wrong decisions. They were helped by coming from Management at American Express has done a great job of families that had admirable qualities. You can’t accomplish anticipating and responding to these, he said. Munger said much in one generation, Munger said, quoting his wife. AmEx isn’t as powerful as it once was, but it’s still a very good Buffett attributed his early success as an investor to having business. Buffett said AmEx has a great history of adapting a great teacher in Benjamin Graham, exceptional focus, the to change. It started as an express mail service, developed right temperament and enjoying the game. He described travelers checks, and then the charge and travel cards. He investing as a perfect game—hard enough not to be easy but said he is delighted to own 15% of the company. not so hard as to be beyond your capabilities. Buffett said he enjoys running Berkshire much more than his investment USE OF CASH partnership days [perhaps because of the broader life it Why does Berkshire carry so much cash [$60 billion as of allows]. March 31]? Couldn’t it pay down some liabilities? Buffett said Berkshire generates a lot of cash and puts it to work only HOW TO ATTRACT MONEY TO MANAGE? as it finds good opportunities. Berkshire’s liabilities are long Munger answered that they didn’t do very well with that dated. For the few that could possibly be settled or paid off until they had a winning record. Buffett said he had a tough sooner, Buffett gave an example of a $3 billion difference time when he tried selling stocks as a broker in 1950 in (in Berkshire’s favor) between the settlement value of one Omaha. He was 20 years old, looked 16 and probably acted liability and its carrying value. He said it was unlikely the 12. When he came back to Omaha in 1956 after working two sides could get together on this difference before the for Ben Graham in New York, his early partners were people liability comes due in a few years, so it stays open. who trusted him with small sums and who knew he had done well so far. Munger said to avoid being a perfect idiot, show MINIMUM WAGE good character and keep doing it. Munger was practicing Citing income inequality in the U.S. and Buffett’s past law before he met Buffett. Buffett told him that law was fine comments on the subject, a questioner asked if Buffett as a hobby but it was a lousy business. Before long, Munger would favor a large increase in the minimum wage. Citing switched to investments. the sixfold increase in real GDP per capita in his lifetime from $8,000 in 1930 to the current level of $54,000, Buffett HOW TO BUILD A NETWORK OF BUSINESS CONTACTS IF said his parents would have thought everyone would have YOU HAVEN’T GONE TO BUSINESS SCHOOL? a perfectly happy life by now, but that is not how it works. Munger suggested doing the best you can with the hand Buffett thinks everyone who is willing to work should have you’ve got, to which Buffett quipped that Munger is very a decent income. He’s not against raising the wage some, but “Old Testament.” Munger said he didn’t have any business raising it a lot would change the number of job opportunities school training; why should anyone else? for people. He favors the earned income tax credit over a minimum wage increase as a way to address the income HOW TO GET PEOPLE TO LIKE YOU (FROM A SEVEN-YEAR differences. OLD)? Get rich, Munger quipped, and then be very generous. “HOW TO” QUESTIONS He continued that both he and Buffett were a bit on the “How To” questions are a staple of the annual meeting. Here obnoxious side in their early age, but they got better at it is this year’s sampling. over time. Buffett suggested that you think about the people that you admire and like and try to emulate their qualities in
10 BROWN ADVISORY BERKSHIRE HATHAWAY ANNUAL SHAREHOLDER MEETING NOTES MAY 2, 2015 MEETING
yourself. Then, think about the people you don’t like, and try to avoid their qualities too. To another question about building a reputation, Munger explained that reputation typically builds over a long period of time. Very few people develop a reputation quickly, like Charles Lindbergh did with one big event. Yet he knows lots of examples where opportunity came to people because of the credibility they had built up over a long period. Buffett added that you can fool people for a while, but as you get older, you ultimately have the reputation you deserve. The same is true for companies.
HOW TO ENCOURAGE THRIFT IN YOUNG PEOPLE? Buffett encouraged starting early, quoting one of his favorite aphorisms “the chains of habit are too light to feel until they become too heavy to break.” He praised the TV production Secret Millionaires Club as an educational tool. Munger, noting that he had failed with some close relatives in this regard, declined to comment.
WHAT MATTERS MOST TO BUFFETT AND MUNGER? Apart from family, what is most important to them? Munger said it was being as rational as he could be, something that he had always felt a duty about. He believes that the culture of Berkshire is widely admired because it sees and acts so rationally. He thinks it dishonorable to stay stupid when you don’t have to be. Buffett said what most matters is Berkshire doing well. Counting employees, insureds and shareholders, there are more than 1 million people involved with or dependent on Berkshire. He wouldn’t be happy if Berkshire were doing poorly for any of them.
2016 ANNUAL SHAREHOLDERS MEETING The 2016 meeting will be held on Saturday, April 30, 2016, in Omaha, Nebraska. Omaha makes a nice weekend getaway with a number of attractions in addition to the annual meeting events. Make your plans now if you would like to attend. Hotels and planes fill up early.
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