Hathaway and the Buffetteers
Return of the Buffetteers
by John Price
with permission from Investor Journal, August, 1998)
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 answer?
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 life.
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 Buffetts
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
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 Sees 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 and capital.
- 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
- 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
- Ideal purchase: buy more of what
you already like and have because the price is
- Insurance is the most important
business at Berkshire Hathaway.
- Political campaign spending is
an underpriced commodity, it needs legislation
to limit it.
- Berkshire Hathaway gets a 20 to
30% return on equity.
- Jack Welch (CEO of General Electric)
gave his secret of lifego 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 might think.
- Q. What keeps you awake at night?
I dont worry. We do the best we can. We
dont predict currentsjust 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 U.S.
- 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
Hathawayperhaps 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 dont 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 perceptions.
- 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 shouldnt
- Definitely think that the demand
for silver exceeds the supply by approximately
150 million ounces per year.
- 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
- 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 didnt take any salary.
These high management salaries have a pernicious
- Can have a circle of competence
for a particular industry, but not a circle of
competence for individual companies within the
industry. It 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 is money.
- Discount future cash flows at the
long treasury rate. Businesses get credit for
free cash. With the best businesses, you dont
need to keep putting in cash.
- 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
- To understand a company, understand
its products, its competition, and its earning
- The best way to teach finance is
to focus on easy cases. For example, in 1904 anyone
could see that NCR was a wonderful company.
- We like homey, Norman Rockwell
types of companies.
- 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
- It is instructive to do post-mortems,
but dont 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
- 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 tough questions.
- We are willing to wait indefinitely
for the right price for the right stock.
- Scuttlebuttyou cant
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, dont
- Dont worry about risk the
way it is taught at Wharton. Risk is a go/no go
signal for usif it has risk, we just dont
go ahead. We dont 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 cant compensate for risk
by using a high discount rate.
- We dont 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
- The best criterion is to buy businesses
on the assumption that you will hold them for
- Dairy Queen [recently purchased
by Berkshire Hathaway] is a lot different than
McDonalds. For example, it employs a lot less
capital. Nevertheless, McDonalds still gets
a good return on its capital.
- I dont 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.
More Buffett principles can be found in the book
of Warren Buffett: Lessons for Corporate America"
by Larry Cunningham which Buffett recommends.
Buffett's investment principles are
put into practice in the Valuesoft Investment
System -- click
here for details.