Buffett on Buffett

John Price, Ph.D.

Do you have a favorite book? One that is full of underlinings, pencilled remarks and scraps of paper as bookmarks? I do. It is called The Essays of Warren Buffett: Lessons for Corporate America.

This book consists of extracts from Warren Buffett’s letters to the shareholders of Berkshire Hathaway selected by Lawrence Cunningham and grouped into chapters covering five major themes.

However you measure Buffett’s investment achievements, they are exceptional. When he took over Berkshire Hathaway in 1965, its book value was $19.46. Now it is around $26,000. Or consider its share price: around $15 in 1965 and now almost $80,000.

However, I think he brings another quality to business that is even more important. Don’t get me wrong. I would love to have been one of those early investors with Buffett who is now a multi-millionaire. But these are isolated cases. His real impact on business is through the honesty, openness and fair-dealing that he brings to it.

It is one of those wonderful truths that when we see it, we wonder how we could have even lost it in the first place. It often seems that most businesses will do all that they can to exploit every loophole and your word is only good until you can employ a lawyer to explain to the world that you didn’t really mean it. (See the article Conscious Investing: Putting Your Money Where Your Beliefs Are by Sandy Price and myself.) Yet I believe that Buffett is showing us that business success comes because of honesty and fair pay, rather than despite it.

Consider the letter Buffett sends to potential sellers of businesses. In it he says that most buyers will say that they need the owners to keep running the business, but in many cases do not keep to this understanding. Buffett continues, "We will behave exactly as promised, both because we have so promised, and because we need to in order to achieve the best business results." (p. 156, my italics)

Or consider taxes. Unlike so many managers, he has no complaint about the taxes Berkshire Hathaway pays, both directly through operating earnings and capital gains and indirectly through the companies it invests in. (p. 205) He once quipped that he would rather be on this side of the taxes instead of receiving government benefits.

This is not to say that Buffett sees his role as bailing out distressed companies. As he remarked a few weeks ago at the annual meeting of Berkshire Hathaway, "We are not in the business of being white knights, but in the business of being investors."

Buffett enjoys making jokes at his own expense. At one meeting he said, "At our annual meetings, someone usually asks, ‘What happens to this place if you get hit by a truck?’ I’m glad they are still asking the question in this form. It won’t be too long before the query becomes, ‘What happens to this place if you don’t get hit by a truck?’" (p. 39)

Another time, after discussing how twice he lost money on sales of Cap Cities, he wisecracked "Maybe its time to get a guardian appointed." (p. 111)

In many places, Buffett supplies the general philosophy of how he chooses companies for Berkshire Hathaway. For example, "Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite—that is, consistently employ ever-greater amounts of capital at very low rates of return. " (p. 86)

How does he locate such companies? This is the most unsatisfactory part of the book. In fact, of everything written by Buffett. On page 187 we learn that "the only logical approach to evaluating relative attractiveness of investments and businesses [is the calculation of intrinsic value, defined] as the discounted value of the cash that can be taken out of a business during its remaining life." Then he says that it can only be an estimate, rather than a precise figure and that two people looking at the same set of facts would likely come up with different figures.

Fair enough. But what we would all like to be told is how he calculates the intrinsic value of a particular company. In the case of Berkshire Hathaway, Buffett teases us with "our annual reports do supply … the facts that we ourselves use to calculate this value." At least this confirms what we might have guessed: he does not make use of analysts’ predictions.

Buffett is more revealing about things that he does not like: "the absurdity of ‘cash flow’ numbers in Wall Street reports" (p. 185), the "abomination EBDIT—earnings before depreciation, interest and taxes" (p. 106) and "the most egregious case of let’s-not-face-up-to reality behavior by executives and accountants" has occurred in the issuance of stock options to management and employees (p. 198).

On the brighter side, filling this gap between what Buffett says about valuing a company and how he does it was the motivation for me to develop Valuesoft. The result: I now have an investment software and seminar business.

At the 1998 annual meeting of Berkshire Hathaway, Buffett said that he likes homey, Norman Rockwell types of companies. This seems appropriate since his approach to business is a homey, Norman Rockwell style. He brings a nostalgia for a simpler time when business was done with a nod and a handshake. Many times he has said that the three most important words in investing are those that he got from Benjamin Graham: always allow for a "margin of safety." If I had a chance to say two words to WB, they would be "thank you."

The book costs $17.45: to order click here. Alternatively you can purchase a complete set of Buffett’s letters to Berkshire Hathaway shareholders by writing directly to the company. You can also get more details about Valuesoft by clicking here.