Here is my takeaway from the Q&A session with Warren Buffett, taken from 13 pages of handwritten notes. The quotations are direct quotes of Mr. Buffett, and the rest is paraphrased from my scribbles…so hopefully it’s reasonably accurate. The questions are only summaries; I tried to get the most important points.
1. (University of Nebraska-Lincoln) With talk of financial regulation and illegalizing derivatives, the so called weapons of financial mass destruction, what is your position on illegalizing derivatives?
a. A derivative is any type of transaction with settlement in the future. Some derivatives carry settlement dates 100 years in the future. Securities have typically been traded with 5 day settlement periods. With settlements out to Judgment Day people have less and less incentives to honor their contracts. Example: I once purchased a derivative for $400K from a Chinese businessman. When it was time to settle, I sent my manager to find the businessman who had vanished. We found him alright; but the businessman’s response was, “I could have you killed for less than $400K.” We dropped the case. Equity-put options often carry settlements of 20 years or longer. Gross receivables on JP Morgan’s and Merrill Lynch’s books are worth trillions, but are present-valued to a small fraction of that using indexes measuring everything from stocks to poverty levels. The same external auditor doing both receivable and payable audits place different values on both ends of the same transaction; it’s very dangerous to have a situation where the solvency of the economy depends on the solvency of all the different agents involved in the derivative market. Derivatives and collateralized securities should be used only as they were initially intended—to lock in fuel prices and interest rates for a short period of time.
2. (St. Louis MBA) Where do you see gold going? With the rising price of gold are gold and gold mining companies good investments?
a. Yes, because there is a lot of fear. Aesop had it figured out a long time ago when he wrote that a bird in the hand is worth two in the bush. “But is the bird really in the bush? And, how long will it take us to get the bird out of the bush?” We’ve all been taught to value investments based on the timing, amounts, and predictability of future cash flows. This model is hard to apply to gold. If we were to amass all the gold in the world together it would be a cube 76 feet square and would be worth approx.. $7 trillion at today’s prices. This would equal the value of all the farmland in the US (1 billion acres, 60% tillable) plus ten Exxon-Mobil companies plus $1 trillion left over for “walking around money.” With $7 trillion dollars, would I rather own the cube or own all the farmland and be able to employ millions of people? There is some speculation that gold could go as high as $10,000 an ounce. If that happens the value of the cube would be approximately the same as the value of the United States. Which is more valuable? The US is constantly improving; things are better for each generation than the last. Our real GDP has increased six-fold since 1930—no other country has come close to matching that level of prosperity. I read about an Andy Warhol painting of a Coke bottle that sold the other day for $60 million and change. It’s difficult to value paintings based on amounts, timing, and reliability of future cash flows. “And it was only an 8 ounce Coke bottle.” People in Zimbabwe are rich in the morning and poor in the evening. People fearful of inflation turn to gold—“not because gold does something, but because people have always ran to gold when they are fearful.” Let’s think about gold for a minute; we dig it up from deep in the ground in Africa at great expense, often with loss of life, we start wars to decide who owns the mines, we dig it up, ship it to the US and Switzerland and dig a deep hole and put it back in the ground to keep it safe. Investing in gold is like investing in fear, and that’s something I do not understand. I won’t be buying any gold.
3. (Notre Dame MBA) Could you tell us about a moral or ethical dilemma you’ve faced and share how you dealt with it?
a. One time Charlie Munger and I traveled to Memphis to visit a chewing tobacco company that we had been approached about buying. It was a sound business with passionate management, way undervalued. They only made chewing tobacco, not cigarettes or cigars, which are more harmful to health. I did some research and saw that chewing tobacco carried high risks of oral cancer. The tobacco company executives all chewed tobacco and had their offices and cars outfitted with places to spit. One of them had a 93-year old grandmother who was still chewing tobacco (“I wouldn’t want to date her”). They tried convincing us that tobacco was not really that harmful to people. During a break in the meeting, Charlie and I went outside and talked about it; I didn’t feel quite right about buying the business even though there was no doubt in my mind that it would be a very profitable investment. We did not do the deal. I don’t have a problem with my businesses selling tobacco; I own distributors who distribute tobacco products to Wal-Mart; one of my convenience store lines makes most of the profit from tobacco products. I didn’t want to own the manufacturing company. It’s alright for others to own them but each needs to follow his own principles. Principles are principles because they aren’t meant to be changed. I can’t point to a specific principle that prohibits me from buying tobacco companies but I won’t do it.
4. (Northern Arizona University BA) Were there any other economic indicators you looked at other than railroads when you bought Burlington-Northern? Are there any other strong economic indicators besides shipping and railroads?
a. American Express is an incredible indicator and shows spending habits of consumers. It was interesting watching the weekly spending reports I get sent from American Express, the data clearly showed activity of consumers. But my strategy is to buy sound companies independent of macro-economic conditions. I am not a good predictor of macro influences. Charlie and I believe that the macro scene is random cyclical and don’t base investing decisions on it. I bought Burlington-Northern because it was a well-managed company that was trading for a good price. I bought 32,000 miles of rail that is being used to transport goods to consumers. When commerce increases my rail traffic will be more profitable as people buy more goods and economy strengthens. I only care about one of the 4 areas of investing (important knowable, important unknowable, unimportant knowable, unimportant unknowable): the important and the knowable. Our theme song at See’s Candies is “What a Friend We Have in Jesus,” and that’s not a coincidence, the candy business is very seasonal and we make 40% of our profit during the holiday season. Candy buying data is strikingly indicative that men have little creativity and never plan ahead. Sales spike on Valentine’s Day; men everywhere are driving down the freeway at 4:30 in the afternoon and will swerve off onto an exit ramp in a mad rush to find a candy store. Gillette has proven this; razors are not hi-tech, there’s no special skill to encasing a piece of steel in plastic. We make 70% of the world’s razors by value; men everywhere use them every morning, not because they’re the best thing for the job, but because men have always used Gillette. The “two minutes of creativity a man has each day” come when he decides which side of his face to shave first.
5. (Rotman MBA) How would you rate Ben Bernanke’s performance?
a. I recently wrote a thank-you letter to Uncle Sam, it’s published in the New York Times a few days ago, thanking everyone for everything they’ve done to keep our economy from falling apart. When Lehman Brothers went into insolvency in 2008, I was suddenly popular at parties with women. They crowded around me asking about their retirement funds and money market accounts. The point is that everyone was very worried about the banks that were going under. Half of the Fed’s $7 trillion dollars were in banks, the other half was in commercial paper. When the commercial paper accounts froze for a week in September, everybody lost trust in the system. T-bills were selling for premiums on 0% interest; in other words, people felt better about owning T-bills than putting cash under their mattress. I sold $5 million in 4-month T-bills to someone for $5,000,090. They chose to pay me $90 for the chance to own T-bills which matured in the future over holding onto their cash. Ben did a great job because he had the courage to act. Other Fed chairmen would have frozen and not done anything until it was too late. Ben is a very smart, has access to powerful data, and is totally devoted to the public good. His looks portray him as a soft man, but he barks when he walks into the room and everybody listens. Ben is doing a great job as Fed Chairman.
6. (Boston College MBA) Tell us a little about your work with the Bill & Melinda Gates Foundation, how is your new “Giving Pledge” campaign going?
Similar question: (St. Louis College MBA) What is your motivation for funding the Bill & Melinda Gates Foundation?
a. Giving Pledge is our campaign to get people in the Forbes 400 list to pledge half of their wealth to charitable causes. All of these people are worth over $1 billion, so they won’t even notice if they give half of it away. I’ve personally called 80-100 of these people already and have gotten around 40 people pledged to do this after a single phone call. Granted, I’ve started with some of the “easier” names, the hedge fund types haven’t shown much interest yet. I met with David Rockefeller in New York and he agreed to host a dinner with several others with similar interests at his place. About 10 of us showed up and all were very open to philanthropy. We talked about how to deal with wealth, how to work out these details before we are dead or too old to make good decisions. Many of these folks talked about their children, some had good relationships, some not so good, but it was good to sit together and share feelings. It seemed like we all had similar motives and really wanted to do the right thing with wealth. Later I had a similar meeting in China with 75 Chinese billionaires. In spite of culture differences, our conversations were remarkably similar as at the New York dinner. They talked about their families, their governments, and they all “wanted to do something about their death.” I feel good about giving my wealth to the Bill & Melinda Gates Foundation. My children are good with choosing who to give money to, but I needed an organization prepared to handle wealth of scale. Bill & Melinda Gates have come into wealth and are good at handling charitable work on a large scale. They have youth on their sides, they’re in their 40s and 50s with enough experience to handle the money side and a good amount of years left and the brain power to make good decisions. Philanthropy is something I am not good at. I don’t have the time to comb through requests and decide which ones are good sources to send money. Philanthropy is not like a business. There is zero market feedback with philanthropy. A person selling something in a business will soon know whether pricing or quality of goods or services is acceptable; not so with giving money away. Philanthropy is different from the giving people do every day or at church on Sundays. By giving money for a good cause they are giving up something, maybe nice clothing, a movie, something. Philanthropists don’t have to make a sacrifice; they don’t have to give up anything they want. I always got everything I want, but I don’t want very many things. The real givers give up something in order to make a monetary contribution to a good cause. Many philanthropic funds don’t end up where they should be, but if we can cure the world of malaria, that’s huge. I could put my wealth in a tomb and “put Egypt out of business.” I could “hire 50,000 of the world’s highest paid actors to haul granite slabs for me” and build a monument that would dwarf the pyramids. “Money represents claim checks for goods and services in the future.” Why would I want to spend it building a monument? You can see the letters I wrote to B&MG on my website, there are few stipulations. I want all of my wealth “spent” within 10 years of my death. I stipulate that it has to really be spent and not just transferred to different agencies; I don’t want someone I don’t know fighting over this wealth 40 years after I’m dead. I feel comfortable with B&MG taking control of this aspect of my business. They don’t charge anything for this service and it’s a huge benefit to me and the world to put this wealth into responsible hands. I told my wife-to-be when we were in our 20s that we were going to be rich someday, but she “thought it was just a pickup line.” I always thought she would outlive me. My wife loved giving away money, and she was very good at it, but when she died in 2004 I had to find a different plan. The plans we made just were not adequate to give away this amount of wealth. Adam Smith wrote back in the 1700s about “specialization of duties.” He didn’t write about specialists of philanthropy but his theories still apply. People hire wealth management specialists all the time to manage their wealth, but they think they can be in charge of spending it and deciding what the best charities are. I invest only in companies I understand, why would I want to spend money when I don’t understand what I’m spending it on? B&MG is the perfect solution for me and they don’t charge a thing. “Philanthropy makes me feel important.” If I were given the choice of being the world’s greatest lover but regarded as the worst, or being the world’s worst lover but regarded as the best, I would choose to be the best lover. Inner scorecard is more important than outer scorecard. People’s inner scorecards always show at some point, you want the inner man to be in order. I want this money spent after my death on things that do the most good for the most people. I won’t be around to make decisions then. “I’m good at thinking outside of the box, but not that good.”
7. (Houston MBA) What do you look for in successful businesses? How have your ideas changed over time?
a. I look for passion more than ability. I know they have ability since they’re in business, but not everybody has the passion to stick with it after they have a good year, or when times are tough. I don’t want to paint another’s painting. I won’t run their business, I want managers to have the ability to continue what they were doing before I gave them a check for $100 million. I like applause, I’m good at giving applause. A good “entrance strategy” is more important than a good exit strategy. I’m not interested in buying businesses that were built to be sold.
8. (Wharton MBA) If investment management does not provide a service for the world, what kinds of careers should we choose?
a. “Wealth gives people a podium” from which they can do a lot of good if they choose. Charlie Munger bemoaned the fact that a lot of really smart people turn out to be hedge fund managers, rather than doing something that improves humanity. There’s “nothing wrong with making a lot of money” “you’ll get over it.” The biomedical science field is a good place for smart people to really shine, but they need funds to do research.
9. (University of Nebraska-Lincoln MBA) Outside of business, what are you most proud of?
a. I’m proud of my wife, proud of my children, my wife “gets 98% of the credit, but I get 100% of the credit for choosing her.” The first teacher for your children is yourself; never underestimate the value of that. “Nobody that feels good about their kids feels like a failure in life.” It’s important that parents feel good about their children, and it helps to spend time with them. There is no rewind button on family life; you get one chance at it, although it takes some people 2, 3, or 4 tries to get it right, your time is very limited. Like the Germans did during the Holocaust, look for people who will “hide you.” Always associate with those better than yourself. You want to find people who will stick with you for the duration, people you can trust with your life because that’s what it comes down to. Satisfaction is important and attainable in life.
10. (St. Louis College MBA) What are the biggest challenges facing leaders today?
a. The world is a better place than it used to be. “I don’t worry about material success at all.” My biggest fear is nuclear or biological warfare. You’ll always have fanatics, in the Stone Age, they could throw stones at their neighbors, but that was about it. Now, a religious fanatic can wipe out a city. Weapons are progressing quickly. As Albert Einstein said after figuring out how to split the atom, “This changes everything in the world except how people think.” Nuclear and biological weapons are progressing at a rapid pace—much faster than the population is growing. Evil people need four things to destroy: Intent, Knowledge, Delivery, and Materials. In Congress now we’re trying to restrict materials. The bigger picture requires effort on all four fronts. We need political leadership; leaders get elected on promises to confront the evil but don’t follow through after they get in office because of the resources required and the unpopularity of the choices required.
11. (Notre Dame MBA) Do you really think that emerging countries pose a challenge to US superpower status, counting China as an emerging country based on per capita GDP?
a. The world is not a zero-sum game. Would you really want a world which has one superpower, is an island of prosperity in a sea of oppression and poverty? I want a world that is continually improving, not one that drives people to poverty for the sake of furthering the interests of a superpower. It’s a good thing that this world is growing; unfortunately China is a huge political football. Politically, in the US, there are three places to point to blame the economy failure: Wall Street, Washington, and China. Wall Street is good at shrugging off blame and Washington, in the interest of politics, is likely to shift more of the blame onto China, unfortunately. It’s very counter-productive to point at China. Do you really want 1.3 billion people not living up to their potential? We will all suffer. Medical advancements and cures for epidemics have taken place in Europe and other parts of the world. We benefit from penicillin today, without even thinking where it came from. There is “no pride of ownership for epidemic cures.” I applaud China for what they are doing and I hope we don’t hold them back.
12. (Northern Arizona University BA) Does our use of import certificates undervalue Chinese currency?
a. Trade imbalances are dangerous. China ships $300 million worth of goods to the US and we give them $75 million and some pieces of paper that they can exchange for T-bills in the future. They hold the paper and continue producing goods. Adam Smith based his trading on limited resources, today we bank on “pieces of paper” because people trust us. Smith didn’t write about how to manage unlimited trust and commercial paper. Import certificates were designed to enable trade without regard to country or industry. We’ll need to deflate our way out of this deficit, and it’s highly unlikely that future generations will want to honor our paper held by China if and when they decide to cash in. When these claim checks are cashed into our economy in the future, we’ll have to give up goods and services in order to satisfy their demands. What is more likely is that we’ll devalue the payables or disregard them entirely. So far people keep taking our pieces of paper. “They aren’t very smart.” “China would be better off turning their ships around in the harbor and distributing their products in their own country.
13. (Rotman MBA) Do global differences in regulation influence company values?
a. Regulation certainly differs from country to country. There’s nothing wrong with other country’s regulation as a rule, it’s just different. I’m not too concerned with other country’s regulations, as long as I understand their tax structure and a little of their culture I feel comfortable doing global business. I wouldn’t touch Zimbabwe but most moderately developed countries are fairly stable. The important part is finding passionate management and a trustworthy government. I once dealt with a Japanese CEO who wanted me to buy his business. He wanted me to come to Japan, but I don’t like Japanese food and he didn’t like American food. After some time had passed, I invited him to Omaha again in May or some month, but he was horrified because it was bad luck to come during that month or something like that. I wondered if “he might think it was bad luck to continue running his business after he received a check from me.” We didn’t make the deal. There was a person from Israel who contacted me about buying his company. He offered to meet me in my office and sent me all his financials. The company looked sound and he showed up at my office. He was a very passionate and intelligent man; he walked out of my office with $4 billion. He wanted me to visit Israel to tour his factories but I didn’t have any desire to go to Israel. He insisted that part of the deal include me traveling to Israel to tour his plants. Several months later I took him up on his offer and traveled to Israel. He had spectacular state of the art plants and I was very impressed. He asked me, “didn’t I wish I had gone sooner?” I said, “No, if I had, I would have been tempted to pay more for your company.”
14. (Boston College MBA) Could you define your no-fuss culture here at Berkshire Hathaway?
a. I write the entire BH annual report, it’s 130 pages long this year. I include the letters I write to my managers, BH principles are stated in there. I want to have a warm brand, Sam Walton did it, long after his death, Wal-Mart keeps on running just like Sam were still around. I want to leave a culture that lasts. BH culture self-selects a given crowd. People who want to make a lot of money quick don’t come here.
15. (Houston MBA) What did you look for in your recent selection of a successor?
a. I was looking for someone with integrity (integrity is still important), the ability, and someone who wants to make a life at Berkshire Hathaway. People who buy BH plan on keeping it for the duration, we’re a tight family. Buying BH is like buying a farm; you expect to keep it for life. I wanted someone who wants to come to BH. I run BH a little different than other companies. Directors are paid $900 a year and have no liability insurance. Other firms pay their directors $300,000 a year to sit in on a few meetings and give them liability insurance with frees them of any personal liability in the company. BH’s directors are here because they like BH. If they screw it up they could lose all they own. $900 a year is nothing. BH wants people who care about the business. We never lost a manager we didn’t want to lose. And we only a lost a very few to the competition. I have one manager here now who could easily make 10 times his current salary working for a competitor. He doesn’t want to leave, that’s the kind of people BH has. Todd Combs will make a great CEO of BH; odds are high that he will still be running investments here 20 years after I’m gone. He will make a lot of money here at BH, not as much as at other firms, but a lot. We don’t have a pyramid structure here at BH. In other firms, the top 4-6 people are competing with each other hoping someone else makes a mistake so they have a chance at the one spot at the top. We pay like a lot of other firms, 10% on outperformance of the S&P, but if there are more than one investment manager, the pay stays the same but we take the bonus out of base salary. Managers also get paid a bonus based on the performance of their coworkers, which takes away competition and encourages them to work together.
16. (Wharton MBA) Is there any type of research or resource that is undervalued when pricing stocks?
a. “The brain.” We don’t have research analysts, we simply think about our investments. I read 5 daily newspapers, and spend 5-6 hours a day reading. Investing knowledge is cumulative, which means what I read 40 years is still valid today. The really attractive things you have to find on your own. I bought a used Moody’s book on Amazon (bet they wondered what a guy from Omaha wanted with a 40-year old Moody’s directory of companies, most old guys would be ordering back issues of Playboy instead) and brought it here today. Here on page 1463 I found a listing for a company called Western Securities that has earnings of $21.29 a share, but the price has been between $3 and $13 a share. It was a local Nebraska company so I went to an agent’s office and the business appeared sound and legitimate. I bought enough to make it 25% of my portfolio, one of the best investments, I only wish I had bought more of it, but I had just bought 75% of GEICO at a good price as well. I read this entire book and many more like it, scanning each page for stocks that looked undervalued. Now we have filters and our computer do this for us while we sleep but then everything was in these books. We can buy with the click of a button and sell a minute later with another click. This liquidity is harmful for investors. I tell my managers to think of investing as if they had a life punch card with 20 slots, one punch for each investment. This way they really think about what they are buying.
17. (University of Nebraska-Lincoln) How do you feel about Nebraska joining the Big 10?
a. Some funny quips about their football team which previously lost, but now is 9-1.