I try to write here about some of my investing experiences in India and abroad. I also review a few investment related books I read along the way and comment on news items that catch my eye. The title of the blog is not intended as a boast, but borrowed from the title of a famous book on investing written more than 50 years ago by Benjamin Graham.
Alongside the Berkshire meeting, Wesco Financials' meetings are a treat for the hardcore addicts. This year was the last of the Wesco meetings where you can see the Abominable No Man Charlie Munger dishing it out for the value investors without abandon. Due to the pending merger between Berkshire and Wesco, this year was the last such meeting. Though, Mr. Munger continues to be the Vice Chairman of Berkshire Hathaway - it will not be the same.
I didn't make it to the meeting. However, there was good coverage - paid and unpaid.
Going to Omaha and Pasadena every May had become a fixture in my life for the past few years. I decided to break with this little tradition starting this year. Initial thoughts were driven by the difficulty of managing two mostly personal trips to the other side of the world in a gap of one month (the second for other unavoidable reasons). Then, came the news that Berkshire was splitting the B shares and the final nail in the coffin was that the canceled international shareholders meet and greet. The last one is where people from outside North America got to meet the man himself. Besides, over the years the quality of the crowd has been deteriorating, that is, in their seriousness towards Berkshire business. Now, it has ceased to be less of a convention and more of a vacation spot.
My decision cannot be equated with a full blown-out divorce, it is more like a couple deciding that they need to spend time apart. And, the big significant difference is this relationship is one sided commitment from my side.
Twitter and live coverage by Omaha World Herald and Morningstar made up for the physical distance. Other bloggers have done an excellent job of note taking and posting them. I am posting some links at the end here.
First some excerpts from the annual report for 2009 and the letter to shareholders:- Dividends
Following a question in 2009 meeting, he added an explanation to the Principle 9 of the Owner's Manual. (For the uninitiated, Berkshire codified its Owner-related principles in 1996 and it addresses the agency problems inherent in a corporate form of organisation where the manager's interests and the owner-shareholder's interests are not aligned. It is a must read for any management/finance professional).
"We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.
I should have written the “five-year rolling basis” sentence differently, an error I didn’t realize until I received a question about this subject at the 2009 annual meeting.
When the stock market has declined sharply over a five-year stretch, our market-price premium to book value has sometimes shrunk. And when that happens, we fail the test as I improperly formulated it. In fact, we fell far short as early as 1971-75, well before I wrote this principle in 1983.
The five-year test should be: (1) during the period did our book-value gain exceed the performance of the S&P; and (2) did our stock consistently sell at a premium to book, meaning that every $1 of retained earnings was always worth more than $1? If these tests are met, retaining earnings has made sense."
Earlier it said:
"We continue to pass the test, but the challenges of doing so have grown more difficult. If we reach the point that we can’t create extra value by retaining earnings, we will pay them out and let our shareholders deploy the funds." And, the question last year was, since you failed this test, will you pay a dividend?
From this year's meeting - "Buffett is asked about whether Berskshire would issue a dividend. Buffett says every dollar left in the business has produced something over a $1.30. Buffett says Berkshire has met the test of finding profitability. Berkshire has made every $1 of retained earnings make more than $1. Buffett says if the company does that over time, it will continue to retain earnings. "
Investment Strategy
"In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite willing to enter businesses that regularly require large capital expenditures. We expect only that these businesses have reasonable expectations of earning decent returns on the incremental sums they invest. If our expectations are met – and we believe that they will be – Berkshire’s ever-growing collection of good to great businesses should produce above-average, though certainly not spectacular, returns in the decades ahead."
Tweets:- when premiums are wrong, go play golf. (too many ppl confuse action w progress/value) Buffett: events around world of last few years makes me more bearish on all currencies than before
We have always had the same potential, it's our perception of what is possible that changes.
Buffett: lending money (buying bonds) boils down to "are they going to broke or not", equity q is much more complicated
Buffett: I knew enough to lend them money, but didn't have enough info to buy the equity [in Harley]
LOL! Buffett: I kinda like a business where guys tattoo your name on their chest [re: Harley]
"If you wanted to bet on higher or lower inflation, you'd want to vote on higher. Maybe a lot higher."
Buffett: your money can be inflated away, but your talent can't be inflated away--regardless of the currency
Buffett: if inflation gets going, it will be hard to stop; trend is not destiny, we have power to control our future
"Talent is the perfect asset to deal with any monetary condition (inflation/deflation). Charlie and I will have to rely on money." When it comes to managing money, Charlie Munger just said: "Take the high road. It's far less crowded."
"I think we're in for a long period for where the ordinary result is not going to be very exciting." -- Munger.
Charlie: equities are the best of a bad lot of available opportunities. In for a long period where ordinary result not exciting
Charlie: fundamental theory is pragmatism because it suits our natures and because it seems to work better
"It's not about how big your circle of competence is but rather on knowing where the perimeter is" -Buffett
Buffett says the pressure of extraordinarily low interest rates on asset prices is hard to overestimate
Buffet on 0.10% interest rates: If you invested at 0.10% when Columbus landed...you would have almost doubled your money by now!
Speculators do no harm if they are bubbles on a steady stream of enterprise - WB quoting Keynes
...but it will be ill-done if enterprise becomes a bubble on a whirlpool of speculation - Buffett quoting Keynes
Munger says stats on gov't debt are misleading because only includes bonds outstanding and not unfunded obligations
"if you want to give away all of your money to charity, it's a great tax dodge." - Warren Buffet
Munger: If BRK would create make-work jobs to increase human hope, the effect over time would be to reduce human hope
"If you believe in creative destruction...as we do in this country..you better also have a social safety net" -Buffett
Munger: The politicians are not behaving better now that the newspapers are weakening. We're going to miss the newspapers.
Munger: It can be hard in India because of gov't regulations. This could lead to faster growth in other emerging markets like China
On buying a rail road:-
"Our BNSF operation, it should be noted, has certain important economic characteristics that resemble those of our electric utilities. In both cases we provide fundamental services that are, and will remain, essential to the economic well-being of our customers, the communities we serve, and indeed the nation. Both will require heavy investment that greatly exceeds depreciation allowances for decades to come. Both must also plan far ahead to satisfy demand that is expected to outstrip the needs of the past. Finally, both require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace and expand the plant.
We see a “social compact” existing between the public and our railroad business, just as is the case with our utilities. If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should – and we believe will – understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without its possessing first-class electricity and railroad systems. We will do our part to see that they exist.
In the future, BNSF results will be included in this “regulated utility” section. Aside from the two businesses having similar underlying economic characteristics, both are logical users of substantial amounts of debt that is not guaranteed by Berkshire. Both will retain most of their earnings. Both will earn and invest large sums in good times or bad, though the railroad will display the greater cyclicality. Overall, we expect this regulated sector to deliver significantly increased earnings over time, albeit at the cost of our investing many tens – yes, tens – of billions of dollars of incremental equity capital." Managing and Evaluating Managerial Performance
Buffett clarifies Berkshire's measurement metrics for evaluating managerial performance. "From the start, Charlie and I have believed in having a rational and unbending standard for measuring what we have – or have not – accomplished. That keeps us from the temptation of seeing where the arrow of performance lands and then painting the bull’s eye around it."
Then he guides you through the maze of seemingly complex thought process to arrive at a simple solution that is typical of Buffett. S&P 500 is the benchmark; Berkshire's share price can be influenced by market forces that are beyond the control of the management; intrinsic value of Berkshire is hard to calculate; so we use book value though it understates. Then he goes to show you what if they had calculated performance using market value. And the conclusion, "..our defense has been better than our offense, and that’s likely to continue." and that "our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue." and promises better-than-average results due to the outstanding businesses and truly great managers.
Reiterating the managerial excellence is a little movie that is played with music to "My Favorite Things" from The Sound of Music. And comments like "If Charlie, I and Ajit are ever in a sinking boat – and you can only save one of us – swim to Ajit." (talking about Ajit Jain of National Indemnity)
From the meeting (courtesy Omaha World Herald's Joe Ruff)- "Buffett is asked about compensation of its managers. Buffett says Berkshire never uses a compensation consultation. Buffett says it is hard to determine one standard for Berkshire's diverse companies. Buffett says some businesses are easier to manage than others, some use more capital expenses than others. Buffett says he tries to figure out how best to pay people based on the economic characteristics of their industries. Buffett says it does not take that much time and it is not rocket science. But he says it does take some understanding of the characteristics of the different companies. And he says it requires some interaction with the managers, with them and Buffett sharing ideas about what they really are contributing to the company. Buffett says Berkshire pays some big money, with manager making 10s of millions annually. And we have managers if we suffer they suffer. But Buffett says everyone wants to be treated fairly. Buffett says the important thing is to have the salaries reached understood by the managers. Buffett says managers really need to widen their moats compared with other companies in their industries. Munger says it is amazing how simple it has been, how little time it has taken and how well it has worked."
"Buffett is asked about having managers who misbehave ethically or legally. Would Berkshire intervene then? Buffett says yes, sure. Buffett says he wants to hear about problems. Buffett says there is an internal function in Berkshire that anything that comes in relating to alleged bad behavior it will be investigated by Berkshire. Everyone once in awhile there have been important transgressions that have come to me. We encourage that. Buffett says a letter goes out every two years, a page and half long. Buffett says in the letter it talks about having more money than it needs, but reputation is important. Buffett says a new line says if reason you are doing something because the next guy is doing it, that is not good enough. Buffett says there has to be a reason better than that. Buffett says Berkshire will have more trouble than it has in the past because it is so much bigger than it used to be. But Buffett says he and Munger want to hear about it fast if there is trouble."
Tweets:- Buffett on compensation: It's not rocket science but requires an interaction w/ managers: what do they actually add 2 the company? Buffett: what I pay managers for is to widen the moat
Buffett on compensation: You still have to treat people fair, even if they don't need the money. "Lose money for the firm and I will be understanding. Lose a shred of reputation for the firm and I will be ruthless."
"When something is found or alleged: Get it right, get it fast, get it out, get it over. But get it right is number one".WB There are many CEOs in america I would like to see gone and Loyd Blankfein is not one of them, says Charlie All I want to know is where I’m going to die, so I’ll never go there
I would love to see another annual report with the following appropriate counsel on avoiding trouble - "Long ago, Charlie laid out his strongest ambition: “All I want to know is where I’m going to die, so I’ll never go there.” That bit of wisdom was inspired by Jacobi, the great Prussian mathematician, who counseled “Invert, always invert” as an aid to solving difficult problems. (I can report as well that this inversion approach works on a less lofty level: Sing a country song in reverse, and you will quickly recover your car, house and wife.)"
What won't Berkshire do?
- avoid businesses whose future they cannot evaluate;
- never be dependent on the kindness of strangers;
- subsidiaries operate on their own - "would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly – or not at all – because of a stifling bureaucracy."...."Charlie and I will limit ourselves to allocating capital, controlling enterprise risk, choosing managers and setting their compensation."
- make no attempt to woo Wall Street. "want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur."
Tweets:- ""Success is avoiding stupidity" Charlie Munger ;) " "You give human beings the flexibility to do absolutely anything they damn well please, they will go plum crazy" - CM "You want to create a structure that minimizes the weaknesses of human behavior" -Buffett
Taking responsibility:
"Last year your chairman closed the book on a very expensive business fiasco entirely of his own making." and goes on to talk about the credit cards to GEICO customers (I was one of them, who closed the card when they decided to charge the fees.)
"GEICO’s managers, it should be emphasized, were never enthusiastic about my idea. They warned me that instead of getting the cream of GEICO’s customers we would get the – – – – – well, let’s call it the non-cream. I subtly indicated that I was older and wiser.
I was just older."
"The major problem for Berkshire last year was NetJets, an aviation operation that offers fractional ownership of jets. Over the years, it has been enormously successful in establishing itself as the premier company in its industry, with the value of its fleet far exceeding that of its three major competitors combined. Overall, our dominance in the field remains unchallenged."
"NetJets’ business operation, however, has been another story. In the eleven years that we have owned the company, it has recorded an aggregate pre-tax loss of $157 million. It’s clear that I failed you in letting NetJets descend into this condition. But, luckily, I have been bailed out. Dave Sokol, the enormously talented builder and operator of MidAmerican Energy, became CEO of NetJets in August. His leadership has been transforming"
"Most important, none of the changes wrought by Dave have in any way undercut the top-of-the-line standards for safety and service that Rich Santulli, NetJets’ previous CEO and the father of the fractionalownership industry, insisted upon. Dave and I have the strongest possible personal interest in maintaining these standards because we and our families use NetJets for almost all of our flying, as do many of our directors and managers. None of us are assigned special planes nor crews. We receive exactly the same treatment as any other owner, meaning we pay the same prices as everyone else does when we are using our personal contracts. In short, we eat our own cooking. In the aviation business, no other testimonial means more."
"It’s my job to keep Berkshire far away from such problems. Charlie and I believe that a CEO must not delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives contract on our books, with the exception of operations-related contracts at a few of our subsidiaries, such as MidAmerican, and the minor runoff contracts at General Re. If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer."
"In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control. If he’s incapable of handling that job, he should look for other employment. And if he fails at it – with the government thereupon required to step in with funds or guarantees – the financial consequences for him and his board should be severe. It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden, with 90% or more of the value of their holdings wiped out in most cases of failure. Collectively, they have lost more than $500 billion in just the four largest financial fiascos of the last two years. To say these owners have been “bailed-out” is to make a mockery of the term. The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well."
On derivative contracts:-
- Though it’s no sure thing, I expect our contracts in aggregate to deliver us a profit over their lifetime.
- Only a handful of our contracts require us to post collateral under any circumstances.
- you should expect large swings in the carrying value of these contracts. "..these wild swings neither cheer nor bother Charlie and me"
"To date we have significantly profited from the float they provide. We expect also to earn
further investment income over the life of our contracts."
"The dangers that derivatives pose for both participants and society – dangers of which we’ve long warned, and that can be dynamite – arise when these contracts lead to leverage and/or counterparty risk that is extreme. At Berkshire nothing like that has occurred – nor will it.
"Buffett is asked what useful function do derivatives serve? The questioner says we have done well without them for years. Buffett turns the question to Munger. Munger says derivatives on things like grain or other commodities are fine, but if all other derivatives vanished he would be fine with that. Buffett quotes John Maynard Keynes as saying speculators do no harm if they are bubbles on a steady stream of enterprise. But it will be ill-done if enterprise becomes a bubble on a whirlpool of speculation. Munger says if a small group with a lot of money and influence are very interested in something, they will win out. He says that is just the way it is."
Tweets:- Warren: different prices for collateralized vs uncollateralized derivative contracts akin to renting furnished or unfurnished apt. Munger: If all derivatives vanished, the world would be a better place Issuing Shares for shares
"Our subsidiaries made a few small “bolt-on” acquisitions last year for cash, but our blockbuster deal with BNSF required us to issue about 95,000 Berkshire shares that amounted to 6.1% of those previously outstanding. Charlie and I enjoy issuing Berkshire stock about as much as we relish prepping for a colonoscopy.
The reason for our distaste is simple. If we wouldn’t dream of selling Berkshire in its entirety at the current market price, why in the world should we “sell” a significant part of the company at that same inadequate price by issuing our stock in a merger?
In evaluating a stock-for-stock offer, shareholders of the target company quite understandably focus on the market price of the acquirer’s shares that are to be given them. But they also expect the transaction to deliver them the intrinsic value of their own shares – the ones they are giving up. If shares of a prospective acquirer are selling below their intrinsic value, it’s impossible for that buyer to make a sensible deal in an all-stock deal. You simply can’t exchange an undervalued stock for a fully-valued one without hurting your shareholders.
Imagine, if you will, Company A and Company B, of equal size and both with businesses intrinsically worth $100 per share. Both of their stocks, however, sell for $80 per share. The CEO of A, long on confidence and short on smarts, offers 11⁄4 shares of A for each share of B, correctly telling his directors that B is worth $100 per share. He will neglect to explain, though, that what he is giving will cost his shareholders $125 in intrinsic value. If the directors are mathematically challenged as well, and a deal is therefore completed, the shareholders of B will end up owning 55.6% of A & B’s combined assets and A’s shareholders will own 44.4%. Not everyone at A, it should be noted, is a loser from this nonsensical transaction. Its CEO now runs a company twice as large as his original domain, in a world where size tends to correlate with both prestige and compensation.
If an acquirer’s stock is overvalued, it’s a different story: Using it as a currency works to the acquirer’s advantage. That’s why bubbles in various areas of the stock market have invariably led to serial issuances of stock by sly promoters. Going by the market value of their stock, they can afford to overpay because they are, in effect, using counterfeit money. Periodically, many air-for-assets acquisitions have taken place, the late 1960s having been a particularly obscene period for such chicanery. Indeed, certain large companies were built in this way. (No one involved, of course, ever publicly acknowledges the reality of what is going on, though there is plenty of private snickering.)
In our BNSF acquisition, the selling shareholders quite properly evaluated our offer at $100 per share. The cost to us, however, was somewhat higher since 40% of the $100 was delivered in our shares, which Charlie and I believed to be worth more than their market value. Fortunately, we had long owned a substantial amount of BNSF stock that we purchased in the market for cash. All told, therefore, only about 30% of our cost overall was paid with Berkshire shares.
In the end, Charlie and I decided that the disadvantage of paying 30% of the price through stock was offset by the opportunity the acquisition gave us to deploy $22 billion of cash in a business we understood and liked for the long term. It has the additional virtue of being run by Matt Rose, whom we trust and admire. We also like the prospect of investing additional billions over the years at reasonable rates of return. But the final decision was a close one. If we had needed to use more stock to make the acquisition, it would in fact have made no sense. We would have then been giving up more than we were getting.
I have been in dozens of board meetings in which acquisitions have been deliberated, often with the directors being instructed by high-priced investment bankers (are there any other kind?). Invariably, the bankers give the board a detailed assessment of the value of the company being purchased, with emphasis on why it is worth far more than its market price. In more than fifty years of board memberships, however, never have I heard the investment bankers (or management!) discuss the true value of what is being given. When a deal involved the issuance of the acquirer’s stock, they simply used market value to measure the cost. They did this even though they would have argued that the acquirer’s stock price was woefully inadequate – absolutely no indicator of its real value – had a takeover bid for the acquirer instead been the subject up for discussion.
When stock is the currency being contemplated in an acquisition and when directors are hearing from an advisor, it appears to me that there is only one way to get a rational and balanced discussion. Directors should hire a second advisor to make the case against the proposed acquisition, with its fee contingent on the deal not going through. Absent this drastic remedy, our recommendation in respect to the use of advisors remains: “Don’t ask the barber whether you need a haircut.”
"our fellows caved in and agreed to this value-destroying deal. “We need to show that we are in the hunt. Besides, it’s only a small deal,” they said, as if only major harm to shareholders would have been a legitimate reason for holding back. Charlie’s reaction at the time: “Are we supposed to applaud because the dog that fouls our lawn is a Chihuahua rather than a Saint Bernard?”
Media over-exposure Tweet : "buffett is appearing in Wall Street 2 w/ michael Douglas? Who knew?"
From the meeting "Buffett is asked if his increased media exposure is good for Berkshire shareholders. Buffett says probably not. Buffett says he has seen over the years the development of broadcast television over print. He says if you want a record of what you actually said, instead of a reporter's and editors' interpretations, it is great to have the broadcast version. I like the idea, whether it is charlie rose or CNBC, a record of my own words, instead of someone's interpretation of it."
Ethics:- Charlie: Every business should decline a lot of business that it doesn't. Just because it's legal, doesn't make it right
"The ideal is that we celebrate wealth only when it has been fairly won and wisely used." -Charlie Munger
Charlie: we get offered things that people won't sell to anyone else. We have our own ethics-based screening device
WB if reason you are doing something because the next guy is doing it, that is not good enough Learning:- "The old men (Warren & Charlie) always continue to learn which is essential!" -Charlie Munger
If you keep asking questions at a young age like that, gradually you learn. Love when Munger ruminates on his childhood.
Charlie: if you're scared to do something, maybe you should get your feet wet with a little more failure.
Charlie: go to bed each night a little wiser than you were when you got up. People who do that almost never utterly fail
Buffett says in a country where the undisciplined are unpunished it brings people to wonder why they should behave properly
"When you picked your wife, you picked the best who would take you. We should live the rest of our lives like that." Charlie Munger
I am a twit @seshnath
Links to Notes:-
http://inoculatedinvestor.blogspot.com/2010/05/2010-berkshire-hathaway-annual-meeting.html
http://www.scribd.com/doc/30895400/Annual-Meeting-2010-Final-2-0
I attended the Berkshire Hathaway Meeting this year as well. Here is a link to my quick notes from the meeting (pdf) grouped by topic and with some background reference to the questions I have also included notes from others and other coverage at the end. Feel free to distribute it.
I am posting my (pdf) brief notes from the Wesco Meeting from May 7, 2008. Enjoy Charles T. Munger's "socratic solitaire". Here are some other links to posted notes as well. Nick Henderson - How about that! Peter Boodel through - Reflections on Value Investing
Posting the excerpts from the meeting (PDF). Approx. 31000 people attended this time. I missed out on some questions while I went out for food/water. Also, I haven't repeated similar answers from previous years. Here are some more sources for meeting proceedings. Morningstar Omaha World Herald
IFRS 3 requires allocation of goodwill among intangible assets. Click here for details on the IFRS . All is well when you read the IFRS. In practice, it means having to reconcile between WARA (Weighted Average Return on Assets) and WACC (Weighted Average Cost of Capital). What is the WACC?
One additional thought though, thinking in parallels of Ricardo's theory of comparative advantage, does it mean that assets will move from the hands of the investors with a high cost of capital to the ones with a low cost of capital? Comments invited.
I am reminded of the Charlie Munger discussion (source: http://articles.wallstraits.net/articles/1361) which I am copying here:-
"Charlie Munger often quotes the late Nobel laureate physicist Richard Feynman, who said the first rule is to not fool yourself, and you are the easiest person to fool. Munger can be merciless if he believes he has caught someone in the act of silly self-deception.
Pitty the poor professor who gets caught up in a debate with Munger on the academic treatment of investment policy. Such was the case at The Benjamin Cardozo School of Law in New York City in 1996 when, due to the death of a close friend, the scheduled moderator was unable to attend. Charlie Munger was asked to step in.
Charlie told the audience: "The accidents of mortality have given you a Baptist bumpkin suddenly put in charge of a bunch of Catholic archbishops who are going to debate revisions of the Catholic mass, in Latin. But I figure I could moderate such a convention."
It was the panel's assignment to discuss the research of Professor William Bratton of the Rutgers-Newark School of Law, which dealth with the corporate decision to pay dividends to shareholders rather than reinvest profits. Munger soon nailed Bratton with what he considered a flawed assumption in the research.
Munger: I take it that you believe that there is no one-size-fits-all dividend policy and that you're with the professor (Jill E. Fisch of Fordham University School of Law) who said yesterday that there wasn't any one-size-fits-all scheme for corporate governance?
Bratton: On that simple proposition I am entirely in concord with Professor Fisch.
Munger: But you say there is some vaguely established view in economics as to what is an optimal dividend policy or an optimal investment?
Bratton: I think we all know what an optimal investment is.
Munger: No, I do not. At least not as these people use the term.
Bratton: I don't know it when I see it... but in theory, if I knew it when I saw it this conference would be about me and not about Warren Buffett. (Laughter from the audience)
Munger: What is the break point where a business becomes suboptimal in an ordinary corporation or when an investment becomes suboptimal?
Bratton: When the return on the investment is lower than the cost of capital.
Munger: And what is the cost of capital?
Bratton: Well, that's a nice one (Laughter) and I would...
Munger: Well, it's only fair, if you're going to use the cost of capital, to say what it is.
Bratton: I would be interested in knowing, we're talking theoretically.
Munger: No, I want to know what the cost of capital is in the model.
Bratton: In the model? It will just be stated.
Munger: Where? Out of the forehead of Job or something?
Bratton: That is correct. (Laughter)
Munger: Well, some of us don't find this too satisfactory. (Laughter)
Bratton: I said, you'd be a fool to use it as a template for real world investment decision making. (Laughter) They're only trying to use a particular perspective on human behavior to try to explain things.
Munger: But if you explain things in terms of unexplainable subconcepts, what kind of an explanation is that? (Laughter)
Bratton: It's a social science explanation. You take for what it's worth.
Munger: Do you consider it understandable for some people to regard this as gibberish? (Laughter)
Bratton: Perfectly understandable, although I do my best to teach it. (Laughter)
Munger: Why? Why do you do this? (Laughter)
Bratton: It's in my job description. (Laughter)
Munger: Because other people are teaching it, is what you're telling me. (Laughter)
The audience laughter points are essential in this exchange, lest it sound like a food fight at a junior high school cafeteria. The bantering was done in a good-natured tone, but the point of the exchange was quite serious. Later, to make sure his comments were not misunderstood, Munger made amends:
I don't want my remark about the cost of capital to be interpreted as meaning that I think the great bulk of Professor Bratton's paper is wrong. I think it's profoundly right. When he talks about agency costs in corporations and the discipline caused by levels of debt and the discipline caused by dividend conventions, I think he is profoundly right. And to the extent that those are the conventional academic explanations, I think it's wisdom he's giving. It's just the cost of capital thing that always makes me go into orbit. (Laughter)
Although he did not say so then, Munger has his own idea of how the cost of capital should be measured. Buffett has explained that at Berkshire, the cost of capital is measured by the company's ability to create more than $1 of value for every $1 of earnings retained. "If we're keeping $1 bills that would be worth more in your hands than in ours, then we've failed to exceed our cost of capital," Buffett said.
CM started with a short speech on the confluence of factors in WB that contributed to Berkshire's success. 1. Mental aptitude 2. Extreme interest in the subject - there is no substitute 3. Early start 4. "Learning Machine" - avid learner. Lucky to be in a subject where he can learn effectively. It is more about learning the method of learning. 5. Decision making concentrated in one mind. Vs. Committees CM compared Singapore to USA in the pace of success. 6. Not being naive relates to mental attitude - by avoiding negatives like self-pity, envy, overspending income, being an extreme idealogue. This is maximisation of objectivity. 7. Reinforcement through rewards for good decision. Some Mungerisms: Quoting Will Rogers - There should be a better way to learn not to pee on an electric fence than actually doing it. Irish Alzheimer's is when you forget everything except the grudges. Quoting a German proverb - Man is old too soon, and too late smart Sit on your ass and read Academics & Learning: Fatal disconnect of academics pick up main ideas of each subject - for instance opportunity cost from economics Checklist method of learning Always invert Sell yourself the best hour of the day Accounting for derivatives Marked to model and marked to market are different Being rational wonderful feeling to be right even better to be trusted by others Why Berky is not repeated 1.Simple - no advantage in being simple 2. Institutional reward system and hierarchy make it difficult Investing in Commodities POSCO is not, it is technology from Nippon Steel Commodity business can be attractive at a price Nature Vs Nurture In a non-pathological environment, mostly pre-ordained by nature than people give credit for Know your strengths Don't be a prisoner to your talents Inefficient Markets 1. Small Markets, or 2. Crazy People doing crazy things Motivation Wanted to be independent to make 'a man of himself' Best from his list of human misjudgements in Poor Charlie's Almanack Self serving bias - 'Little me wants it, why can't little me have it' Opportunity cost Best measure to look at life
WB - If we don’t understand something, we don’t try to compensate with a higher Margin of Safety.If you cannot see out what the business is going to be like for 5-10 years, do not invest in it.
Healthcare:-
WB – Berky would be interested in investing in a business with low frictional costs of distribution.
Intrinisic Value of Berky:-
WB – Should not be judged solely based on Book Value, but on use of retained earnings as well.
Derivatives:-
WB – There are valuation issues.Both sides of the same trade can value the same instrument differently and come up with different values.This is unusual.
Comments:- Usually, when a liability or a receivable is valued, the debtor and creditor always assign the same currency value to the transaction.
WB – Leverage and various forms of program trading are prevalent
Trade Vs. Buy & Hold:-
WB – Constant trading of assets can be an unhealthy practice.You have to understand human behavior to understand trading better.
CM – Bad results cannot be predicted with Gaussian distributions.The use of Beta and other statistical tools are prevalent because it is easy to teach and easy to compute.
Intrinsic Value: –
WB – Refers to Aesop’s fable – “A bird in hand is worth two in the bush”.
Global Warming:-
WB – Catastrophe exposures in insurance companies.Suggests that the US Govt. should err on the side of the planet.
CM – The effects of global warming can be tackled with capital.
Stocks Vs. Bonds:-
WB – Stocks are still a better investment than bonds
Small Funds:-
WB – High returns are possible for smaller funds compared to large
Sub-primes:-
WB - As long as the unemployment does not rise and inflation does not rise, its effects on the housing market will not affect the economy.
Volatility:-
WB - Volatility is not a good measure of risk.Use of Beta is not appropriate.Risk comes from not knowing what you are doing.
Management Quality and Integrity:-
WB – Look for direct and honest reporting
Filter of trust:-
WB – People give themselves away with the things they talk, the things they think are important
CM – Be especially suspicious when the proposals are too good to be true.
Discount Rates:-
CM – Just because you can measure something doesn’t mean it is the controlling variable.
Inflation Protection:-
WB – First level of protection, earning power
Second, owning good business with pricing power defined as the customers willingness to give up current income for use of its products
Railroads:-
WB – Vs Trucking – cost of fuel affects trucking 4X more than railroads and there is not much capacity addition in railroads.
Self-Development:-
In response to the question of a 10 year old girl who wants to earn money
CM – Sell yourself the best hour of the day and sell only the rest to others.
Investments:-
WB – Do not own a business with a weakening competitive edge.
Dollar:-
WB – Bearish without any significant policy changes on the part of US.
Cm – Weakening dollar not resulting in higher inflation is a surprise.
The meeting opened with the cousin Jimmy Buffett playing the Berkshirehathawayville version of his song. WB announced his plan for a cartoon series for children to impart financial education in an enjoyable manner. The Q1 2007 results were posted with WB explaining that insurance rates have come down recently, but the effect will start showing up in a couple of quarters or so due to a lag effect in rates ratcheting down. He offerd caution on cat. insurance and mentioned that over a long term berky would be expect to break-even in tnis business and still come ahead because of its ability to manage float and generate float income. He brought up the issue of a high accounts receivable by 7 billion than normal due to the Equitas deal closing in April. Views on:- Private Equity * Funds invested are locked in. It's hard to get out for the investor. * Fund Managers are compelled to invest since it is in their interest to earn more fees by generating more funds. They cannot go back to investors with surplus funds in hand. * Trigger for the slow down could be junk bond yield spreads going up higher hampering leverage. Overseas investments WB has no bias against. Low holdings not reported in annual report. Reporting limit threshold of 3% in Europe a deterrent. Executive Compensation * Ratcheting and envy at play * Non-independent comp committees. * Compensation should be based on controllable factors. For instance, extraction cost based comp for an oil executive, not oil prices. Factor should be relevant as well. Interest rates * Credit contraction as a result of higher rates. Contraction as was historical is not probable. Fed not likely to orchestrate a credit crunch. Follies of excess liquidity may bring about unhealthy legislation. High Corporate profits WB - Share in GDP getting higher, labor's share down It is not likely to persist. CM - Share of financials is higher is the causw. Investment banks etc earning abnormal profits. Historically high consumer credit is also the reason. Naked Shorting WB welcomes shorters, sees it as a money making opportunity by lending stocks. It is a hard position to take. Gambling * Excitement seeking is the underlying. * Tax on ignorance - making it easier to gamble is preying on ignorance, not the job of a govt that serves people. How to become a good investor * Read everything you can * Fill your minds with ideas, sort out the good ones * Jump into investing. Reading about investing and actually doing it is as different as reading a romance novel and actually doing "something else". * WB has same thought pattern as when he was 19 abt investments CM - Rationalise - "What do you own and why do you own it?" WB - Write an essay on why you would buy the company at the price
A few things about Charlie comes out:- * Love of books - biographies and other non-fiction * Great thinking ability * Charlie's personality hidden behind the curmudgeonly shell * Social Responsibility through support of various causes like abortion rights and health care
Even an accomplished author like Janet Lowe is unable to do justice and unravel the life, thoughts and business history of the complicated personality of Charles Thomas Munger. The book is divided into various chapters, not so much in a chronological fashion. There are some of his speeches reproduced in the appendix as well.
Last Saturday I attended the Berkshire Hathaway Meeting. Here is a good note in pdf format by Whitney Tilson on the meeting and here or here is another one. Personally, it was a pleasure to be at the meeting. I have never spent a whole day listening to someone talk without getting bored, is to say the least. The icing on the cake was the opportunity for international shareholders to meet Warren, Charlie and Bill Gates (who is also a director). It was definitely the event of my lifetime.
I came across an interesting story about 2005 Berkshire Hathaway meeting. There was a book sale - of "Poor Charlie's Almanac". I had heard of "Poor Richard's Almanac" with wit and wisdom of Ben Franklin, whose philosophy strikes a chord with me. But Poor Charlie? I hadn't heard of Charlie Munger before, other than a casual mention as the Vice Chairman of Berkshire. I read some excerpts (thanks to Amazon!!) and was immediately impressed (which is saying much for me). I promptly placed an order on Poor Charlie's Almanack.
The coffee table book is a cornucopia of investment wisdom, is to say the least. It is a lattice work of investment thought process, to borrow a term from the book a "lollapalooza". I have read it once, back to back during Summer and would like to go back and read it again this Summer to capture a few ideas that I may have missed. Watch this space for more, soon.
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