Excellent Book: Charlie Munger For All Seasons
Ref: Adam Blum’s 2017 Berkshire Hathaway Annual Meeting Notes – May 6, 2017
Introductory Comments
Guide 1: Use Your Senses
Warren on he and Charlie: “You can tell us apart, because he can hear, and I can see.”
“The realized investment gains or losses in any period really mean nothing. We don’t really think about the timing at all, except in relation to our intrinsic value.” Over $90B in unrealized gains is in the company. They have a slight preference for taking losses as opposed to gains for the tax effect, mainly this year as they’re taxed on gains at 35% and also get tax benefit on losses. There’s some chance that their corporate income tax rate will be lower after this year, meaning losses would have a smaller tax benefit in the future.
It was a wonderful period at GEICO, because competitors have intentionally cut back on new business. New business brings significant acquisition costs in the first year, and there’s a higher loss ratio on new versus renewal business. Out of fear of missing earnings, GEICO’s publicly traded competition didn’t want to pay the penalty on first-year loss and originated fewer policies. “Of course, that’s made to order for us, and we just put our foot to the pedal.”
Float increased $14B to $105B year-over-year in the first quarter of 2017. It’s nice to have that. And that’s one reason cash is so high. Warren feels very good about the quarter even though operating earnings are lower. “One quarter means nothing as long as we build value.”
Guide 2: Index Funds For The Average Investor & Praise for Jack Bogle
Special recognition of Jack Bogle (Vanguard Group): “Jack has done more for the American investor than anyone in this country. Index funds wouldn’t have happened without him. It was not in the interest of Wall Street to develop these, because they brought down fees dramatically. They have delivered for shareholders a result better than Wall Street professionals as a whole, in part due to low costs. Jack at a minimum has saved investors tens of billions without hurting them, and those numbers will be hundreds of billions over time – happy birthday, Jack (88 on Monday) – I’ve got good news for you, Jack. In only 2 years you’ll be eligible for an executive position at Berkshire, so hang in there, buddy.”
Q&A
Guide 3: Finding and Correcting Bad Behavior Are Two Important Components Of The Equation. An ounce of prevention is worth more than a pound of cure.
Q1 – Wells Fargo’s decentralized structure gave too much autonomy to community banks. How is Berkshire Hathaway not exposed to this same risk?
“We have a more decentralized plan than any company remotely near our size and count more heavily on principles of behavior than loads of rules.” Warren shows the Salomon Brothers testimony at every meeting and issues very few communiques to managers – once every 2 years – he tells them that they have all the money they need but don’t have any reputation to lose – better than a thousand-page guidebook. With 367k employees, people are always doing something wrong. The real question is whether managers are worried about finding and correcting bad behavior and whether that gets to Omaha. Wells Fargo had three big mistakes, but one stands out. The incentive system there was built around cross-selling and the number of services per customer. This incentivized bad behavior. Undoubtedly, people were paid and promoted based on this number. “We have made similar mistakes in designing the system, but at some point the CEO gets wind of it and has to act.” The Salomon CEO (John Gurfreund) found out Paul Mozer was “flimflamming the US Treasury” on April 28th, and right then he had to report Mozer to the Fed Board. Gutfreund didn’t do this, because it wasn’t the pleasant thing to do, and then on May 15, at another US Treasury auction, Mozer the pyromaniac lit another fire, and then it was all over. It had to stop when the CEO learned about it. The last mistake was that that Salomon totally underestimated the impact of what they had done when it came out; the total fine was small, and so management measured the seriousness of problem by the size of the fine. The main problem is the CEO didn’t act when he learned about it. At Berkshire Hathaway, the main source of info for Buffett of anything done wrong at any subsidiary is the internal audit hotline – they get about 4,000 alerts a year – most are frivolous, but anything serious has led to action. It’s a good system but not perfect. Buffett assumes a lot of communications came in like this at Wells Fargo and that it was a huge error if the complaints went ignored or were sent to be addressed back down below.
Munger: “Put me down as skeptical when some law firm thinks they know how to fix something like this. If you’re in a business like Wells, you need a huge compliance department, but doesn’t mean everyone should solve problems with compliance – entrusting good managers is a better system.”
“An ounce of prevention is worth more than a pound of cure.”
“Gutfreund described his problem at Salomon as a traffic ticket”
Guide 4. Something Has Got To Give. Driverless Car May Make The World Safer But Insurers Will Suffer
Q2 Driverless trucks are a lot more of a threat to BNSF than an opportunity. Driverless cars being pervasive would mean that they’re safe and would cause harm to the insurance industry. If they make the world safer, it will be a very good thing but not for insurers or railroads.
Charlie: “I think that’s perfectly clear.”
Guide 5: There Can Be A Moat In Branded Candy
Q3 “You know it when you see it.” It’s a business that they can look out 5-10-20 years and see a decided competitive advantage that would last over the period with a trusted manager that would fit in with and was eager to join the Berkshire Hathaway culture. Then it’s a matter of price; they’re willing to lay out a lot of money now based on what they think an asset will deliver over time. The higher the certainty, the more comfortable they are with the price. In 1972, the question was, “would folks in the future want to buy high end candy?” To date they have taken out $2B pretax from See’s Candy, so that was a “yes.” “It doesn’t work very well if you go to your wife or girlfriend (I hope they’re the same person) and say ‘here’s some candy, I bought the cheap one,’ so See’s did have a bit of a moat”
Charlie: “We were young and ignorant then; Now we’re old and ignorant.”
“We would be very wise to buy at a slightly higher price but wouldn’t have done it then. We looked a lot smarter than we were. Charlie would’ve bought it for more, but I was unwilling.” The founder’s grandson wasn’t interested in the business. He was more interested in girls. But he almost changed his mind and didn’t want to sell. Rick Guerin said Charlie spent an hour talking to the kid about the merits of girls and grapes to convince him.”
Their early experience of fixing unfixable businesses was a benefit. They couldn’t make a purse out of a sow’s hair and had to rub their noses in bad businesses to learn what they didn’t want to do or couldn’t do.
Guide 6: A good company is an economic castle with a moat protecting it, and there’s a knight in there warding off marauders. The marauders will never go away.
Q4 – Berkshire Hathaway major stock holdings are businesses Buffett likes. Being the largest holder of the four largest airlines isn’t much more than just industry thought. All businesses have some problems; they didn’t buy them with the idea that would never have competition. The largest holdings are in strong hands, and Buffett likes their financial policies and position. Where do they have durable competitive advantage? A good business will have several new competitors, but investors must judge the ability of management to ward off competitors.
A good company is an economic castle. The moat around it protecting it, and there’s a knight in there warding off marauders. The marauders will never go away. Coke in 1886 Amex and 1852, were founded and had lots of challenges past, present and future. Insurance has them too. They paid $8mm to purchase National Indemnity in 1962, and now their insurance holdings are tens of billions of dollars. There will always be things to do that really intelligent management and a decent distribution system can do to ward off marauders; Buffett reviews the stock portfolio every single day.
Charlie: “I don’t think I have anything to add there either.”