Investment Wisdom

93. Berkshire Annual Meeting 2017 – Part 3 – Wisdom Guide 13 – 18

Excellent Book: Charlie Munger For All Seasons

Ref: Adam Blum’s 2017 Berkshire Hathaway Annual Meeting Notes – May 6, 2017

Guide 13. Berkshire Way: We’ll grab all the opportunities we can without losing sleep.

Q11 Buffett says that all returns are calculated after tax; for deferred taxes on unrealized gains on securities, they will get the all the benefit – for some other businesses some tax benefit will be competed away and some won’t be – he has seen it in action – some will inure to shareholder benefit and some will be competed away – company-specific – but the $95mm off deferred taxes ($9.5B x 10% tax rate reduction) is real.

Munger: “If things go to hell in a handbasket and then get better later, we will do better than others. We are good at navigating through that kind of stuff.” “When the rest of world is fearful, we know America will come out fine. We won’t put the company at risk. We’ll grab all the opportunities we can without losing sleep.

Q12 Sold his used Cadillac for $100k plus to benefit Girls Inc – the buyer didn’t have any license plates on the car but was pulled over. Cops were skeptical of his story, but Buffett had signed the dashboard, and the cops saw that and asked if the driver got any stock tips; Buffett can’t recall ever selling a used car at a profit other than that time.

Q13 – why did Buffett advise his wife to invest in index funds versus into Berkshire Hathaway? She won’t be selling to buy an index fund – every single share of Berkshire Hathaway will be going to philanthropy – so far 40% has been distributed – for someone who’s not an investment professional, what’s the best investment where there’s less worry than anything – big thing is money to not be a problem – there’s no way that there will be an issue absent a nuclear attack if she invested in the S&P; Buffett’s aunt Katy, whose husband used to employ Charlie and Warren, worked all her life and died at 97 with a few hundred million dollars, because she was in Berkshire Hathaway. She’d write Buffett and say she hated to be a bother but was curious if she would ever run out of money. Buffett told her that she’d run out only if she lived 986 more years. There will be people who come around with various suggestions on what to do with the money he leaves his wife, and there’s a chance she won’t have as much peace of mind only owning one stock as owning the index.

Munger: “The Mungers are different – I want them to hold the Berkshire. The S&P algorithm is very hard to beat, but I an just more comfortable with the Berkshire Hathaway”

Buffett: “It’s the family business .”

Munger: “If you protect your heirs from stupidity of others, you may have some good system, but I am not much interested in that subject.”

Q14 – would’ve invested additional $15B each with 3G in Kraft-Heinz if there was a friendly deal tobe had with Unilever.

Q15 – how to spread value investing philosophy? Keynes wrote about the propensity of people to speculate – when it gets rampant and “social proof” that some speculation worked recently, it gets more widespread. “There’s nothing more agonizing than seeing your neighbor who has a lower IQ getting richer than you are.” Early on in development of markets, there is more tendency for speculation than markets that have been around a few hundred years. The casino aspect of markets comes into play with people seeing others doing well. China being a newer market with widespread participation is likely to be extreme.

Charlie certainly agrees. “The Chinese will have more trouble. To the extent you’re working on it (teaching rational value investing), you’re on the side of angels, but lots of luck.”

“Fear spreads like you can’t believe, unless you’ve seen it.” $175B flowed out of money market funds in three days during the crisis. If they think there’s easy money, people will rush to it and create new converts until the day of reckoning comes.

Munger: “We’ve done a lot of preaching to not much effect.”

Buffett, implying that they’ve capitalized on no one being rational: “And that’s probably good for us!”

Q16 – impact of investment tax credit – Tax issues do not enter into calculation of an investment or portfolio allocation at all at the Berkshire Hathaway level. It’s true in wind and solar that they’re dependent on the tax law (government wants to move people’s energy preferences against what the market system is doing), and they wouldn’t have been done without subsidization. But changing depreciation schedules won’t impact what they’re going to do on the railroad to make it safer and more efficient. They can’t recall in all the years saying “do this because tax laws are being or might be changed;” it’d be useful if the chairs of the House/Senate tax committees would flag the effective date of the changes.

Munger – nothing to add – “I wouldn’t change anything at the railroad over a tax jiggle.”

Guide 14. Declines in Coal: It will die over time. Over the extremely long term, all hydrocarbons will be used, including all the coal – they’re huge resource for all of humanity and have no good substitute. I am all alone on this one, but I want to save them for the next generation.

Q17 – coal declines – It will die over time. The specifics of any given year relate to natural gas prices – demand is up for coal from last year because gas is higher-priced; the speed of the decline is unknown, but people don’t create generation plants overnight.

Munger: “Over the extremely long term, all hydrocarbons will be used, including all the coal – they’re huge resource for all of humanity and have no good substitute. I am all alone on this one, but I want to save them for the next generation. We will use every drop sooner or later even as chemical feedstock. I expect natural gas to be short in supply eventually.”

Storage is a real problem even if they have the capability of producing a lot of energy from wind or solar.

Guide 15. Buying a high return-on-assets company with low capital intensity beats the hell out of a similarly growing capital-intensive business.

Q18 Buying a high return-on-assets company with low capital intensity beats the hell out of a similarly growing capital-intensive business. The five largest US market cap companies are $2.5T, close to 10% of whole US market. One could run them with no equity capital at all. “It’s a very different world than Carnegie’s steel mills and Rockefeller’s tank cars – you literally don’t need any money to run the top five companies in the country.” Buffett owns a few businesses like this, but they don’t grow – if he could find them in a field that grow, they would be at the top of the list.

Munger: “The world has changed a lot, and people who’ve gotten into these businesses have done very well.”

Buffett: “A lot of people chasing that are receiving a lot of money from venture capital. It’s a wonderful field, but not everyone is going to win big.”

Q19 – Abdication/delegation of management duties to subsidiaries enable businesses to run better than if the subsidiaries were part of the S&P 500 and were targets of activists looking for a jiggle in the short term. Their structure frees up at least 20% of the time of a CEO who otherwise would have lot more responsibilities at a public company in terms of meeting with analysts, etc. The CEOs at Berkshire Hathaway can spend all their time improving their businesses.

Guide 16. We are trying to be a good example in the world. No one would be here at the meeting if we didn’t set a proper example and weren’t honest.

Munger: “We are trying to be a good example in the world. No one would be here at the meeting if we didn’t set a proper example and weren’t honest.”

Q20 – structured settlements – they issue these for insurance companies to give folks a lump sum against the payment stream from injury settlements – Berkshire Hathaway has a preferred position because they like the longer maturity situations. The assumption that they can earn more money than is inherent in the cost of these injury settlements; people trust them more than others to make the payments – if interest rates continue at present levels, will have some losses though; have to make sure the original claimant is still alive as they can’t count on relatives of the deceased to “turn off the faucet.”

Q21 – held equity in USG through asbestos bankruptcy – because it was very cheap. The business was disappointing, because the gypsum business was disappointing. Managements of gypsum businesses got too optimistic each time the business rebounded, and supply exceeded demand over the years.

Q22 – impact on insurance of Ajit leaves – He’s irreplaceable, but there’s a terrific operation in insurance outside of him, which is terrific-squared with Ajit. A lot is institutionalized and extraordinarily able management is there. They bought Guard Insurance in Wilks-Barre, PA, and it’s been a gem with brilliant management. The same goes for other businesses Ajit bought. Medical Protective with Tim Kenesey was the same story. Buffett thinks without Ajit, they’d still have world’s best P&C insurance operation.

Munger: “A few years ago, California changed the workers comp law, and Ajit just took $10B out of the air – he saw it when no one else did.” Producing underwriting profits while someone is handing them over float is the best business. This gives them hundreds of billions they can earn on, as if someone handed them $104B and paid them to hold it. Now with all the investment managers doing reinsurance offshore for permanent capital, it’s gotten more competitive, but it’s still a wonderful business. “I’ve just been handed something Kraft-Heinz came out with – some of the members of the audience may not approve – it’s a ‘create your own cheesecake’ concoction, and it’s a 170 calorie one – I’ve had three of them – I will let someone else eat the broccoli but I will eat five of these.”

Q23 – succession plan – It’s still the same as it was before. They have never had more good managers than they do now. The managers have the jobs they want in life, which is a lot better than having a lot of folks who want to run Berkshire Hathaway one day.

Q24 – where to go fishing for the next 3-5 years? They don’t discuss sectors of interest much nor the macro environment. Instead, they’re purely opportunistic and look at all sorts of businesses all the time almost as a hobby. They have a bunch of filters and know in first five minutes or less “can we really ever know enough about this to make a decision?” It’s getting harder to anticipate consumer behavior than they thought in order to project returns on present and prospective capital. But they still reading signals from people in the first meeting with the other side.

Guide 17. Leveraged buyouts has made buying companies more competitive.

Munger: Some subsidiaries do bolt-on acquisitions that make sense, but the general field of buying companies is competitive with all these leveraged buyouts (“and don’t call it private equity – that’s like a janitor calling himself chief of engineering”). Leveraged buyout people can get to a decision within a week with shadow banking and all. “We do well, because people don’t want to sell to those guys.”

A 61-year-old business owner with all the money he needs told Buffett that all he’s worried out on his drive to work is that he doesn’t want to leave his wife stuck with the business. He can’t sell to a competitor who will dump employees. He can’t sell to leveraged buyout firm that’ll leverage it to the hilt and then resell it. “It isn’t because you’re so special, there just isn’t anyone else who I want to buy the company – if you’re ever proposing then don’t say that!” They will lose a lot because of the cheap money out there. “If all an owner cares about is getting highest price, we are not a good call. We can offer happiness to a person who sells us the business. He will have lots of money and be doing what he loves doing while leaving family and employees in the best possible position. This is not the equation of many people who buy businesses borrowing everything they can and resell after dressing up the accounting.”

Q25 – successor compensation Buffett allegedly said he’d think about and address at a future meeting: “At my age, I don’t have to worry about things I said that I would do later.” He hopes for someone already very rich who’s been working a long time and is not motivated by 10x or 100x the money they think they need. He hopes to find someone who may even set the example of taking less than what market value is. They’d pay a very modest amount with an option that’s increasing in strike price annually assuming there are substantial retained earnings each year (why reward a manager for keeping money?). They’d maybe even make the options exercisable only a few years into retirement.

Guide 18. On Compensation Consultants: “If the board hires one after I go, I will come back.”

Munger: “I have avoided compensation consultants all my life. I hardly can find the words to express my contempt.”

Buffett: “If the board hires one after I go, I will come back.”

Munger: “There’s a lot of mumbo jumbo in this field, and I don’t see it going away. What consultant will ever get another assignment if he recommends the CEO payment be in the 4th quartile. It produces an inconsistent result with how representors of an owner should be.”

“Capitalism is golden goose we all live on.”

“The only excuse I won’t take is that everyone else is doing it – just like in stock compensation not being viewed as a cost. It’s worse than Galileo. I would hope that my successors would already be wealthy.” No Berkshire Hathaway director is in it for the money. They have bought all their stock in the public market. “How can a director who hasn’t shelled out a dollar for stock be counted on to do what’s best for owners?”