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Monday, May 2, 2011

Marry the best who will have you and other wisdom from Munger and Buffett

I spent the last weekend in Omaha, Nebraska with two of the my heroes- Charlie Munger and Warren Buffett. After attending the Berkshire Hathaway (BH) for a few years, I still get amazed how a shareholder meeting attracts 40,000+ people and the meeting is about two guys having fun. Everyone else  enjoys watching them have fun. The format is six hours of open Q&A. There is no preparation by Munger and Buffett. Anyone can ask anything about anything expect what BH is going to buy/sell next. You will see it in the notes  that a wide variety of topics are covered. Notes from previous years are available here.

The David Sokol issue was covered by Buffett and that part of the meeting has been recorded so I have not covered it in my notes. You can see it here. Munger talked more this year compared to previous years. I just love this man. He is brilliant!

Following are my random notes from the meeting:

  1. Buffett does two things in his job- 1) keep operating managers happy 2) allocate capital. 
  2. Make decisions based on opportunity cost. There is no better way.
  3. Marry the best who will have you – Munger
  4. “Lose money from the firm and I’ll be understanding. Lose a shred of reputation and I’ll be ruthless.” Buffett  [from Salomon Bothers hearings].
  5. The balance sheet does not represent goodwill very well. For example, the value of a new Geico customer is ~$1,500. If 66 people sign up today, Geico will get Goodwill worth $100k. And, these $100k won’t be represented anywhere on the Geico balance sheet.
  6. Sometimes Net Income is a very deceptive but it gets a lot of media attention every quarter. The quarterly net income has no bearing on how satisfactory the quarter has been. For example, seasonality, long term business decisions, market conditions, accounting adjustments, etc. all affect the net income number.
  7. Hubris is the only explanation on why really smart people do really stupid things.
  8. Most interesting part of any proxy statement is “History of Transaction”.
  9. One should not make important decisions in anger. And, one should not put an iota of ruthlessness than necessary when punishing someone. Like Tom Murphy said, “you can always tell a man to go to hell if it is such a good idea.”
  10. The affect of POMO (Permanent Open Market Operation) ending in a few months would be minimal because the fact that POMO is going to end is well known.
  11. The bible says, “meek shall inherit the earth” The question is, “will they stay meek?”
  12. It has gotten better to replace CEO. However, it is still very hard to replace a mediocre CEO especially when he is the chairman of the board as well. To reduce the chances of getting a bad CEO, a company should have an independent chairman with large shareholdings and should have no desire to be a CEO.
  13. The two sectors which Buffett and Munger want to invest in over next 50 years are Technology and Energy. However, both don’t believe that they have the expertise to invest in Tech/Energy. They have no desire to develop that expertise either:-). Therefore BH is not going to invest in Tech/Energy. Technology companies have high degree of disparity i.e. some win really big and others lose everything .Furthermore, a new technology can make a tech company irrelevant in a few years.
  14. When making investment/acquisition decisions, Buffett looks at:
    1. Industry Dynamics
    2. How the business developed over time.
    3. Easy of entry [for other companies to get into that business]
    4. Durable Competitive Advantage
    5. Economics of the business
He followed the same rules for Lubrizol acquisition.
  1. BH is valued like an operating company. The value of the investing business is not reflected in the stock price.
  2. Making acquisitions with stock is a bad idea. Stock has a intrinsic value of the company and it should be sparingly used as currency. When you are making an acquisition with stock what you are saying to shareholder is that I am giving away my business I already own and like for something that may be good. Doing an all stock deal is saying that either the seller is stupid or the buyer does not value his own business.
  3. Intrinsic value is a range and not an exact number.
  4. US is the most extraordinary economic story. Buffett was born on August 30, 1930. Since then the average standard of living has increased six times! Nothing happened for centuries re standard of living for average people. However, in the US since 1776 we have seen an economic miracle. Of course, the ride has been bumpy. We have problems all the time but the power of capitalism is enormous. The US has a bright future ahead.
  5. The US is not going down. Rest of the world has caught up with the US.
  6. Consumer products that take little capital to grow are wonderful businesses and they survive inflation well if they can tolerate price increases to offset inflation. For example, 20+ years ago, when BH bought Sees candy, it was a $25M/year business. Overtime, BH has invested ~$30M in assets in Sees candy and today it is a $300M/year business. On the other hand, businesses that have to invest capital to grow, manage inventory, receivables, etc. don’t do well during high inflation periods. 
  7. I’m a better investor because I’m a better businessman. And, I am a better businessman because I am a better investor- Buffett
  8. When a company pays dividends, it is telling the shareholders that the company has lost the ability to convert a dollar into anything more than a dollar. BH has no plans of paying dividends .
  9. In the coming years, US banking profits will be considerably less because the banks’ leverage is reduced. It is good for the society but not good for banks:-) 
  10. FDIC does not cost US taxpayers a penny.
  11. One should read annual letter of M&T Bank and Jamie Dimon’s letter to understand what is going on in the banking world.
  12. In capitalism, market creates a reward system that people who deal with money make the most money.
  13. In words of Elizabeth Warren, the dollar bill should read “In government we trust” instead of “In God we trust”. It is government’s job to keep the currency valuable.
  14. All currencies decline with time. The economic system works that way. Japan tried a different approach and it did not work.
  15. Purchasing power of US$ will decline over time. The question is at what rate.
  16. One dollar in 1930 is now worth $0.06. So, inflation has not destroyed us. We have adapted really well to inflation.
  17. One can invest in three types of assets
    1. Currency
    2. Non-productive Assets (like Gold that do not produce anything)
    3. Productive Assets (that produce something, like a business)
BH mainly invests in productive assets because you can value them and return is not based on other people’s speculation.
  1. The Gold Story: If you take all the Gold in the world, and make a cube out of it, it will be a cube with side-length of 67 feet and it will weigh 170 metric tons. You can sit on top of it and feel like you are on top of the world for a few minutes. Then what? The cube does not do anything. The chapter 12th of Keynes book explains very well how the value of Non-Productive assets goes up. By investing in Gold, you are betting that other people will value it more at a later time.
Munger does like the idea of investing in Gold because the value of Gold goes up with the world goes to hell. The concept is bizarre. You dig gold out of ground in Africa, ship it to the US to Federal Reserve and the Fed puts it back in the ground (locker). 

All Gold in  the US is worth $8 Trillion and all farm land in the US (one billion acres)  is worth only $2 Trillion. There is something wrong with this picture. 

  1. We don’t invest in paintings of soup cans either:-)-Munger
  2. Buffett did not like selling securities because when the price of a security goes down, you have to face people. When Buffett started his partnership, he was very clear to investors that he will not provide visibility into how he will invest.
  3. If you are starting a hedge fund, you have two jobs- 1) attract money 2) invest for above average returns. However, with the current fee structure, one maybe better off just focusing on attracting money:-) 
  4. BH conglomerate structure offers tax advantages. In the seventies and eighties the Conglomerates became generally unpopular because many of them were operating like semi-ponzi scheme i.e. they are were printing stocks and buying companies for confetti (stock). Buying real assets for confetti runs out of gas eventually.
  5. How most mangers operate, “I know what I am going to report [next quarter] but I don’t know how I am going to do it.” This behavior causes managers to fudge numbers and do unethical things.
  6. On how Buffett/Munger would like to be remembered after death
    1. For old age. Munger wants people to say that “this is the oldest corpse I have ever seen.”
    2. For “Fortune fairly won and wisely used.”-Munger
    3. Or like Will Chamber said, “Finally, I sleep alone.”
  7. Adam Smith said that a great civilization has a lot of ruin in it. Greece is still around Munger does not understand that for a country whose main economic activity is tourism, the countrymen go on vacation during the busy holiday season
  8. I would rather be born in the US today than any other place at any other time-Buffett
  9. An average investor should choose to invest in index funds over mutual funds because mutual funds charge high fees and do not perform better than index funds.
  10. I am a big fan of lower expectations. That is how I got married. My wife lowered her expectations-Munger
  11. It is so much fun to be trusted- Munger
  12. BH has 260,000 employees. At any given point, someone is breaking some policy. Leaders should set an example on how they deal with the violation of integrity. Buffett sent his friend, who worked for BH, to jail because he was doing fraud.
  13. The government has done a good job with Stimulus and has kept the economy going. Stimulus is part of how the government is operating today-they are taking in 15% of GDP and spending 25% of GDP
  14. We [Americans] are creating households faster than houses. Hence, the housing market will catch up and start growing again. Buffett’s best guess is that it will start happening by the year end.
  15. Enabling companies which enable other companies to produce goods are doing well. Both TTI and Iscar sales are rising. Hence, the economy is back on track to grow.
  16. If Munger were to design the tax system, he would make sure that the tax system discourages trading. And, Munger is not happy that 25% all engineers go into Finance. The current tax system is highly flawed. If I buy an S&P futures contract and hold it for ten seconds before selling it then 60% of my profit is taxed at long-term gain and 40% at short-term gain. There is something wrong with a tax system where a hedge fund manager has lower tax rate than a taxi driver.
  17. It is tough to know the direction of oil and commodity prices. Oil and commodities are non-productive assets. You can’t really create an edge in guessing the price of oil
  18. Munger recommends reading “In the plex” a book about Google. He does not know how he is going to use what he learned in the book but that does not matter because what you are here for is to go to bed a bit wiser every day.
  19. If the society has to intervene to save a company for the sake of society then the CEO of that company and his spouse should be left down broke.  And, there should be severe penalties for the directors of the company. The current incentive system is misaligned.
  20. Re too big to fail, we did not fix the problems so you can confidently expect that we will see more failure. It is a problem of stupidity and not of evil. Academia deserves a lot of the blame.
  21. People attracted to finance today are better suited for snake charming -Munger
  22. Serving on a lot of boards is for the birds-Munger
  23. We spend every day thinking about earnings power and intrinsic value of BH.
  24. It is almost impossible to have an edge in making equity investments today. That is one of the reasons BH is more focused on acquisitions.
  25. May you live until the A stock splits-Munger [BH has no plans of splitting the A shares]
  26. Ajit Jain has made no decision that I [Buffett] could have made better. He loves what he does which is important for doing well.
  27. The secret of success in any field is getting interested in it:-Munger
  28. When you see a duck on the pond rising, you should understand if it is doing it with its own merit or it is just raining- Buffett
  29. When you evaluate underlying economics of a  business, you should look at return on net tangible assets and not worry about goodwill. However, when you are allocating capital, you should look at goodwill. Amortization of goodwill does not make sense. However, if you paid too much for a company then goodwill write-off makes sense. AOL/Time Warner merger is a good example of goodwill write-off 
  30. Costco has extreme meritocracy and self-imposed extra-ordinary ethical duty. They have been able to achieve remarkable success. There is Costco in South Korea that is going to do $400M in sales this year. Munger is on the board of Costco.
  31. Buffett told a story about Munger’s love for Costco.  Both Munger and Buffett were traveling on a plane which was hijacked. The hijackers wanted to shoot both Munger and Buffett. However, they asked both of them for a last wish. Munger went first. He said he wants to give a talk about Costco to all passengers. The hijackers thought the wish was reasonable and granted it and they turned to Buffett for his last wish, Buffett said, “shoot me first.”
  32. Business should be taught by studying companies. How they go up, come down, survive or disappear. In addition to Costco, other good companies to study are GM and IBM. No one made graphs that show how companies evolve. “I am yearning for these graphs” said Munger. Harvard used to do that and they stopped doing it because of bureaucracy. There should be a Harvard Case Study about that. In bureaucracy, people try to hold on to their territory.  
  33. Your kids should not get an idea that they are special regardless of how much money you have. Academically, it will be tough for American kids to compete with kids in emerging markets. Munger advised, “lose gracefully.”
  34. Base price for the options for a new CEO should be set at market value of the company at the time. CEOs should be compensated on the increase in market value during their tenure.
  35. Somebody in America has to be an exemplar of not grabbing it all he can. The new BH CEO will do that.
  36. If there is enough energy then the water purification problem goes away. Israel makes drinking water out of sea water every day.
  37. One should not measure deals based on other deals one has done. The goal should be to make a deal you can make at that time and it should have nothing do with other deals one has made in the past.
  38. Woody Allen took a speed reading class and he was telling a friend that he finished war and peace in twenty minutes. It is about Russia The goal of reading should be understanding and not how fast you can read.
  39. The only thing more stupid than debt ceiling bill the congress did was in 1897 when Indiana House representative introduced a bill to reduce the value of π to 3 so that it is easier for kids.
  40. Debt ceiling is a mistake. The debt carrying capacity of US is much higher today than twenty years ago. US will not have a debt crisis as long as we can keep on issuing debt in our own currency.
  41. There is bipartisan stupidity in the government. Both parties are trying to see who is more stupid. They keep on topping each other.
  42. 20% of US electricity comes for nuclear power. And, 80% of France electricity comes from nuclear power.
  43. It is CEOs job to be the Chief Risk Officer. Buffett is the Chief Risk Officer at BH.
  44. BH stopped its charitable donation program, which allowed shareholders to donate to any charity of their choice and get tax write-offs, because people started boycotting Pampered Chef and was affecting livelihood of 50,000 employees of Pampered Chef which is a BH company. 
  45. BH does not rule out companies [for acquisition] that don’t represent high growth if the price is right. BH looks at earnings potential and future capital requirements.
  46. The growth projections are useless and represent precise falsification. They do more harm than good. I [Buffett] have never seen an investment banker show earnings gowning down over time. It is like asking a barber if you need a haircut. We [Buffett and Munger] do calculations in our head re growth projections.
  47. On BH investments in China, Munger said that it like a general went out south and came back and told his boss that the Indians always walk in a single file. When the boss asked how do you know. The general said that he saw one and he did. The point is that BH has not had enough experience investing in China yet. BYD investment is doing well.
  48. All BH cash is in T-Bills. It is stupid to try to maximize gains from short-term investments.
  49. BH can use its taxpaying capacity to use wind power [Wind Power offer tax benefits to corporations].
  50. Advice to recent graduates: anything you can do to enhance your skills will pay-off eventually. Communication skills are very important. I [Buffett] only has one diploma hanging on my wall and that is for the $100 course I took with Dale Carnegie on communication. Do what you are passionate about and continue skill development. Focus on learning easy stuff. A field where the experts disagree is usually very hard to grasp. My [Buffett] economics courses in college were waste of time.
  51. Re-insurance business looks easier than it is.
  52. You cannot judge an investor in six months or a year. You need five years.
  53. Alabama uses more brick per capita than any other US state.
  54. Sees candy business loses money 8 months out of the year. So, we look at the business 3 out of 4 quarters, it looks bad. However, we know that Christmas comes every year and we will make up for the loses
Enjoy and attend the meeting next year!