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Tuesday, May 8, 2012

Business Schools Teach a lot of Nonsense and other Learnings from Munger and Buffett

Omaha, Nebraska was probably the most exciting place to be on May 5, 2012. I paid my annual homage to Charlie Munger and Warren Buffet last weekend at the Berkshire Hathaway annual shareholder meeting in Omaha. Just like previous years, it was a great show which offered wisdom and humor. You can see the notes from last year's meeting here. Following are my random notes from the 2012 meeting: 


35,000+ shareholders at the meeting
1. Make decisions based on opportunity cost. 

2. CEO of any large organization, especially financial organization, should be the Chief Risk Officer (CRO) as well. Risk assessment is a very important capability for a CEO and is right up there with capital allocation. Buffett is the CRO at Berkshire. 

3. Risk is not accessed properly by people because it is not taught properly in business schools. Use of sigmas to measure risk is stupid. 

4. Ability to commit and follow through make Berkshire trustworthy. When the opportunity is right, Berkshire acts with speed and finality. This makes Berkshire unique among the big players. 

5. Munger told a story re risk assessment. There was a man who ran a business and he fired a guy. The guy asked the man why he was getting fired despite doing a good job. The man replied, "I am rich and old. You make me nervous." 

6. Berkshire's insurance business was over-reserved for 911 i.e. Berkshire had allocated money for a big, distractors, and unlikely event like 911. 

7. Business Interruption rules re insurance are still not clear. If a car company has business interruption insurance then does unavailability of a car part due to floods in Thailand qualify as business interruption? The insurance claims from 2011 Thailand floods will take years to get sorted out. 

8. Buffett/Munger are not spending any time giving advice to China. Munger said that they should be asking China for advice. 

9. Berkshire's four larget investments are valued at $50B. Some of these investments are 25+ year old. And, Buffett/Munger probably talk to the CEOs of the companies they have invested in probably twice a year. Berkshire does not invest in businesses which need their advice. 

10. Berkshire wants to keep their cash position around $20B because they are conservative and feel good with this number. Berkshire may do a buyback of its shares if the stock price falls down to 110% of book value.

11. American banks are in far better position today than four years ago. The American financial system is in fine shape. Europe on the other hand is not doing so well. ECB had to come up with 1 Trillion Euros (which is 1/6th of all deposites in the US) to replace outflow of money from Europe. The European banks got 1 Trillion Euros at 1% interest. Buffett said, " I wish I could get 1 Trillion Euros at 1% for 3 years but I am not in trouble so I can't get it". Overall, the Fed did the right thing during the 2008 financial crises by forcing banks to take capital when they did not need it. 

12. The difference between Europe and US financial systems is night and day. Europe has a lot of problems. The lack of federal union in Europe is a recipe for a lot of indecision. Henry Kissinger said, "If I want to call Europe, what number do I dial?" 

13. Most of the bank deposits in the US are from consumers and most of the deposits in Europe are wholesale. 

13. This year, the kWh (energy use) declined by 4.7% in the US. This has probably happened for the first time. Natural gas in now priced ~$2 and Oil is priced ~$100.  This 1:50 ratio between Natural gas and Oil pricing was unthinkable a few years ago. This has changed everyone's thinking in a short period of time. 

14. US being energy-independent is a stupid idea. We should use all the coal before we touch Natural gas. We should save Natural gas for future generations. 

15. Credit score is a good predictor of driving habits. 

16. For some reason, February is the best month for Geico which is doing well on all three fronts of insurance business. They are marketing, risk selection, and customer retention. 

17. Geico is signing 300k new policies every year. The book value of Geico is $1B but real value of Geico is around $15B. 

18. Business Schools teach a lot of nonsense. The education is improving but what they have taught so far is a considerable sin. In teaching investments, the schools are focused on one fad after another, usually mathematically focused. They should just teach two things re investing: 

   i) How to value a business? 
   ii)How to think about markets?

19. Buy businesses less than they are worth. And, only buy businesses whose value you understand. Investment is not really that complicated. 

20 Black-Scholes is not the best way to value a business. 

21. Last year, 400 largest income families in the US earned $270M on average and 131 of them paid less than 15% in taxes. And, 31 paid less than 10% in tax. In 1992, when the average income for the top 400 families was $25M, only 16 of them paid less than 15% in taxes. Under the Buffett rule, a small number of people who are paying 15% or less in taxes would pay a minimum tax around 30% like the rest of the people in that income bracket and like how they used to get taxed. Buffett's cleaning lady pays 15.3% tax. The rule calls for shared sacrifice for the country.

22. Energy generated by wind gets $0.022 per kWh federal tax credit in the US. Both solar and wind energy generation won't work without government subsidies. You cannot count on them as base energy generation i.e. you still need energy if the Sun is not shining or if the wind is not blowing. However, they make good supplements to other forms of energy. 

23. State utilities usually don't pay federal taxes because they wipe out earnings with bonus depreciation. Hence, they can't take advantage of federal tax credits for wind/solar energy. 

24. You don't give up your citizenship when you start running a company (re Buffett sharing his thoughts on taxes, etc.)

25. Berkshire has around 270k jobs and only 15k are outside the US. 

26. Private Equity firms buy companies to sell them. Berkshire buys companies to keep them. 

27. Berkshire has been around for 47 years and has seen its share price cut in half four times. It is a beauty of the markets that stocks sell at silly prices sometimes. 

28. Benjamin Graham was right when he said that Mr. Market was a psychotic drunk.  If you just read and understand chapter 8 and 20 of the Intelligent Investor, you will do well with stocks. Make your decision on buying stocks based on what the business is worth and not on the market. 

29. Stocks are a marvelous game. You get an opportunity to buy something everyday at a different price. Imagine that you are a farmer and you want to buy the farm next door. According to the stock market, the owner of the other farm will come to you everyday and offer a different price. 

30. Macroeconomics never comes into discussion when Berkshire is buying a business. There are only two things which are important. What is the business worth and what is the price? 

31. Both BNSF and Geico are better businesses today than 5-10 years ago. 

32. Utilities are required to engage in derivates (hedging). 

33. Market is there to serve you and not to advice you. 

34. Moving forward, derivates will not be a huge factor at Berkshire. When the current Berkshire derivates expire, they will make ~$10B. 

35. Both Munger and Buffett think about worst case scenarios more than anything else. 

36. EBITDA is nonsense. It should be called Earnings before what really costs anything. Berkshire values businesses based on pre-tax earnings

37. Different non-insurance operating businesses have different characteristics so the valuations vary accordingly. Generally, Berkshire is comfortable buying businesses at 10x pre-tax earnings. 

38.  In 1965, Berkshire stock was valued at $15/share and Gold was valued at $20/ounce. Today, Berkshire stock is valued at $120,000/share and Gold is valued at $1,600/ounce. 

39. Gold is an unproductive asset i.e. it does not produce anything. A business on the other hand is a productive assest. It produces products/services and cash. It is very hard for an unproductive asset to beat a productive asset. 

40. 98.5% of Buffett's wealth is tied in Berkshire stock. Hence, all of Buffett's best ideas are for Berkshire. 

41. Property casualty insurance is a better business than life insurance because it has less constraints.  

42. News is something you don't know but you want to know. Local newspapers still has a lot of local stories which you can not find anywhere else. There are around 1,400 newspapers in the US. There used to be 1,600. 

43. Newspapers will survive in areas where people have a strong sense of community and hence people care about local news. It would be a decent business and not a great business. 

44. Amazon is terrible for a lot of retailers. 

45. Berkshire is not in the business of changing people. Just like in marriage, if you are marrying someone hoping to change him/her, you are going to be disappointed. 

46. When markets get chaotic, the floors disappear i.e. stock price can go way below the book value of a good business. 

47. If there are 270,000 people in an institution, it is inevitable that some of them are doing bad things. 

48. General Re has been restructured and now has the right size to do well. 

49. Buffett gets to paint his own painting (make decisions) and lets his managers do the same i.e. he does not tell them what color to use. Most Berkshire managers don't have to work. They do it because they like it more than anything else. 

50. Berkshire never participates in an IPO. It makes no sense even thinking about them because whatever the people bringing the company to the market claim, these are not special investments. The price is set by the people who make more money with the higher price. 

51. Berkshire stays away from things they don't understand. All Berkshire decisions are based on just two things: 

i) Earnings power of the company 5-10 years from now
ii) Competitive position of the company 5-10 years from now

You cannot get that predictability for a lot of companies so you can narrow down your universe of investment pretty quickly. 

52. You can be very rich with investing if you do one or two things right every now and then without doing stupid things. 

53. If you get a prospectus for an investment where the seller is getting a large commission, don't read it. 

54. Look at what other smart people are buying. Munger said that Buffett has made many people rich because they just copy what Buffett is buying. 

55. If the business is shrinking naturally then let it shrink. Don't try to artificially meet the targets. 

56. Berkshire has 8 companies in its portfolio which would qualify to be in Fortune 500 just by themselves. 

57. Berkshire would not invest in Apple and Google because they can not predict what the earnings power and competitive position would be in next 10 years for these two companies. And, the chances of being way wrong with IBM are far lower than with Apple and Google. Hence, the investment in IBM. 

58. Today, rail is 3x more efficient than trucks for transportation of goods. 

59. Life in the markets has no relation to sigmas

60. Berkshire does not instruct its businesses to use each others' products. 

61. The mess with Fannie Mae and Freddie Mac is still not sorted out. Canada avoided the whole mortgage lending disaster. US got into it because of many reasons. One of them is that Alan Greenspan overdosed on Ayn Rand when he was younger. 

62. Berkshire now has 600,000 shareholders. 

63. Todd Combs and Ted Weschler were hired by Berkshire because they posses three qualities in addition to their capital allocation skills. They are: 

i) Intellectual integrity 
ii) Commitment to Berkshire 
iii) Character 

They can go and work at many other places or work on their own but they chose to work with Berkshire. 

64. Both Todd and Ted get $1M in annual salary and they 10% of the sum by which they beat S&P 500 on three year rolling basis. Furthermore, 80% of the compensation is based on their own performance and 20% on the other person's performance. this encourages collaboration. 

65. "I cannot put passion into someone but I can have a structure that can take the passion away."- Buffett

66. "Prostitution would be a step up for these people [compensation consultants]." - Munger 

67. 2.5% GDP growth is remarkable for a wealthy country like the US. Curent US GDP per head is $48k. 

68. Our country is not a mess. Our politics maybe a mess. 

69. 1% annual growth in real (after inflation) GDP per capita over the next 20 years would be a sensational result for the US. 

70. Super PACs are not good for democracy. Hence, Buffett will not donate money to them. Marshall plan is the kind of politics Munger likes to support. 

71. If Berkshire paid dividends then the net worth of Berkshire shareholders would be less today. MidAmerican Energy may have an opportunity to deploy $100B+ in capital at very reasonable rates over the next 10-15 years. Hence, Berkshire has no plans for paying dividends. 

72. Buffett acquires new skills every decade. 

73. Buffett and Munger do not worry about mistakes. They have made mistakes re people but you can't sit and learn about them. You have to experience them. One should learn from other peoples' mistakes. 

74. Read a lot about disasters. 

75. Berkshire does not build barriers to entry. It buys them. 

76. If you are in industry with no barriers, you have to move really fast and always stay ahead. 

77. The big barriers are in the mind. For example, in peoples' minds Coke is associated with happiness. It is really hard to overcome that barrier. 

78. By 2030 not many cars will be electric. 

79. BYD is getting more competitive. 

80. Hydrocarbons are the most precocious resource in the US. 

81. When the government is operating at 10% deficit, it is stimulus to the economy but we don't call it that. 

82. Avoid medium and long term government bonds as investments. 

83. Munger thinks that Paul Krugman is a genius but he maybe too optimistic. 

84. We need more sacrifice and more civilized politices to save fiscal virtue. 

85. US corporate tax rate is ~35% but the actual rate paid by corporations last year was ~13%. 

86. Corporate tax is not a big issue because it is less than 2% of GDP in the US. The bigger problem is healthcare spending which is ~17% of GDP spending. 


Enjoy and attend the meeting next year!