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The Berkshire Special 2018

The Warren & Charlie Show
The Oracle of Omaha and his long-time partner shared insights right from moats to cryptocurrencies at Berkshire Hathaway’s 2018 annual meeting at Omaha. Edited excerpts

Warren, you previously said that there are two parts to your job — overseeing the managers and capital allocation. Ajit and Greg now oversee the managers, which leaves you with capital allocation. However, you share capital allocation with Ted Weschler and Todd Combs. Does that mean you are semi-retired or, if not, please explain?

BUFFETT: I’ve been semi-retired for decades. Well, it’s hard to break down the percentage of the time that I was involved. Ajit and Greg have been doing a great job. Likewise, Ted and Todd are doing a very god job when it comes to investing, managing $12 billion-$13 billion each. We have $170 billion now in equities, $20 billion in bonds and another $100 billion in cash. And I still have the responsibility, basically, for the other $300 billion. Clearly, we’ve got two people in Ajit and Greg who are smarter, more energetic, and just bring more to the job every day. Ted and Todd not only do a great job with the $12-13 billion each but they also do – have done a number of things for Berkshire that they do it cheerfully, but more importantly, very skillfully. There’s one thing or another that I will have them looking into or working on, and sometimes I steal their ideas.

MUNGER: Well, I’ve watched Warren for a long time, and he sits around reading most of the time and thinking. Part of the Berkshire secret is that when there’s nothing to do, Warren is very good at doing nothing.

Warren, have you given a thought to other Berkshire managers becoming publicly more visible so that future generations of successful business owners continue to bring deal opportunities to Berkshire like they have in prior decades?

BUFFETT: I don’t think our reputation is dependent on Charlie or me but on the reputation that Berkshire is a very good home for companies, particularly private ones. There will be a little testing period for whoever takes over but basically we’ve got the money to do the deals. People can see how our subsidiaries operate in the future and the truth is that I think some of the other executives are getting better known. As I mentioned, my phone isn’t ringing off the hook with good deals but maybe the next guy will get more calls. We absolutely are the first call and we will continue to be the first call whether Charlie or I answer the phone or somebody else does.

MUNGER: It is weird that about 99% of public companies that change hands in a sort of auction provided or presided over by an investment banker is leveraged to the gills and then re-leveraged. Their money is coming out of charitable endowments and pension plans. Sooner or later this is going to end in an unpleasant episode, and, I think, we’ll be around in good shape at that time.

Warren, one of your more famous and perhaps most insightful quotes goes as follows, “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” In light of the unauthorized accounts scandal at Wells Fargo at what magnitude of leakage would Berkshire consider changing vessels?

BUFFETT: Wells Fargo proved the efficacy of incentives and it’s just that they had the wrong incentives. That was bad. But they committed a much greater error by ignoring the fact that they had a faulty incentive system. You can’t have 377,000 employees and expect that everyone is behaving like Ben Franklin. If we find something wrong is going on, we need to do something about it. Wells Fargo and Salomon didn’t do it. The truth is we’ve made a couple of our greatest investments with people who have made similar errors such as American Express and Geico. And that caused a lot of pain at American Express in 1964. It caused a lot of pain at Geico in 1976. It caused a layoff of a significant portion of the workforce, all kinds of things. But they cleaned it up. I see no reason why Wells Fargo as a company from both an investment standpoint and a moral standpoint is in any way inferior to the other big banks with which it competes. I like Tim Sloan as a manager, and he is correcting mistakes made by other people. Charlie says that an ounce of prevention isn’t worth a pound of cure but about a ton of cure.

MUNGER: Wells Fargo is going to be better going forward than it would have been if these leaks had never been discovered. I think Harvey Weinstein has done a lot to improve behavior. If I had to say which bank is likely to behave the best in the future, it might well be Wells Fargo, of all of them.

I’m a huge fan of you Charlie, mostly for your 25 Cognitive Biases. I’m fairly certain that your cognitive biases work for internet-related companies. Now that you’re partnering with Amazon [and JP Morgan] on healthcare, I’m curious, have you started to understand how to apply these biases to internet-related companies? Or is there another set of tools you use to decide if you understand a business? Because you guys talk a lot about not investing in businesses that you don’t understand.

[Berkshire has a partnership with JPMorgan Chase & Co and Amazon to cut healthcare costs and improve services for their employees]

BUFFETT: We have 2-3 organizations with leaders that I admire and trust, and we hope to do something. We have a hugely noncompetitive medical cost in America relative to any country in the world. Medical costs have soared from 5% of GDP to 18% which are currently the highest worldwide and have gone from $170 per capita in 1960 to $10,000 now. It’s a tapeworm eating into the competitiveness of American businesses. We have fewer doctors, hospitals and nurses per capita than some of the other countries that are well below us. We want our employees to get better medical service at lower cost. But we do think there might be ways to make real significant changes. Maybe the three organisations, which employ over a million people, can think of a better way without that 18% going to 20%-22% in the lifetime of our children. We are positioned better than most others to try and make sure we’ve got the right partners. So, we will give it a shot and see what happens.

MUNGER: There is some precedent for success in this public service activity. If you go back many decades, John D Rockefeller, using his own money, made an enormous improvement in American medical care. In fact, there’s never been any similar improvement done by any one man since that rivals it. So Warren, having imitated Rockefeller in one way, is just trying another. And maybe it’ll work.

I read in the newspapers about the Federal Reserve and the inflation numbers. There must be an increase supply of treasury bonds that must go to auction. My question is how would it impact the yield or interest rate?

BUFFETT: I don’t know, and the good news is nobody knows. There are a lot of variables in the picture. Moreover, long-term bonds are terrible investments. Long-term bonds, at these rates, are basically ridiculous because the Fed is telling you they want 2% inflation while the bonds don’t bring more than 3%. And of course, if you’re an individual, then you pay tax on it. You’re going to have some income taxes to pay. Let’s say, it brings your after-tax return down to 2½%. So the Federal Reserve is telling you that they’re going to do whatever’s in their power to make sure that you don’t get more than a half a percent a year of inflation-adjusted income.

You’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge.

MUNGER: Well, it wasn’t fair for our monetary authorities to reduce the savings rates, paid mostly to old people, as much as they did. But they probably had to do it to fight the great recession. But it clearly wasn’t fair. And the conditions were weird. In my whole lifetime, it’s only happened once that interest rates went down so low and stayed low for a long time. It was unfair but it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So, we’re all a bunch of undeserving people, and I hope that we continue to be so.

BUFFETT: In 1942, we used to buy savings stamps, which used to be called US War Bonds. You put $18.75 and you got back $25 in 10 years. And that’s when I learnt that that $4 for three — in 10 years — was 2.9% compounded. Even an 11-year-old could understand that 2.9% compounded for 10 years was not a good investment. But we all bought them. But we all bought them as a part of the war effort. The government knew that significant inflation was coming. The war took our debt up to 120% of GDP and it was the great Keynesian experiment and it sent us on a wave of prosperity. The government then reneged on every citizen who put their money in, and treasury bonds have been unattractive ever since, except in early ’80s. I mean, you really had a chance to invest your money by buying zero-coupon treasury bonds, and in effect, guarantee yourself that for 30 years you would get a compounded return, you know, something like 14% for 30 years of your lifetime. So every now and then, something really strange happens in markets and the trick is to not only be prepared but to take action when it happens.

Elon Musk on his Tesla earnings call said, “I think moats are lame...” So Warren, it seems the world has changed. Business is getting more competitive. Pace of innovation, technology is impacting everything. Is Elon right?

MUNGER: Elon says a conventional mode is quaint. And that’s true of a puddle of water! And he says that the best moat would be to have a big competitive position. And that is also right. You know, it’s ridiculous. Warren does not intend to build an actual moat. Even though they’re quaint.

BUFFETT: There’s been more moats that have been — become susceptible to invasion — than seemed to be the case, earlier. But there’s always been the attempt to do it. But certainly — you could work at — certainly should be working at improving your own moat and defending your own moat all of the time. And then — Elon may turn things upside down in some areas. I don’t think he’d want to take us on in candy. Being the low-cost producer, for example, is a terribly important moat. And something like Geico — technology has really not brought down the cost that much. But among big companies, we are a low-cost producer, and that is not bad when you’re selling an essential item.

Do you think Apple would be better spending $100 billion on buyback or buying other productive businesses the way you have generally preferred?

BUFFETT: Apple has an incredible consumer product. I think it’s extremely hard to find acquisitions that would be accretive to Apple in the $50 billion or $100 billion or $200 billion dollar range. They do a lot of small acquisitions and I am delighted to see them repurchasing shares. We own 215 million or 5% of it. With the passage of time, we may own 6-7% simply because they repurchase the shares. I love the idea of having our 5% grow without laying out a dime. They are not going to find $50 billion or $100 billion acquisitions at a remotely sensible price. I don’t see anything that would make a lot of sense for them in terms of what they would have to pay and what they would get, whereas I do see a business that they know everything about. So, we very much approve of them repurchasing the shares.

MUNGER: Generally speaking, in America, when companies go out hell bent to buy other companies, they are worthless after the transaction is made than they were before. A great many places have nothing better to do than to buy their own stock. Apple would be very lucky if they had something available at a low price that they could buy. I think that the reason these companies are buying their stock is that they’re smart enough to know that it’s better for them than anything else.

BUFFETT: That does not mean we approve of every buyback.

MUNGER Some people just buy to keep the stock up, and that, of course, is insane and immoral. Apart from that, it’s fine.

Were there any particular reasons why Berkshire did not ramp up its stakes in Visa and MasterCard to more meaningful levels, especially during those years when American Express was struggling?

BUFFETT: Yeah. When Ted and Todd, or either one of them — I won’t get into which one of them specifically — bought, or for that matter they could both have bought — Visa and MasterCard — they were significant portions of their portfolio. And there was no embargo or anything on them owning those stocks because we had a big investment in American Express. I could have bought them [Visa and MasterCard] as well and, looking back, I should have. American Express has done a fabulous job and now we own 17% from 12% earlier. We have done it without spending a dime and it’s a company that has really done a fantastic job in a very competitive field where lot of people would love to take their customers away from them. It is really quite a business and we love the fact that we own it.

MUNGER: Well, we would have been a lot better with all of our stock picking if we could do it in retrospect. But at the time we had a big position in American Express and there is one tiny cloud on the horizon of the payments processors, and that is a system of WeChat in China. I don’t have the faintest idea how important that cloud is, and I don’t think Warren does either.

BUFFETT: Payments are a huge deal worldwide and you’ve got all kinds of smart people working in various ways to change the payment arrangement. There are a lot of people who will game the system and switch from one card to another based on the rewards and that sort of thing. But there is a very substantial group for which American Express does something special, and they keep capitalising on that premier position with that group.

Buffett, this year at the end of the annual report you probably listed the newspapers that Berkshire owns today along with their circulation. The circulation of 26 newspapers that Berkshire still owns of the 28 that it originally bought fell sharply. Imagine that you are writing about Berkshire’s experience with newspapers, what would you be saying?

BUFFETT: The problem has been that no one except Wall Street Journal, New York Times and now, probably, The Washington Post have come up with a digital product that will replace the revenue that is being lost as print newspapers lose both circulation and advertising. It is very difficult to see with the lack of success in terms of important dollars arising from digital, how the print product survives over time. I’m afraid that’s true of 1,300 papers in this country. I would like to see daily newspapers become economically viable because of the importance to society. Economic significance to Berkshire is almost negligible as we’ve bought all the papers at reasonable prices, but the significance to the society is enormous.

MUNGER: The decline was faster than we thought it was going to be. We miscalculated, we may have done it because we both love newspapers and have considered them so important in our country. These little local newspaper monopolies tended to be owned by people who behaved well and tended to control the politicians. And we’re going to miss these newspapers if they disappear. I hope to God it doesn’t happen, but the figures are not good,.

Since 2008, after tax corporate profits have been 8 to 10% of GDP. Do you believe this is a permanent shift in the US economy? Or will corporate profits revert back to the 4%-6% GDP range that was normal in the 20th Century?

BUFFETT: You now have the four largest companies, by market value, in the US — a $30 trillion market — that essentially don’t need any net tangible assets. If you go back many years and look to the largest companies, it would be AT&T, General Motors and Exxon Mobil. These companies required a lot of capital to produce earnings. American industry has gotten incredibly more profitable, in aggregate, over the past 20-30 years. Look at the return on the S&P 500, the earnings as a percent of net tangible assets, and the rest is just, you know, if you buy a company that has a million dollars worth of net worth and you pay a billion for it, it still only had the million dollars of net worth. I mean you just paid more for it. So, the basic profitability of the company is huge, even though your investment may be at a significantly higher price. If you look at the earnings on tangible net worth of the S&P 500 and compare it to 20 years ago, it is amazing. And that is really due to the fact that this has become somewhat, you could call it an asset-light economy. Those four companies now comprise close to 10% of the market value of the entire publicly traded corporate America and don’t need any money. They will earn even more money with the tax rate going down.

How do you go about attempting to forecast the degree of future success of one specific product in a good business versus another, such that you invest in American Express and Coca-Cola rather than Diners Club or RC Cola, for example?

BUFFETT:  With American Express it was an interesting situation because Diners Club got there first. American Express went into the credit card business because they were worried about what was going to happen to Travelers Cheques. But the interesting thing that happened when American Express went into competition with Diners Club, was that instead of charging less than Diners Club, they ended at higher prices. If you were a sales person and pulled out that American Express card, you would look like you were JP Morgan. If you pulled out the Diner’s Club, you looked like a guy who was kiting his checks from one month to the next. Ralph Schneider and Al Bloomingdale developed the Diners Club and they were very smart about getting there first but they weren’t smart about merchandising it subsequently. All kinds of colas came out over the years, but Coke is the real thing. I wouldn’t take RC at half the price of Coke. A 6.5-ounce Coke sold for a nickel in 1900 and now is not much more, whereas in 1942 a newspaper was 3 cents. So, the enjoyment has gone dramatically down on an inflation-adjusted level. Coke is a real bargain product. Just like with See’s — if you were a teenage boy, and you went to your girlfriend’s house and you gave the box of candy to her or to her mother or father and she kissed you, you know, you lose price sensitivity at that point. We like products where people feel like kissing rather than slapping you. We are betting on the ecosystem of Apple products led by the iPhone but see characteristics that make me think this is extraordinary. So far we’ve been right on American Express and Coca-Cola. After the Amex scandal in 1963, there was really worry about whether the company would survive. But no one quit using the card. Nobody quit using the Travelers Checks. When we are talking about a consumer product, we want to see how a consumer product behaves under a lot of the circumstances. Then we want to use scuttleback method of investing, as mentioned in Phil Fisher’s book Common Stocks and Uncommon Profits. You can get a feel for some products and then there are others you can’t. Sometimes you’re wrong. Ted and Todd do a lot of that and they have some people helping them out in doing it, too. Charlie has done it with Costco. It has an enormous appeal to its constituency. They surprise and delight their customers and there is nothing like that in business. If you have delighted customers, you’re a long way home.

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