Thursday, February 23, 2006

Charlie Munger on The importance of reading

"In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time -- none, zero... You'd be amazed at how much Warren reads -- at how much I read. My children laugh at me. They think I'm a book with a couple of legs sticking out." by Charlie Munger (May 9, 2003)

Charlie Munger's Investing mental models

"You need a different checklist and different mental models for different companies. I can never make it easy by saying, 'Here are three things.' You have to derive it yourself to ingrain it in your head for the rest of your life." by Charlie Munger (May 15, 2002)

"You must know the big ideas in the big disciplines, and use them routinely -- all of them, not just a few. Most people are trained in one model -- economics, for example -- and try to solve all problems in one way. You know the old saying: to the man with a hammer, the world looks like a nail. This is a dumb way of handling problems." by Charlie Munger (May 15, 2000)

Charlie Munger on How to get rich

A young shareholder asked Munger how to follow in his footsteps, and Munger brought down the house by saying, "We get these questions a lot from the enterprising young. It's a very intelligent question: You look at some old guy who's rich and you ask, 'How can I become like you, except faster?'" (May 9, 2003)

Munger's reply was: "Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts... Slug it out one inch at a time, day by day, at the end of the day -- if you live long enough -- most people get what they deserve." (May 9, 2003)

Stock Market Predictions

“I don't know if we'll ever see stocks in general at mouthwatering levels that we saw in 1973-4 or 1982 even. I think there's a very excellent chance that neither Warren or I will see those opportunities again, but that's not all bad. We'll just keep plugging away.” by Charlie Munger (2003 Annual Meeting)

“It's not out of [the realm of] possibility though. You can never predict what markets will do. In Japan, a 10 year bond is yielding 5/8 of 1%. [Who could have ever imagined that?]” by Warren Buffett (2003 Annual Meeting)

Happiness and Success

“I tell college students, when you get to be my age you will be successful if the people who you hope to have love you, do love you. Charlie and I know people who have buildings named after them, receive great honors, etc., and nobody loves them -- not even the people who give them honors. Charlie and I talk about wouldn't it be great if we could buy love for $1 million. But the only way to be loved is to be lovable. You always get back more than you give away. If you don't give any you won't get any. Everybody loves Don Keough [former senior executive and Board member of Coca Cola]. There's nobody I know who commands the love of others who doesn't feel like a success. And I can't imagine people who aren't loved feel very successful.” by Warren Buffett (2003 Annual Meeting)

“You don't want to be like to motion picture exec who had so many people at his funeral, but they were there just make sure he was dead. Or how about the guy who, at his funeral, the priest said, "Won't anyone stand up and say anything nice for the deceased?" and finally someone said, "Well, his brother was worse."” by Charlie Munger (2003 Annual Meeting)

Warren Buffett on Preparing for the future

"Imagine that you had a car and that was the only car you'd have for your entire lifetime. Of course, you'd care for it well, changing the oil more frequently than necessary, driving carefully, etc. Now, consider that you only have one mind and one body. Prepare them for life, care for them. You can enhance your mind over time. A person's main asset is themselves, so preserve and enhance yourself."


"I agree. We took an $88 million loss to get out of Gen Re's derivative business. Many companies have similar problems, but don't want to face up to them. You're seeing the unwinding of a derivative book in the Enron debacle. You couldn't devise a worse system. It's like hell." by Warren Buffett (2002 Annual Meeting)

“Charlie and I think that there is a low but not insignificant probability that at some time -- I don't know when; it could be three years, it could be 20 years -- derivatives could lead to a major problem. The problem grows as derivatives get more complex. We hoped to give a mild wakeup call to the financial world that there's a problem. In the energy sector, derivatives destroyed or almost destroyed institutions that shouldn't have been destroyed. [He mentioned Enron.]” by Warren Buffett (2003 Annual Meeting)

“In engineering, people have a big margin of safety. But in the financial world, people don't give a damn about safety. They let it balloon and balloon and balloon. It's aided by false accounting. I'm more pessimistic than Warren. I'll be amazed if we don't have some kind of significant blowup in next 5-10 years.” by Charlie Munger (2003 Annual Meeting)

Warren Buffett on Feedback mechanisms

"Having a good partner is key. Charlie will not accept anything I say because I say it. It's great to have a partner who will tell you when you're thinking is wrong."

"Having good feedback mechanisms is terribly important. We have a very good system."

Warren Buffett on Index funds

"Just pick a broad index like the S&P 500. Don't put your money in all at once; do it over a period of time. I recommend John Bogle's books -- any investor in funds should read them. They have all you need to know."

Warren Buffett on Shorting stocks

"It's an interesting item to study. It's ruined a lot of people. You can go broke doing it."

"You'll see way more stocks that are dramatically overvalued than dramatically undervalued. It's common for promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock trading at 10-20% of its true value. So you might think short selling is easy, but it's not. Often stocks are overvalued because there is a promoter or a crook behind it. They can often bootstrap into value by using the shares of their overvalued stock. For example, it it's worth $10 and is trading at $100, they might be able to build value to $50. Then, Wall Street says, "Hey! Look at all that value creation!" and the game goes on. [As a short seller,] you could run out of money before the promoter runs out of ideas." (2001 Annual Meeting)

"Charlie and I have agreed on around 100 stocks over the years that we thought were shorts or promotions. Had we acted on them, we might have lost all of our money, every though we were right just about every time. A bubble plays on human nature. Nobody knows when it's going to pop, or how high it will go before it pops." (2002 Annual Meeting)

"I had a harrowing experience shorting a stock in 1954. I wouldn't have been wrong over 10 years, but I was very wrong after 10 weeks, which was the relevant period. My net worth was evaporating."

Warren Buffett on How to avoid fraud

"There's no short answer on how to avoid fraud. But there are whole fields where there's too much fraud, so we avoid them."

"We've been defrauded very infrequently over the years. If we do get defrauded, it'll be by someone carrying [Ben Franklin's] Poor Richard's Almanac under his arm."

"Crooks are often obvious. For example, Robert Maxwell's nickname was 'The Bouncing Check,' yet Salomon was trying to lend him money until three weeks before he went under. Wall Street has no filter, as long as there's profit."

Warren Buffett on Turnarounds vs. One-Foot Hurdles

"A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers."

"Both our operating and investment experience cause us to conclude that “turnarounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price."

Warren Buffett on Losing and Regaining Competitive Advantage

“There aren't many examples of companies that lose and then regain competitive advantage. I have a friend who likes taking over lousy businesses and trying to turn them into great businesses [I wonder whether he was referring to Jack Byrne of White Mountains Insurance?]. I asked him for examples of this [bad businesses turning into good businesses] over the past 100 years [and he couldn't name very many].”

“One example: Pepsi lost its edge post-WW II when costs went up, but they successfully changed. To some extent Gillette lost its competitive edge in the 1930s to penny blades, but then regained it.”

“But generally speaking, when a company loses its edge, it's very difficult to regain. Packard [cars] went downscale one year and never regained its upscale image. Department stores have done this. You can always juice sales by going down market, but it's hard to go back up market.”

Warren Buffett on The Borsheim Advantage

“The Borsheim selections are sent all over the country, some to people no one at Borsheim's has ever met. (They must always have been well recommended, however.) While the number of mailings in 1990 was a record, Ike has been sending merchandise far and wide for decades. Misanthropes will be crushed to learn how well our "honor-system" works: We have yet to experience a loss from customer dishonesty. At Borsheim’s, we attract business nationwide because we have several advantages that competitors can't match. The most important item in the equation is our operating costs, which run about 18% of sales compared to 40% or so at the typical competitor. (Included in the 18% are occupancy and buying costs, which some public companies include in "cost of goods sold.") Just as Wal-Mart, with its 15% operating costs, sells at prices that high-cost competitors can't touch and thereby constantly increases its market share, so does Borsheim's. What works with diapers works with diamonds.”

Warren Buffett talks about his Purchase of Nebraska Furniture Mart

“One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. I’d rather wrestle grizzlies than compete with Mrs. B and her progeny. They buy brilliantly, they operate at expense ratios competitors don’t even dream about, and they then pass on to their customers much of the savings. It’s the ideal business - one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners.”

Warren Buffett on Inevitables

“Of course, Charlie and I can identify only a few Inevitables, even after a lifetime of looking for them. Leadership alone provides no certainties: Witness the shocks some years back at General Motors, IBM and Sears, all of which had enjoyed long periods of seeming invincibility. Though some industries or lines of business exhibit characteristics that endow leaders with virtually insurmountable advantages, and that tend to establish Survival of the Fattest as almost a natural law, most do not. Thus, for every Inevitable, there are dozens of Impostors, companies now riding high but vulnerable to competitive attacks. Considering what it takes to be an Inevitable, Charlie and I recognize that we will never be able to come up with a Nifty Fifty or even a Twinkling Twenty. To the Inevitables in our portfolio, therefore, we add a few "Highly Probables."”

Wednesday, February 22, 2006

Warren Buffett talks about his Purchase of Wells Fargo

“Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.”

Tuesday, February 21, 2006

Warren Buffett on Investing expectations

"We think people whose expectations were set from 1982 - 1999 will be disappointed [with future investment returns]. But there's nothing wrong with earning 6% annually on your money, in a world of low inflation."

Munger: "One of the smartest things a person can do is dampen investment expectations, especially with Berkshire. That would be mature and responsible. I like our model and we should do nicely."

"The problem is the starting point in predicting modest returns for equity investors. [Expectations were too high.] In 1999, a Gallup poll showed people expected 15% [returns from stocks] in a low inflation environment. In a low inflation environment, how much will GDP grow? If there's 2% inflation and 3% [real] growth, that's 5%. This will be the rate of corporate growth, so if you add dividends, you get 6-7% [annualized returns] before frictional costs -- and investors incur high frictional costs (they don't have to, but they do) -- which adds up to 1.5%. [This 4.5-5.5% is] not bad."

Warren Buffett on Capital Expenditure

“Such an attitude is clearly delusional. At 95% of American businesses, capital expenditures that over time roughly approximate depreciation are a necessity and are every bit as real an expense as labor or utility costs. Even a high school dropout knows that to finance a car he must have income that covers not only interest and operating expenses, but also realistically-calculated depreciation. He would be laughed out of the bank if he started talking about EBDIT.”

“Capital outlays at a business can be skipped, of course, in any given month, just as a human can skip a day or even a week of eating. But if the skipping becomes routine and is not made up, the body weakens and eventually dies. Furthermore, a start-and-stop feeding policy will over time produce a less healthy organism, human or corporate, than that produced by a steady diet. As businessmen, Charlie and I relish having competitors who are unable to fund capital expenditures.”

Warren Buffett on Acquisitions

"GEICO is a great business. Over the past 20 years, they've done three acquisitions to get into new businesses and they've all been disasters. Why when you have a wonderful business would you want to get into an inferior business? It happens time after time after time. Charlie and I have no such inclinations."

“In making acquisitions, Charlie and I have tended to avoid companies with significant post-retirement liabilities. As a result, Berkshire's present liability and future costs for post-retirement health benefits - though we now have 22,000 employees - are inconsequential. I need to admit, though, that we had a near miss: In 1982 I made a huge mistake in committing to buy a company burdened by extraordinary post-retirement health obligations. Luckily, though, the transaction fell through for reasons beyond our control. Reporting on this episode in the 1982 annual report, I said: "If we were to introduce graphics to this report, illustrating favorable business developments of the past year, two blank pages depicting this blown deal would be the appropriate centerfold." Even so, I wasn't expecting things to get as bad as they did. Another buyer appeared, the business soon went bankrupt and was shut down, and thousands of workers found those bountiful health-care promises to be largely worthless.”

Warren Buffett on Growth

“We face another obstacle: In a finite world, high growth rates must self-destruct. If the base from which the growth is taking place is tiny, this law may not operate for a time. But when the base balloons, the party ends: A high growth rate eventually forges its own anchor.”

“Carl Sagan has entertainingly described this phenomenon, musing about the destiny of bacteria that reproduce by dividing into two every 15 minutes. Says Sagan: "That means four doublings an hour, and 96 doublings a day. Although a bacterium weighs only about a trillionth of a gram, its descendants, after a day of wild asexual abandon, will collectively weigh as much as a two days, more than the sun - and before very long, everything in the universe will be made of bacteria." Not to worry, says Sagan: Some obstacle always impedes this kind of exponential growth. "The bugs run out of food, or they poison each other, or they are shy about reproducing in public."

"We don't want people focusing on growth. It's suicide [in the insurance business]."

Warren Buffett on Stock Options

“Shareholders should understand that companies incur costs when they deliver something of value to another party and not just when cash changes hands. Moreover, it is both silly and cynical to say that an important item of cost should not be recognized simply because it can't be quantified with pinpoint precision. Right now, accounting abounds with imprecision. After all, no manager or auditor knows how long a 747 is going to last, which means he also does not know what the yearly depreciation charge for the plane should be. No one knows with any certainty what a bank's annual loan loss charge ought to be. And the estimates of losses that property-casualty companies make are notoriously inaccurate.”

“Does this mean that these important items of cost should be ignored simply because they can't be quantified with absolute accuracy? Of course not. Rather, these costs should be estimated by honest and experienced people and then recorded. When you get right down to it, what other item of major but hard-to-precisely-calculate cost - other, that is, than stock options - does the accounting profession say should be ignored in the calculation of earnings?”

“Moreover, options are just not that difficult to value. Admittedly, the difficulty is increased by the fact that the options given to executives are restricted in various ways. These restrictions affect value. They do not, however, eliminate it. In fact, since I'm in the mood for offers, I'll make one to any executive who is granted a restricted option, even though it may be out of the money: On the day of issue, Berkshire will pay him or her a substantial sum for the right to any future gain he or she realizes on the option. So if you find a CEO who says his newly-issued options have little or no value, tell him to try us out. In truth, we have far more confidence in our ability to determine an appropriate price to pay for an option than we have in our ability to determine the proper depreciation rate for our corporate jet.”

“It seems to me that the realities of stock options can be summarized quite simply: If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?”

Warren Buffett on Selling Policy

“Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it is. In such a case, we will sell our holdings. Sometimes, also, we will sell a security that is fairly valued or even undervalued because we require funds for a still more undervalued investment or one we believe we understand better.”

“We need to emphasize, however, that we do not sell holdings just because they have appreciated or because we have held them for a long time. (Of Wall Street maxims the most foolish may be "You can't go broke taking a profit.") We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.”

“Selling, however, is a different story. There, our pace of activity resembles that forced upon a traveler who found himself stuck in tiny Podunk's only hotel. With no T.V. in his room, he faced an evening of boredom. But his spirits soared when he spied a book on the night table entitled "Things to do in Podunk." Opening it, he found just a single sentence: "You're doing it."”

“Interestingly, corporate managers have no trouble understanding that point when they are focusing on a business they operate: A parent company that owns a subsidiary with superb long-term economics is not likely to sell that entity regardless of price. "Why," the CEO would ask, "should I part with my crown jewel?" Yet that same CEO, when it comes to running his personal investment portfolio, will offhandedly - and even impetuously - move from business to business when presented with no more than superficial arguments by his broker for doing so. The worst of these is perhaps, "You can't go broke taking a profit." Can you imagine a CEO using this line to urge his board to sell a star subsidiary? In our view, what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.”

Thursday, February 16, 2006

Quote of the day

"When I was seven years old, my grandfather, Karl Wallenda, put me on a wire two feet off the ground. He taught me all the elementary skills: how to hold my body so that I remained stiff and rigid; how to place my feet on the wire with my big toe on the wire and my heel to the inside; how to hold the pole with my elbows close to my body. But the most important thing that my grandfather taught me was that I needed to focus my attention on a point at the other end of the wire. I need a point to concentrate on to keep me balanced."

- Tino Wallenda (He Found Me)

Warren Buffett's advice to students

Monica Reed, 23, a business major asked what students can do to find their true passion as Warren Buffett did with investing. He told her to try to varied experiences and keep an open mind.

"I plan to travel, expose myself, like he said, to the world of international business and see what turns me on," Reed told the Reno Gazette-Journal afterward.

Buffett said the two most important things students can do to improve themselves is to hone their communications skills and focus on things that they admire in other people.

He described an exercise he does in classrooms in which he asks students to look around and pick the person they most would like to have a 10 percent share in their future earnings.

"Would you pick the person with the highest grades? No. The highest IQ? No," he said.

"It's usually the person who works well with other people, who is honest, who gives credit to others. ... Be the person you want to buy part of."

Tuesday, February 14, 2006

UCLA Anderson School of Management & USC Marshall School of Business Q&A with Warren Buffett

Mr. Warren Buffett is an energetic and charismatic man with a great sense of humor. He loves what he does and has a unique ability to absorb large amounts of information and condense it into a simple point of view.

DISCLAIMER: Only the words in bold italics are direct quotes. Everything else is paraphrased.

Question: Can you comment on Alan Greenspan’s recent remarks regarding the reversal of asset values that typically occurs after prolonged periods of sustained low volatility?

· Greenspan is correct.

· There has been a compression of credit spreads. I bought billions of junk bonds a few years ago.

· Things could get real bad should interest rates continue to rise.

· “Wall street swings in huge manners.” It will make you all rich if you can keep a level head and make rational, educated decisions.

Question: What advice can you give MBA students entering the field of investment management?

· First of all, investment management is a great field, if you like it, it won’t feel like work. It is a field where you can get paid extraordinarily well.

· Have passion for what you do and where you work.

· Work for someone you admire. “I found my passion working with Ben Graham. When I first went into his office, I told him ‘I’ll work for free’. Graham promptly replied ‘you are still overpriced’.”

· “For me, the money was not that important. The starting salary was not that important.”

· “Alternatively, if you like investing on your own, just start digging. Dig into companies, turn pages and wait for something to jump out at you. Research, research, research”

· “Nobody is going to tell you about the great ideas”

· Mr. Buffett started with Western Insurance Securities. He found his opportunity in the 1951 Moody’s Banks & Finance manual. Great western insurance was trading at $3-$13 a year but was worth $20 at Book Value.

· Even if you are working for a company, invest on your own no matter how small your capital.

· Build your knowledge base because knowledge is cumulative. Had Mr. Buffett not researched insurance companies, he would not have been ready or willing to make the investments.

· Ideas should come from what make sense to you, not from what you read or from what someone else tells you. Act on what you learn yourself.

· “Grade yourself on your temperament.” Temperament is the ability to not be swayed by the market. See what you are supposed to see.

· Before making an investment decision, take out a notebook and without looking at the price of a company write “I am buying X shares in this company for Y price because…” The only reason to buy a company (or shares in a company) is that it is worth a lot more than it is selling for. You then do your homework to find the “range” of prices that the stock is worth.

· Investing is a “positive sum game”: if you rule out all the bad moves you’re going to win.

· It is almost impossible to come to an exact value for a company.

Question: How do you keep such a level head and perspective? How does bridge and exercise help you maintain this perspective?

· Being in Omaha helps. Not having Wall Street whispering 20 ideas a day into my head.

· I like to act on what I know. Things that make sense jump out at me.

· Ideas should come from what you know and have learned. Exercise and Bridge keep my head clear and sharp.

· For example, during the market bubble, the market capitalization was at 170% of GDP, with real earnings contributing to 6% of GDP. That equates to a market multiple of 30. At other times, you have seen the market trading at 70% of GDP, “you do the math.”

Question: What do you think of white collar crime and the penalties given out recently? Also what advice can you give about staying out of trouble in this respect?

· “The people who have been convicted of these crimes are getting what they deserve. But it is not a perfect justice system by a long shot.”

· On how to stay out of trouble, Mr. Buffett recalled a story he heard about a man on death row reading The Bible for the first time. When asked what he was doing, the man responded “I am trying to find loop holes.” Relating to a code of ethics for companies that are hundreds of pages long, there will always be loop holes.

· “Judge every action as if a smart and slightly unfriendly reporter was writing an article about it on the front page.”

· “There is plenty of money to be made in the center of the court.” If you feel like [the morality of the business decision] is not clear, it is probably wrong. When it is right, you don’t question it. Mr Buffett referred to his managers coming to him with moral ambiguity: if they are calling me it is probably wrong - they don’t call if things are morally right.

Question: Our generation is dealing with pension and social security issues, what problems do you see our children and our children’s children facing?

· From a non-economic point of view, terrorism has escalated to an entirely new level and will be with us for a while. I did some math on probability of terrorist event. 10% per year over next 50 years equates to 99% probability. 1% over next 50 years is something like 40% probable.

· Economically, we consume 6% more than we produce. I feel that a lingering issue will be the trade deficit. We consume foreign goods in exchange for paper—be it bonds or stocks—and that is going to come back to haunt us someday. There will be political consequences.

· The United States has a flat tax rate, once you account for income tax, payroll tax, strategic tax planning, etc. This has “happened without anyone knowing it.”

Question: What role government should have in Economy/Business?

· There is definitely a role for government but it is a tight rope that must be walked carefully. For instance, when China (CNOOC) comes in and wants to buy Unocal, and the government disallowed the acquisition; that is getting to a questionable point (I realize the national security issues, but it doesn’t seem right).

· “A pure market system does not work.”

Question: It has been stated over and over again that the U.S. Stock Market will be facing a single digit return environment. As a result, investors are looking elsewhere to get their desired returns. What are you views on this issue?

· Single digit returns aren’t all that bad. Occasionally the barometer in the stock market gets ahead of itself. It has been running a “little rich” lately. It’s crazy to think you are going to be able to earn consistently 10% when global GDP is at 5%.

· We want to be producing things that China is consuming.

· Greenspan sent me a 1901 NYT article; Greenspan mentioned that the paper cost one cent in 1901 and now costs one dollar. Greenspan joked that that’s only a 4% CAGR in price!

· We are living seven times better than we were 100 years ago.

Question: If we use the “Margin of Safety” criterion so often touted by Ben Graham and Warren Buffett, is there a danger of becoming by-standers as no worthwhile investments come our way even after long waiting periods?

· Margin of Safety is the untapped pricing power in a business.

· In an investment management job, if you must pick companies to invest in, pick those that although fully valued, are still excellent companies with strong business models.

· Pick companies with enduring competitive advantage:

o i.e.,: See’s Candy and Borsheims jewelry. Items that carry an emotional value.

o When you don’t care about a product, it’s a commodity.

· Management that will do a good job:

o Love the business not the money.

o You must be able to read people.

· Buffett skips to work each day because the outcome is not known.

· He often makes decisions with out firm (hard) numbers but with firm knowledge of a good margin for safety.

· Mr. Buffett gave an excellent example of the concept of Margin of Safety. He asked if any of us would consider driving a truck weighing 9800 lbs over a bridge that can withstand a max of 10000 lbs. Of course, the resounding answer was NO. Nobody wants to take a risk of that nature. The designer of the bridge could have made slight errors when calculating the max weight capacity. Further, the bridge might not be as strong today as it once was. So, only drive a truck that is well below 10000 lbs.

Question: In a speech you made several years ago to a group of college students you stated that “there might be more to be gained by studying business failures rather than studying business successes.” Can you please give an example of a recent failure and share what you believe is the lesson to be learned from this example?

· Companies must have enduring economics—competitive advantage—and management you admire and trust. I ask myself, of management, “Do they love the money or do they love the business?” I do not try to lock in management with employment contracts at Berkshire. I try to spot the extremes and deal with high probabilities.

· Most of my mistakes have come from omission or not investing in companies that I should have in industries that I know (e.g. companies within his circle of competence: Wal-Mart). I do not count the tech bubble because I don’t understand it that well.

· Don’t dwell on your mistakes too long because things always change and the next problem will be a little different—e.g. Dexter Shoe’s (underestimate changing industry dynamics).

· Take action on what you can figure out yourself, and swing big. Usually other people won’t be swinging.

Question: How do you view India and China as possible investments?

· We want China as a market. China is an economy that is working well.

· In 1790, there were 4 million people in the US. At the same time, China had a population of 250 million. They are just now realizing a business model that works for them and are unleashing power that the US recognized over 200 years ago.

· Mr. Buffett views the 8% GDP growth as real and sustainable in China.

· Berkshire Hathaway invested in Petro China because it was cheap, not because it was “China.”

· Berkshire Hathaway will continue to look at investments in China but will discount them and pay less because of the risks and uncertainty involved.

Question: Forbes recently listed America’s 400 wealthiest individuals, and while reviewing the bio’s I noticed a fairly high divorce rate. Can you discuss the challenges of balancing an ambitious work ethic and a healthy life at home?

· Times have definitely changed. It used to be that the man brought home the check and the wife was expected to take care of the home and understand. Now both spouses work on many occasions and this is an extremely demanding field.

· “You cannot maximize two variables in any equation.” You must have an understanding spouse that recognizes what makes you happy and is supportive of your decisions.

· The most important part of all is children—the first five years of a child’s life are the most important. You cannot relive these years, which are the most developmental years of a child’s life. Never use sarcasm with a child.

· They will remember if you let them down. I have never been let down and that is a large part of what has made me so successful.

· I plan to give my children enough money “so they can do anything but not so much that they can do nothing.” Each of the children has a foundation set up that I give money to. My daughter is active in an organization that provides help to underprivileged children. They start working with the kids when they are very young to try to give them all the opportunities that more wealthy children get early in life.

Question: Role of Hedge Funds

· A hedge fund is nothing more than a change in compensation. There is no magical secret they have, in fact Ben Graham actually started the first one in 1924 even though he is not credited for it.

· Large institutional investors have developed unrealistic market return expectations. These investors do not want to change their expectations, and so have pursued alternative investment vehicles. With 7% returns, a 2% management fee is a large fee. Hedge funds will disappoint investors over the next few years.

Question: If you were to start a holding company today, and had capital constraints similar to those you had when you began your career, what would your strategy be? How would it differ from your previous strategy with Berkshire Hathaway and why?

· You want to make big decisions, not many decisions.

· If you had a punch card for your life and you could make only 20 decisions, you are bound to be successful because each one you make you will have a high conviction for.

· If I had $10 million (or $1 million) to invest I would crush the S&P; I’d look to beat it by at least 10% per year; with $10 billion, I will eek by it.

· Cull the universe for small companies and apply basic filters

· Would buy small companies; would screen certain criteria like EV/Sales and others looking for cheap companies that adhere to other criteria (Interest Expense to Earnings and EBIT).

· Concerning my venture in Korea; I invested my money (a relatively small amount). I found numerous companies trading at two times their earnings. Examples: Posco (PKX) is the most profitable steel company in the world and earns $4 billion after tax. Daihan Flower Mills is another good example.

· REITS are relatively overpriced now, but were a good value in 1991 when they were “not sexy.”

Question: Which value investors in today's world remind you of your earlier investing days?

· I do not operate from NY, so I am not very aware of the current crop of value investors; amongst my peers, there are a few people like former students of Ben Graham, who exhibit the same style of investing.

Question: Do you think it is a problem with the U.S. Economy that so few non-for-profit universities have been founded in the last 50 years?

· Not really a problem; the U.S. university system is very strong.

· “I was fortunate growing up in Omaha when I did” – the world was not equal – I was taught by very sharp women who weren’t allowed to have careers.

· I am grateful for the terrific public school education I got in Omaha. It was very beneficial having great teachers—most of whom were women because there were so few other jobs for them at the time. Now that there are more career opportunities for women, fewer talented women are going into teaching.

· I am more worried about preschool and elementary education. We need to make it more economically equal.

Question: What do you consider to be the concerns of next generation?

· 100th anniversary of E=MC2. 1945 unleashed the power to harm great numbers of people in a single instance, unlike conventional arms dating back hundreds of years beginning with throwing stones, the musket, the cannon, etc.

· Knowledge of how to create nuclear, chemical, and biological Weapons of Mass Destruction (WMDs) is now available. Material availability is the bottleneck and must be controlled.

· Some say that eradicating poverty is the solution to the threat of WMD’s. That is wrong. Only rich nations have used nukes. The only way to prevent a major terror event is to control the supply of WMDs.

· Leo Szilard drafted letter for Einstein to Roosevelt warning about the power of nuclear energy. Hitler luckily did not obtain it first because he persecuted the Jews: Einstein was a German Jew.

· Economically, the country will do great. The current account deficit may cause disruptions and “cataclysmic” markets from time to time. Transfer of ownership is not infinite, and political issues will arise as a result.

· When dislocations happen, markets do weird things, and there is a lot of money to be made.

Question: Given the sharp growth in the real estate market, what do you see happening in the hot markets such as Los Angeles and San Francisco over the next few years?

· There will be a correction in the market.

· I do not blame the people for buying expensive houses because creative loans were too attractive.

· I expect there to be a considerable decline in the prices over the next few years (a 10% or greater decline would be very possible.

· REITs are generally overpriced.

· Inflation could make the situation much worse.

Question: What are your views on Healthcare Reform?

· Spending is 14% of GDP, or roughly 2-times as a percentage of GDP of other developed countries.

· Must “ration” healthcare. Historically, supply of healthcare has been rationed by income. This is difficult to do by government in a “rich democracy.” “But I wouldn’t want to be the guy to do it.”

· The challenge is separating services that could be universal from services like critical care. The last period of life support consumes the majority of health care costs. This leaves a predicament that has serious political ramifications: how do you choose who lives longer and who doesn’t? Currently the system favors the wealthy who can afford the best life support systems, but there is too much political risk to “ration” the system. Who will do it?

· The natural competitive market is low cost with no loss in quality. US companies will have to compete on low cost and will therefore need low cost structures (implying health care benefit costs must either be stabilized or reduced).

Warren Buffett on Buying Policy

“The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.”

“Buy companies with strong histories of profitability and with a dominant business franchise.”

“An investor should act as though he had a lifetime decision card with just twenty punches on it.”

“It is more important to say "no" to an opportunity, than to say "yes".”

“Always invest for the long term.”

“Buy a business, don't rent stocks.”

“An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.”

“Buy pieces of wonderful companies that you intend to keep forever.”

"Our investments continue to be few in number and simple in concept: The truly big investment idea can usually be explained in a short paragraph. We like a business with enduring competitive advantages that is run by able and owner-oriented people. When these attributes exist, and when we can make purchases at sensible prices, it is hard to go wrong (a challenge we periodically manage to overcome).

“Before looking at new investments, we consider adding to old ones. If a business is attractive enough to buy once, it may well pay to repeat the process. We would love to increase our economic interest in See's or Scott Fetzer, but we haven't found a way to add to a 100% holding. In the stock market, however, an investor frequently gets the chance to increase his economic interest in businesses he knows and likes. Last year we went that direction by enlarging our holdings in Coca-Cola and American Express.”

“When carried out capably, an investment strategy of that type will often result in its practitioner owning a few securities that will come to represent a very large portion of his portfolio. This investor would get a similar result if he followed a policy of purchasing an interest in, say, 20% of the future earnings of a number of outstanding college basketball stars. A handful of these would go on to achieve NBA stardom, and the investor's take from them would soon dominate his royalty stream. To suggest that this investor should sell off portions of his most successful investments simply because they have come to dominate his portfolio is akin to suggesting that the Bulls trade Michael Jordan because he has become so important to the team.”

“Be fearful when others are greedy and greedy only when others are fearful.”

"The most common cause of low prices is pessimism -- some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.”

Munger: "If you buy something because it's undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That's hard. But if you buy a few great companies, then you can sit on your $%@. That's a good thing." Buffett added, "We want to buy stocks to hold forever."

“Focus on price and value. If a stock gets cheaper and you have some cash, buy more. We sometimes stop buying when prices goes up. This cost us $8 billion a few years ago when we were buying Wal-Mart. When we're buying something, we want the price to go down and down and down.”

Monday, February 13, 2006

Warren Buffett on Debt

“We rarely use much debt and, when we do, we attempt to structure it on a long-term fixed rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, depositors, lenders and the many equity holders who have committed unusually large portions of their net worth to our care.”

“At the height of the debt mania, capital structures were concocted that guaranteed failure: In some cases, so much debt was issued that even highly favorable business results could not produce the funds to service it. One particularly egregious "kill- 'em-at-birth" case a few years back involved the purchase of a mature television station in Tampa, bought with so much debt that the interest on it exceeded the station's gross revenues. Even if you assume that all labor, programs and services were donated rather than purchased, this capital structure required revenues to explode - or else the station was doomed to go broke. (Many of the bonds that financed the purchase were sold to now-failed savings and loan associations; as a taxpayer, you are picking up the tab for this folly.)”

Warren Buffett on Share Repurchase

“One usage of retained earnings we often greet with special enthusiasm when practiced by companies in which we have an investment interest is repurchase of their own shares. The reasoning is simple: if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price? The competitive nature of corporate acquisition activity almost guarantees the payment of a full - frequently more than full price when a company buys the entire ownership of another enterprise. But the auction nature of security markets often allows finely-run companies the opportunity to purchase portions of their own businesses at a price under 50% of that needed to acquire the same earning power through the negotiated acquisition of another enterprise.”

“There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively-calculated. To this we add a caveat: Shareholders should have been supplied all the information they need for estimating that value. Otherwise, insiders could take advantage of their uninformed partners and buy out their interests at a fraction of true worth. We have, on rare occasions, seen that happen. Usually, of course, chicanery is employed to drive stock prices up, not down. The business “needs” that I speak of are of two kinds: First, expenditures that a company must make to maintain its competitive position (e.g., the remodeling of stores at Helzberg’s) and, second, optional outlays, aimed at business growth, that management expects will produce more than a dollar of value for each dollar spent (R. C. Willey’s expansion into Idaho).”

“When available funds exceed needs of those kinds, a company with a growth-oriented shareholder population can buy new businesses or repurchase shares. If a company’s stock is selling well below intrinsic value, repurchases usually make the most sense. In the mid-1970s, the wisdom of making these was virtually screaming at managements, but few responded. In most cases, those that did made their owners much wealthier than if alternative courses of action had been pursued. Indeed, during the 1970s (and, spasmodically, for some years thereafter) we searched for companies that were large repurchasers of their shares. This often was a tipoff that the company was both undervalued and run by a shareholder-oriented management.”

“That day is past. Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price. The shareholder who chooses to sell today, of course, is benefited by any buyer, whatever his origin or motives. But the continuing shareholder is penalized by repurchases above intrinsic value. Buying dollar bills for $1.10 is not good business for those who stick around.”

“Charlie and I admit that we feel confident in estimating intrinsic value for only a portion of traded equities and then only when we employ a range of values, rather than some pseudo-precise figure. Nevertheless, it appears to us that many companies now making repurchases are overpaying departing shareholders at the expense of those who stay. In defense of those companies, I would say that it is natural for CEOs to be optimistic about their own businesses. They also know a whole lot more about them than I do. However, I can’t help but feel that too often today’s repurchases are dictated by management’s desire to “show confidence” or be in fashion rather than by a desire to enhance per-share value.”