I recently gave a talk at the Chicago Graduate School of Business. One of the students that I met there, James Bray sent me his notes on their trip to Omaha to meet Buffett.
His write-up, which is full of gems, is in the extended entry, or you can download the file here:
May 12, 2006
Chicago GSB Trip.
Notes by James Bray – student at Chicago GSB
Dave Sokol was the “warm up act” – answered questions for about 30 minutes, then WB answered questions for around 2 hours. Took us to gorat’s for steak.
• On July 5, 1991, WB met Bill Gates for the first time and asked him if you could only hire from one school, which one would it be? The answer was IIT. Spoke highly of Ajit Jain, an IIT alumni. Only person besides WB & CM to be listed in personnel risk when they issued class B shares.
• Indian Investmnet is “fashionable”. Money follows fashion and results on Wall Street. The US mkt is around 16 trillion, represents 50% of all stocks. Talked aout Korea – companies trading at 2-3X earnings with good balance sheets. Better values in smaller markets. Capital Flows don’t matter.
• ISCAR investment: got a letter last year. “if you don’t want to put your business on the market like a piece of meat, we’re the ones who get the call” got a letter – “in certain letters character and talent just jump off the page”. Charlie met him and liked his character too. Seller didn’t like the price (they never do) but took it.
• Jewelry owner salary 100,000 per year “I don’t want to make more than you” Tha’ts the kind of people they hire
• When an entrepreneur has worked their whole life on a business painting – their fathers painted it, and they care, we’re their only call. I tell them, “Your painting, your life’s work can hang in the Metropolitan Museum, or you can sell it to a porn shop operator. He’ll make the breasts a little bigger, and sooner or later a man in a trenchcoat will show up and buy it from him, change it some more and sell it to somebody else.”
• Petro China
o Would be a 100 bn company in the us, selling for 35 bn in china
o Discount greater than the risk it should have reflected.
o Compared with Yukos, which was “statistically cheap” WB chose china over Russia. China would treat capitalists better
• Likes US markets – understands culture, intstitutions, and taxes.
o “A good way to lose sleep, but it’s not sinful – it’s not illegal, immoral, or fattening.”
o There have been lots of shorts – companies run by frauds, “It’s not hard to figure out” but it’s run by a very good, full-time promoter. If he could make something worth x sell for 10x, who’s to say he can’t make it sell for 20x? Mentioned resorts international short story in some book on Wall Street (have to find out author’s name)
o May 1901 NY Times article on the Northern Pacific Corner Morgan & 2 groups (the Schiffs) bought over 50% of the Northern Pacific Company (through shorts) and the rest of the market collapsed. There was a little box in the corner of the paper – a brewer in Newark died jumping into a bat of hot beer. He was short the stock, which went from 170 – 1000.
o Daniel Drews quote about shorting: He who sells what isn’t his’n must buy it back or go to pris’n.
o You can make more money on the long side.
• Question: Time management
o Gates schedules everything, WEB schedules nothing.
o “I have set up my life to do what I like to do. We have 16 people downstairs, no committee meetings, no HR, because I don’t like them. Designing a company is like painting a painting. If you like landscapes, why paint seascapes?”
o Mid-America – I don’t need to think about it or be informed. I can go home, put on some sweatpants, and play bridge on the Internet (don’t tell the shareholders)
o Churchill: we shape our houses and then they shape us
o If you gave me 2 choices in life: be the CEO of GE or deliver my old paper route, I’d take the paper route. It’s more fun. I believe in enjoying yourself.
o Munger got out of HLS with now money, a wife and kids, and was working hard, billing $20/hour to clients. He said I’ll sell myself the best hour of the day. His best hour was from 6-7AM.
• Account Deficit / Dollar
o Mostly repeated what he’d said in 2004 annual report.
o Peter Lynch Quote – pick a company that can be run like an idiot and still survive, b/c sooner or later it will be run like an idiot. USA is like that kind of company.
o I look for a business I can understand
o “I’m afraid of change – I don’t know who will win”
Uranium in 1950’s
Auto huge developments
Originally 2000 auto companies – all of them failed
Aircraft – net result of air travel been a huge loss. If there was a capitalist on the ground at Kitty Hawk, he should have shot them down.
Simple things: chewing gum. Snickers has been the #1 candy bar in the US for 40 years. Other countries’ candy bars don’t sell here. The safety razor was invented 70 years ago, today 70% of the safety razors sold are from Gillette. Will probably be the case in 20 years.
o Investing Process
Is this something where I can see reasonably well into the future?
Is there a sustainable competitive advantage?
• Abnormal ROIC
Is there able and honest management?
• Not geniuses
Is the price interesting?
What is in front of me -> think -> move.
• Larson-Juhl. Explained business (Custom wood frames, relationships with over 18,000 framers. People want frames that are really nice and they want them soon. Larson Juhl’s sales staff calls on framers 4-5 times per year – great relationships. 85% of orders received by 4PM are delivered the next business day. Satisfied customers who are not price conscious. WB asked, would I want to compete with this company?
• Housing market. Real estate is not a homogeneous commodity (unlike stocks). The market closes and reopens. “You’ve had a bubble in the process of being burst” Significance of long term interest rates. As rates increase, we should see a major change in the residential real estate market. Most people don’t sell – this slows down the number of transactions. People have been using home equity like an ATM machine to get 600bn more purchasing power.
• Formalization of risk.
o “Nothing we do is risky. We define risk differently”
o Daihan Flower Mills – no risk at 3x earnings with a good balance sheet.
o Risk does not equal covariance – “handy for finance professors, because they can write down an equation, but it has no utility.”
o Talked about buying the Washington Post – in 1973 its market cap was 100M. On any other basis the company’s net worth was 500M. valuation was depressed due to a generally weak market and the fact that they had infuriated Nixon (fear of retaliation). Price was cheap = “riskier academically” but less risky as an actual investment. People were selling it because it was going down. This is behavior you see nowhere else. If farmland was getting cheaper, you’d buy more. People don’t do this with stocks.
o Risk involves getting in where someone can pull the rug out under you.
o Leverage is risk.
o Wrigley’s & Gillette – the only risk is that the price will get cheaper (which means it is less risky).
• Looks at stocks as parts of a business
o No loss of 1% of net worth.
o Discipline of price.
• LTCM – very smart people fully invested in their fund, but blew up. Why? Borrowed money. They “learned too much math” and levered up too much.
• Fear puts people into paralysis. Then leverage will kill you. His phone rang on Sunday during LTCM blow up. “When we get a call on a Sunday, we’ll make money, because there’s blood on the streets.” Things stop and people with high IQs are paralyzed by fear. And then, there is no risk.
• Companies have a culture and attract likes. People imitate whoever is at the top. If the person at the top cheats on their accounting, everybody else down the chain will start cheating on accounting. Culture is important and takes years to create. The main way it’s created is through how you act. The wrong culture is hell to change. WB pays for personal travel, etc.
• Associate with people who are better than you. Marry up, employ up, work for your heroes. Associations rub off. Tell me your heroes, I’ll tell you how you’ll turn out. People in the room (us) have IQ, energy, and smarts to burn. No bad results will be due to deficiencies in this area.
• Ben Graham’s success exercise.
o Take one hour. Think of the one classmate who you’d like to own 10% of for the rest of their life. 10% of all of their future income. What do you think about? The person who others admire and want to work with. Person who works hard and gives others credit. It’s simple. Select those qualities for yourself.
o “Now the fun part” who would you want to short? The guy who turns other people off.
o Qualities are chosen.
o BG did that. Wrote everything on a piece of paper and developed habits. You will find that you can attain or get rid of qualities accordingly.
• Tom Murphy – ABC / Cap City – BH’s most able executive. People want his approval. It’s not about money. BH has never had a compensation consultant. People want fair treatment and applause. Applause makes people feel better than money.
• Mentioned woman in Omaha who was Jewish during WWII, hidden throughout Europe. You will measure your success by the number of people who will hide you
• Intrinsic Value
o 600BC Aesop: A bird in hand beats 2 in the bush. But he didn’t fill out the whole thing. What is the certainty that there are 2 birds in the bush? What about interest rates? AT Brk we try to figure out how many birds are in the bush. There are no asset plays. Lay out money today for more money later on . “At some point you get out more money than you put in.” not necessarily by selling. Don’t think of sale price. That is a merchandising question, not an investing question. PetroChina pays out 45% of its earnings. That is surety.
o A stock is a bond whose coupons are not printed yet. You print the coupons (you don’t know what they are). How does it look?
o Early on he sold if he found something cheaper. Now he only sells if his thesis changes or he develops management distrust.
• CEO Pay
o Jim Kilts is an extraordinary manager who deserved his pay. I am not irritated by exceptional CEO’s being paid like exceptional CEOs. I am irritated by village idiots being paid like they are exceptional CEOs.
o David Sokol could have been paid 12M more than his partner (and his partner would never know) but insisted that they be paid 50/50. That’s they kind of people they hire.
o OK to pay a lot for performance. Not OK to pay a lot for non-performance.
o Happy CEOs refer board members to other boards. “Now it’s spreading to boards of directors” 350K/yr for directors. Big shareholders must get upset and be vocal about it to change the system.
o Check out the 1934 edition of security analysis. PC Allen (not sure if I heard it correctly) is a classic arb. Situation.
o Rockwood chocolate LIFO inventory. (talks about this in one of his letters (1988), so I’m not repeating the whole story here).
o Arbitrage should be unleveraged, not complicated. You only need to assess probabilities.
• Health Care
o BRK has never initiated post retirement defined benefit health care plans, but inherited some. GM problems came about because pension costs were not expensed under accounting roles of the 1960’s. They increased retirement benefits instead of wages (which boosted net income.) This was like shorting health care. Now they pay the equivalent of 1000 extra for each ton of steel vs. their competitors. BRK likes to pay up front so there are no surprises. GM thought they owned the world. Wagoner is a terrific CEO but the chickens are coming home to roost.
• Everything else you buy, you want it to go down (farmland example).
• “We judge management by how the business performs.”
Personal characteristics / General observations
• Amazing memory – knew facts, figures, and history like the back of his hand.
• Genuine enthusiasm – he literally reminded me of an enthusiastic kid about 22 years old talking about whatever he’s most excited about.
• Truly a sense of wonder about things.
• Generous with his time. Made a point of being fair about everything. IIT was visiting too, he made a point of alternating questions between the groups and walking up the aisle so people in the back could ask questions too. He started with IIT, but at one point called on 2 GSB students in a row. He took an IIT question last – evening out the number of questions between the two schools. I don’t think this was a coincidence.
• Got my picture taken with him. I complimented him on his tie (which had the Berkshire Hathaway logo on it). He said “Thanks. I’m wearing Fruit of the Loom Underwear. We sold 45,000 dollars worth at the annual meeting.” I asked him how much furniture he sold. He replied “30 million.” The CEO of Borsheim’s later confirmed that number.
• IIT students were mobbing him like he was the Beatles in 1964. He was a very good sport, very patient. Seemed to even enjoy it a bit.
• Very kind, great wit and sense of humor – maybe a bit mischevious
My question to Dave Sokol:
WB is known for being a very astute judge of character who is very good at evaluating management. How did he evaluate you, and what did he do differently from other people who have evaluated you as a manager in the past?
Answer: WEB has the talent to get to the essence of a business and its people. He knew Walter Scott and had the benefit of observing him over many years. When DS was going to sell Mid-American Energy to WEB he made a flipbook presentation. It was never opened – WB knew the business better than DS did! Said that WB “reads everything” synthesizes data and sees opportunity.
After speaking for a few minutes, WB told him “The enemy of your business is inflation.” DS said he knew several utility CEOs who could not have boiled it down so simply. Regulator doesn’t care about utility costs in a non-inflationary environment.
My question to WEB:
You regularly write that a company’s return on capital is a better measurement of its performance than its growth in earnings. I noticed KO’s board members now have performance pay based on operating earnings targets (which look easily attainable). What do you like about this arrangement, and what would the ideal directors compensation package be?
(he didn’t call on me – lots of students had questions. My guess is it might not be perfect, but it’s still better than just giving them 300,000 cash. Still, it’s always good to hear his perspective on governance/incentives. Maybe next time……)