WARREN BUFFETT RESPONDS TO QUESTIONS FROM 85 WHARTON STUDENTS ON NOVEMBER 12, 2004
1) Is it more difficult to find predictable businesses today than it has been historically because the rate of change has increased within most industries? Has the accelerating rate of change within most industries caused you to reassess your buy and hold investment thesis, particularly given the inability for many consumer brands like Coke and Gillette to grow?
There are basically two ways to look at change. We see change as the enemy of investments, if it wasn’t the richest people would be librarians. Some businesses will change very quickly. We are looking for ones that don’t. If you can predict the change then you can become very rich, but the net investment (e.g. from what went on at Kitty Hawk – air flight) to equity investors is a huge negative. For example, I have a list of over 2000 companies that made automobiles, now the last two, GM and Ford, are in trouble. Hundreds are out of business – many people didn’t know that Maytag and Du Pont made automobiles. The net investment for investors has not been a great deal. We look for certainty of what won’t change. You mentioned Gillette. After 100 years, Gillette still has 70% market share, and yet the distribution, product and raw materials are not mysterious. It has survived within our capitalist system and you know its products will be used regularly.Coke sells 50% of the carbonated beverages worldwide: about 1.3 billion 8 ounce servings, higher than last year and the year before. I guarantee Coke, Wrigleys and Gillette will dominate. The internet won’t change what brands people like.We are looking for the absence of change. Fruit of the Loom and Haynes together have 80% of boys underwear in the US. I guess we will keep wearing underwear. Bill Gates welcomes the absence of change, he just doesn’t get it in his business. Microsoft and E-Bay have some moat. If you can identify change, that is great, but it is a lot riskier and so is the chance of our strategy not working. So we look for absence of change. We don’t like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs. Patents are the worst way to ensure demand. There is still plenty of opportunity to find predictable demand. The problem isn’t the lack of opportunities, it’s the prices.
2) You wound up the Buffett Partnership in 1969 due in part to the virtual disappearance of investment opportunities for the analyst who stresses quantitative factors. In your view, is today a better investing environment than 1969? How is it better and worse?
1969 was tough. It wasn’t pleasant to do. I had grown from $105,000 to $100,000,000. I had a lot of propositions to take over the partnership. If I had a similar partnership I would have closed it around 2000 in the height of the internet boom.We were all in REITS in March 2000 when NASDAQ was hitting its high. If I had had a large partnership I would have folded it, but not if it was small. It has to do both with how I feel and how the partners feel. I feel like a jerk (losing on a relative basis) and the jerks are making money. I won’t persist in trying to make money when I don’t understand what is going on. It is harder to invest and risk other people’s money than to invest your own money.We still get opportunities: for example, we got $8 billion into the Junk Bond thing in 2002 and would have gone up to $22 billion if we had more time. We were buying as fast as we could.Investing is the world’s best game. I was in the department store business – you have to match you competitors – it’s a business that throws defensive decisions at you all the time. We want a business with not defensive decisions. Investing is a perfect example. Just watch ball after ball come through and wait for your fat pitch. You can sit and wait for just the right pitch. Harder when you invest in public and the fans are screaming “swing you bum.”But at your age, you can fool around with small money and I see things to do there.
3) You made an argument for 7% returns over the next decade in Fortune. Given that (1) profit margins are at least 30% above historical averages, (2) the ratio of prices/GDP is at least 25% above historical averages, and (3) interest rates are ~25% below historical averages, assuming mean reversion, wouldn’t one conclude that while economic earnings growth plus dividends may be 7%, that we are at an unsustainable valuation plateau?
We are near the high-end of the valuation band, but not really at an extreme. I have commented on the market 4 or 5 times in Forbes interviews previously (1969, 1974, 1981, and 1977 in Fortune). Most of you can say if something is overvalued or undervalued, you can spot the occasional extreme cases.There is a big band of valuation and the idea is to calibrate extremes. When I look at a business, I look for people with passion. I can recognize a 98 or a 6, not a 63. This rule is good enough in life and investment. You refer to my 2001 article, but returns have not exceeded 7%, so I guess that this is not that precise of a band.I suspect that stocks are too high now. Nothing is cheap and I am not finding a lot of now but there will be a day when you will be shooting fish in a barrel. The important thing is to be prepared to play heavily when the time comes and that means that you cannot play with everybody.
4) You have said in the past that you would rather buy a great business at a fair price than a fair business at a great price. If the price is fair to both the buyer and the seller and the buyer does not substantially improve the business, then it would be hard to see how the buyer would obtain superior returns from such an investment if the price already discounts the quality of the business. Since you clearly look for superior returns can you explain how you buy at a price that is both fair to the seller and still leaves you room for abnormal returns?
Periodically the stock market does not price rationally. Great businesses have been sold for ridiculously low prices in the past. Unlike negotiated sale of businesses, the market is like an auction and stocks traded on it are not perceived as ownership shares in business. While the price of farmland or apartments in Nebraska does not to vary a great deal around the mean, and have little chance of having wild aberrations, stock prices on the other hand may sometimes vary by as much as 50% to 100%. Accordingly, there are opportunities to buy stocks in businesses at low value.So we really try to buy wonderful businesses at ridiculous prices. In the case of Washington Post, in 1973 the whole of the company was only selling for $80M (5M shares at $16 each). This is a business that owns a number of newspapers, four TV stations and several magazines (like Newsweek). Most analysts would have agreed that the intrinsic value of the assets was around $400 to $500 million. But you could buy little pieces of the business for much less. Seizing this opportunity, Mr. Buffett purchased around 9% of the shares for $10 million in 20-30 tickets from institutional investors who couldn’t sell fast enough because they thought the share prices would keep falling. They wouldn’t have argued that the business was not worth $400 million, just that the stock was going down. Subsequently, Mr. Buffett has steadily increased Berkshire’s holding in the company (to around 22%) and today the company is worth about $10 billion dollars.Making purchases through a negotiated markets for entire businesses is different. You may get a decent result. These transactions are to a mild degree effected by the auction market. As Peter Lynch often says, companies will cut the flowers and water the weeds – when a company is in trouble it often sells the crown jewels.
5) What value would you personally attach to $1 received 1 year from today with 100% certainty?
It depends on how much purchasing power $1 dollar has in one year. You need to find the present value of that $1 dollar, using the discount rate (i.e., Treasuries of equivalent maturity). It is very similar to analyzing the stream of a company’s earning flow. How much long term earnings flow you would like to have using the discount rate? Also, you need to be aware of whether the interest rates over the medium-to-long term will change quite big or not. Your expectation of the “normal” interest rate will drive what discount rate you apply to the streams of a Japanese company in the mid-1990s, for example. If you think the interest rate will rise sharply, and do not want to buy long-term bonds, you need to think about whether you like to buy the company’s long-term earnings yield. If you do like long term bonds, STRIPS are a good investment.
6) This week Eric Rosenfeld recounted the last days of LTCM and your participation in a potential bailout. He believes that if they could have gotten you back on your cell phone in Alaska the bailout would have been consummated: “to this day I think it would’ve gotten done if he [Mr. Buffett] was in town….however, nobody was willing to put in $4 billion without consulting [Mr. Buffett]”. Could you share your version of the story?
Eric called me on Sunday while I was playing bridge. I could tell from the sound of his voice that something grave was transpiring. On Monday he was on vacation with Bill Gates in Alaska, so he was negotiating on a satellite phone, while Bill was looking on. Meanwhile the captain kept moving the boat closer to shore so they could see the bears or something. Gates thought the whole situation was very amusing.On Tuesday, he was at Yellowstone, and negotiating using an intermediary at Goldman Sachs, and finally gave Goldman his terms on Wed morning. He told Peter (GS Banker) to put in the bid – $3bn from Mr. Buffett, $750mm from AIG, and $250mm from GS. He told Peter to sign his name on the (in)famous letter. Peter asked if he was crazy, but Mr. Buffett told him to just do it. So Peter signs my name, John Corzine’s and Hank Greenberg’s. He figured if he was on the hook, so he might as well sign Hank Greenberg’s name. I don’t think anybody’s signed Hank’s name before. I then went on the bus through Yellowstone (out of range for the satellite phone).John (Merriwether) got $150mm ($250?). But it left a lot to work out between Wednesday and Monday. “If I’d been in NY, we’d have made the deal….that’s [description of Eric Rosenfeld’s version] a very accurate rendition of what happened.”They [LTCM] and [NY Fed Governor] McDonnough played the hand the way they should have….but I got to see Old Faithful. I’ve told Bill Gates lots of times he’s cost us a lot of money.I knew the stuff they were doing…these are the kind of positions I would’ve put on…I think we would have made multiple billions…I’ve made a lot of money on weekends.I don’t blame him [Merriwether] – he got an extra $150 million
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