13) You often talk about the importance of investing only with people you like, trust and admire. However, you’ve bought companies only days after you became aware of them. How do you evaluate the owners and managers of a company before investing?
After mentioning that he’s actually bought companies after only brief telephone conversations, Mr. Buffett admitted that “every now and then you miss”, but added that “it’s better than the odds of marriage”. He went on to say that “sometimes you size up people better with more time”, but he didn’t sound like he needed much time to recognize the type of character he looks for.
The key question for him when evaluating the management of a potential acquisition target is “do they love the money or the business”. His concern is that he monetizes the owner/manager’s wealth and that may cause the latter, if he doesn’t truly love the business, not to work as hard after he’s sold out to Berkshire. He said he looks for the “obvious cases” of owners who truly love their businesses and added that he’s mostly been successful (has had “a good batting average”) in identifying them.
For those owners, their businesses are their life’s work, which Mr. Buffett compared to a painting: “You spent all your life painting this painting. You can sell it to us and see it hanging in a place of honor in a museum. Or you can sell it to an LBO operator and see it hanging in a porn shop.
“I once bought a jewelry business over the phone. I could tell that the current owner was the ‘right’ type of person. The owner’s great grandfather had started the company and I could tell that the owner really loved the business.”
Mr. Buffett said that he can usually “size someone up in less than a day”. The most import question he poses in buying a business and looking at management is, “do they love the business?” He phrased it in this way: “If you spend your whole life painting a picture would you rather have that painting on exhibit at the Metropolitan Museum of Art, or would you rather earn 5% more on the sale of the painting and have it hanging in a porn shop?”
He has had a great batting average in picking companies and people. But he says that “we can’t tell with everyone and once in a while we make a mistake.”
14) The profits of financial companies as a % of total US corporate profits is at an all-time high (~40%) — is this just the result of the carry trade, which will end, or perhaps bogus use of derivatives, or is there something more structural changing?
15) On his fears about US dollar weakness:
The dollar is not overvalued on a purchasing power basis. Macroeconomics is not our usual game, however if some economic facts are screaming at us, we jump on them. We don’t usually do junk bonds, however if you cast your eye about, you can always find deals. I don’t feel like doing macro bets as much with other people’s money as my own. We work with big currencies– eight of them. I don’t have a view about which will move most against the dollar. My view is that the dollar will weaken. Countries support their own currency– Japan wanted to keep their currency down which kept the US currency up. I don’t know if China or HK will decouple their currency from the US. I like to have earnings in other currencies because they convert into more dollars, however I keep most of our cash in dollars.
16) On probabilistic thinking: while we would all love to do it, how does one distinguish between true subjective probabilistic thinking and bias induced guesswork?
Of course we try to make decisions based on probability and not guesswork. I agree strongly with the thoughts in Robert Rubin’s book (In An Uncertain World). It’s all probabilities. The one time when Charlie and I have trouble doing this is when it comes to firing people. I hate doing that and I avoid it as much as possible. We had one manager at one of our companies who developed Alzeimer’s disease. It took us a long time to see it, and after we saw it, it took us a long time to act on it. Fortunately, the company still did well even while he had Alzeimer’s, so we’ve developed a new rule around here: Only buy businesses that are so good that someone with Alzeimer’s can manage them!
We all think we’re doing the former – probabilistic thinking.
Mr. Buffett said he tries to always use probabilistic thinking. That’s what he likes about the insurance business and investments. We try to think through every decision that comes to us. Some decisions are simple probabilities.
However, Mr. Buffett added that we’re human and probabilistic thinking is not always possible. Mr. Buffett said that when dealing with other people, such as firing someone, is a time in his case that he may stray from probabilistic thinking. An example was when Mr. Buffett denied that one employee who ran one of his businesses had Alzheimer’s for one year beyond when anyone else would have picked up on it. He said how hard it was for him to fire him, especially since he loved the person but he was just no longer good at the job. He, therefore, unintentionally postponed the decision. Mr. Buffett said he looked for countering evidence because he hates to fire a CEO he likes. He said he will tolerate a lot from someone who has been an associate. Mr. Buffett then joked that now he buys business that even a person with Alzheimer’s can run!
One thinks they know when they’re getting way from probabilistic thinking, but you can not always detect it.
Mr. Buffett recommended Bob Rubin’s book in which he recommends ways to think in the economic world
He concluded that business is all probabilistic thinking but some thinking is better not being calculated, for example in relation to people you love and humans in general.
17) You said a year or two ago that the ratio of US corporate profits as a % of GDP was historically high, at 6%, and would likely fall. Since then, the ratio has gone up (nearing 8%). Has something structurally changed, or are you confident that the ratio will still fall back?
Mr. Buffett responded that he doesn’t believe the 8% rate will be sustainable, and he views 6% as a more reasonable figure in the long-run. Moreover, he has trouble reconciling high corporate profits % (even at 6% level) with the corresponding figure of federal taxes paid by corporations, which is currently also at a very high level – 1.5% of GDP.
After a brief discussion of corporate profits and corporate taxes as a percentage of GDP, Mr. Buffett shared an interesting view on federal taxation. In a way, federal government owns a special class of stock (let’s call it Class AA stock) in every corporation. For example, last year Berkshire Hathaway paid ~ $3.4 bil. to federal government in relation to this “stock.” The more the company reinvests in its business, the higher next year’s earnings and tax payments are – i.e. the higher the dividends and the value of the AA stock are). Moreover, at any point in time, the federal government can change the % of earnings to be distributed to it (i.e. change the tax rate). If the government would ever decide to “go public” with a security of future Berkshire Hathaway tax payments, that stock would be very attractive. Wall Street would love it. In fact, at 35% tax rate, that stock could be worth as much as the entire Berkshire Hathaway.
Go to Part 1 , Part 2 , Part 3