Q&A Session With Warren Buffett And Charlie Munger [NOTES] P-2

Below is the Part-2 of Questions and Answers session that was held today in Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) Annual Shareholders meeting. Questions include: Cash Decisions Made, Float Shrinking, Google, Apple & IBM, Risk Of Political Issues, Super PAC etc.

Link To Part 1 of Q&A Session

How are cash decisions made – reinvesting versus dividend?

Happy with 12% ROE
Doesn’t want capital intensive businesses that need to reinvest just to stay alive

Question on float shrinking

Float could shrink but the bet is slightly higher
The p&c business really has to be in the top 10% to do well
Won’t grow wildly

How do you value declining businesses?

They are not worth nearly as much as growing businesses
Generally speaking it pay to stay away from declining businesses
Newspaper is declining business – understand it well but where to make real money I being in growing businesses and that is where the focus sold…
Cigar butt approach of getting one free puff isn’t worth the energy and intelligence
Go towards expanding businesses
They are playing out certain declining businesses
Berkshire started with declining businesses – tetiles and shoes and department store in Baltimore
Charlie in charge of a business that did $120mm in the 1960s and now does $20k a year
$6mm has turned into $30bn based on baltimore store
Same with blue chip

What is follow or fad in investments today?

A lot – Charlie
Stay away from things that warren does not understand meaning not having a reasonable fix about earnings power and competitive position in five to ten years and where the company will stand within the industry
If the price is crazy you get down to an even smaller universe
Berkshire has not bought a new issue / IPO
iPOs cannot be the most attractive thing by nature
If you have thousands of opportunities from stocks throughout the world and some security is going to market it does not make sense to spend five seconds thinking about new issues
There are industries they know who will have a marvelous future but unclear who the winners will be
A number of filters before they think about these companies more
Just need to do one or two things well not a whole. Lot
Avoid a big disaster is the key
Munger thinks rules of thumb if large commission then do not read it and the other thing is that as a place to look you need to look at what others are buying

What are the implications if Berkshire comes under the investment company act of 1940?

it was quite pertinent when he was forming the partnership but there is no way Berkshire will come close to this
Own 8 companies that are fortune 500 stand alone and is not an investment company but the background of both causes people to hang onto that notion

When will china have a great company like Coca cola?

China has great companies already, I can’t pronounce them but they have some great, great companies – Charlie

Question on Google and Apple?

Huge companies that make large amounts of money, tough to dislodge where they have stregnths but would not want to buy either one…not at level of conviction to buy but “sure as hell wouldn’t short them”

IBM easier to understand – chances of being way wrong in IBM is less than google or apple but does not mean IBM will do better
Berkshire would not have predicted what would have happened with apple
Warren does not know how to evaluate new products and they dont know a lot about computer science

Politics affects businesses. Coal plant closings. Excel pipeline. How does Berkshire manage that risk of political issues?

Railroads and utilities and insurance companies are very much affected by politics. In railroad economics is on its side and economics usually wind out to politics.
Main problems are not political as well
Railroads had over 1.2mm employees (or 1.7) but no is only 200,000 do things have become much more efficient

Berkshire book value per share versus s&p change or s&p book value?

It would bounce around over the years based on the price to book multiple
It would be about 35% higher versus the book value gain
Show the book value of s&p but it’s a wash
Long term has tracked book value

Studying collapse of AIG and saw different segments increasing risk and decreasing risk. How to manage risk?

No sharing across unit
Mot uncoordinated individuals at sports or executive level
No organized way to share information across companies
They may see each other sometimes
They want business to run autonomously

Trees are greatest resources. Why not buy a timber company?

We would not consider the other activities to determine whether they would get into forest products companies
They have looked at several forest products companies but have not found any that met returns against purchase price
Easy business to understand but the math has escaped them in term of being compelling
A lot of forest products companies convert to flow throu companies that don’t pay income tax so Berkshire would be at a disadvantage
Berkshire is at a disadvantage where people can convert into pass throu entities for example REITs

Question I think about money needed to keep as reserve

Charlie and warrens job is to look at the downside and the margin of safety and not invest in an opportunity of doubling money if there is a 0.1% chances of going broke

How do these super smart people do dumb things? To a man with a hammer every problem looks like a nail. They twist problem so it fits the solution.

They have a life of understanding of history

Life in financial markets has no relation to sigmas

Business schools have improved but so has wall street

Question on Swiss re -some premium volume ends in 2012…

It’s a big five year contract that expires. If that expires and premium goes down by billions
Nn event in terms of future strategy
Every decision is independent
If the business volume has to shrink

Question on Freddie and Fannie…

This is the longest question letter…wow
Crowd clapping to get this long question over with…probably has been 3-5 minutes…

Well I got through college answering fewer questions than that – warren
Big laugh
Government guaranteed program brings down the cost for sure
These entities can stay in conservatorship for a while

Question about experience with Todd combs and Ted weschler?

Concerned about how record is achieved more than record itself
Quality of character, real commitment and loyalty, and have seen hundreds of good records but these two were perfect
They are paid each a salary of a million. A year and are given ten percent of amount by which portfolios beat the s&p on a three year rolling basis and each is 80% of own and 20% of each others business so they can collaborate
Same as Lou Simpson
Whether they employ people under them comes out of record and works far better
One and three quarters billion but added an extra billion
They operate through own brokers
If they are getting into new name warren will want to know
They have a much bigger universe so they can look at a lot more things
Pitched in for other duties that they are not directly compensated on
They will do a great job when they are running a whole lot more money
Todd did substantially better than the s&p last year
Most of united states would starve to death on the formula – Charlie
They ran hedge funds but now they are thinking about the same things but taxed more and better lifestyle
Lifestyle much better at Berkshire – Charlie
“free coke machine” – warren

Competitive advantage question

Warren says he needs to know how things will look in five to ten years

Another question

Warren and Charlie love what they do and are excited every day because they get to paint there own painting
More fun to do it together
Job is to not get in the way and change things
There is no standard formula
Businesses are so different that you can’t have one standard formula
Could hire consultants but never have
Page and a half of people that make a million or over at Berkshire but it does relate to logical measures of performance and the amount of time is buffets time as the compensation committee himself
Prostitution would be a step up for compensation consultants – Charlie
Charlie is also in charge of diplomacy at Berkshire – warren

What will it take for America to grow at 4% again?

Charlie says a lot will take to get to 4%
If population grows and real GDP is 2-2.5% that 4% would be remarkable…it’s nice to have in real terms but 2.5% is a remarkable rate of growth
Charlie bets the united states with a mature economy, competition, and social safety net thinks that 1% per capita in real growth means
Business profits as a percent of GDP are at their height

Donation to super PAC?

“no I won’t” – warren
The whole idea of super pacs is wrong and huge money by few people influencing politics is not needed
“I don’t want to see democracy go in that direction.” – warren
Charlie said its lucky to have two candidates as good as they are this year
If I thought I could reduce legalized gambling by donating to super pacs I would – Charlie

Question from Glenn Tongue

I don’t think you should be in this room if the short term nature turns you on – Charlie (loosely quoted)

Question on buybacks

Hope that evil day of dividends is far away – Charlie
Won’t repeat the mistake of a dividend when they did it years ago – warren
Perhaps a $100bn to reinvest in mid America
“we’ll think about it when we’re older.” – warren

Question on how to repeat performance – can we do even better now with stuff we know now?

If you have endless time and small amounts of money you can find ways to do very well
More and more have been exposed and if they were at the million dollar level there would NPR more places to look

Question about mistake minimization…Besides learning from own mistakes, effective techniques to minimize mistakes

Think in terms of worst case situation
Warren doesn’t worry much about mistakes and dod not think about doing things differently in the future
You may get some advantage by learning about people over the years – will make mistakes with people and will recognize the extraordinary ones better than 40 or 50 years ago but not improvd by any conscious improvement
Learn a lot from other peoples mistakes – Charlie
Constant study of other peoples disasters…warren has been absorbed with reading about disasters…focused on financial folly…people with high IQs didn’t really have an understanding of how human begins behaved

How do you build barriers to entry in industries which there are few?

Pretty tough
We buy barriers…we dont build them – Charlie
There are some industries that are never going to have barriers to entry and you have to operate fast because others will be willing to come in
Great barrier to entry is something like if you gave me $10 billion to knock off coca cola warren wouldn’t know how to do it…you’re not going to change mind on how people think with that money
Richard branson and virgin cola…brand is a promise…didn’t work
If you’re buying something at a huge discount from replacement cost and it’s essential then that’s a good barrier to entry

Question about BYD and with new cars going on sale in US if that will affect company

Car market in china is huge market and that is the main focus
First cars they try to bring here is in CA where there is a market for fleets that are environmentally friendly
In 2030 not many will be electrics – Charlie
Amazing how fast people in china are doing what took the united states much longer to do

Question on how to value the insurance business

the economic value comes from the ability to utilize float if obtained at a bargain rate
Value relates to large float and the rated you get to invest that

Question on oil

Would have been better if we were not an oil exporter previously and had used imports then
Current account deficit has changed for better but it looks better than three or four years ago
The single most precious resources here and Charlie is all about using up other peoples energy
Oil and gas independence – we don’t want that but we want to conserve itself
Exact opposite idea than other on this idea
“And of course I think I’m right” – Charlie

Question about each generation 20-25% better. What good does GDP growth matter if they don’t enjoy that themselves…

They certainly agree
The majority of mutual companies do not have
May be some factors that push democracy to plutocracy
When Charlie first went to Boston, the mayor was running the town from a federal penitentiary

Question on debts and the economy

The world has seen many failures of sovereign debt
Would avoid buying medium term or long term government bonds
Hard question

Last question – taxes – what is the ideal corporate tax rate to help economy.

Last hearths rate was around 13% and the corporate rate is around 35% so you got to write off additional items
Corporate profits is not the issue…there are huge amounts of money in the corporate world
It’s not a lack of capital nor is it tax rates
Could argue for fairness across corporations but getting from here to there is going to be very difficult but once you out proposals everyone complains and fight with intensity against bill that far outstrips those who are on other side of things
Charlie thinks the VAT would be logical

End of Q&A Session..