Visiting Warren Buffett
Notes from a Columbia Business School trip to Omaha, Nebraska on Friday, March, 24, 2006
Agenda
8:30 – 10am - Visit Nebraska Furniture Mart w/Bob Batt, grandson of founder Rose Blumkin and senior executive
10am – 12pm - Q&A with Warren Buffett at Berkshire Hathway headquarters
12 – 2pm - Lunch at Gorat’s steakhouse w/Buffett
2 – 4pm - Visit Borsheim’s (jewelry store) w/ Susan Jacques, CEO
Intro
I recently had the good fortune of visiting Warren Buffett in Omaha with a group of roughly 130 Columbia MBA students and several professors. Most of the students were taking a Value Investing seminar with Bruce Greenwald, a professor in the Value Investing Program at Columbia. Joel Greenblatt and Eddie Ramsden, adjunct professors in the program, also came along. Special Thanks to Erin Bellissimo and Liz Koe from the Heilbrun Center for Graham and Dodd Investing for helping set up the trip.
Buffett has hosted a number of similar such visits over the past few years and will host several dozen this year. Many of the notes from other visits can be found online with a little digging. The visit was fantastic. Everyone we encountered from Berkshire was a class act.
Below are my general observations and my notes from the Q&A. This is not meant to be a complete transcript of what happened. In cases where Buffett covered a story that he has previously told, I tried to link to it. I tried more to capture the gist of what was said than the exact quote. What is below is taken from my scribblings and memory, and any factual errors or misrepresentations are my own.
General observations
Eddie Lampert, the hedge fund manager and current chairman of Sears Holdings, is a long time Buffett admirer. In his recent letters to his shareholders, Lampert has used the adjective commercial numerous times to describe the type of employee he is looking for. It’s a peculiar adjective, one that you don’t hear very often, and it well signals Buffett’s impact on Lampert.
The word “commercial” perfectly describes Warren Buffett and the soul of what he has built at Berkshire Hathaway. Buffett is shamelessly and unabashedly commercial. The man has spent most of the waking hours of his 75 year life obsessively reading about, learning about, and engaging in the game of business. During our visit, when he was not telling us about an off-the-wall deal from his past (like trying to buy a town in Ohio as a 21 year old in 1951) or some commercial genius he idolizes (Rose Blumkin), he was trying to sell us jewelry and mattresses, or mugging for the camera with his capitalist groupies. He clearly enjoyed every minute of it. Buffett is an exemplar and cheerleader of the capitalist ethic, and in this circle, at least, he is virtually a rock star. He is both the dean and the Elvis of American Business.
Buffett's commercial spirit extends to the entire Berkshire Hathaway family. Bob Batt, one of three executive officers at Nebraska Furniture Mart, and Susan Jacques, CEO of Borsheim’s, each took a few hours to show us around their respective stores. They both clearly knew their businesses cold, and they are obsessed with pleasing the boss. Bob Batt understands the furniture business better than almost anyone else on earth, from the design of the showroom floor to the export competitiveness of fifteen different developing countries. Susan Jacques could break down the competitive characteristics and financial details of her jewelry competitors to the nth degree. She chatted with me for fifteen minutes on the threat of the internet distribution players in the jewelry business, and was keenly aware of the threats she faced ten years out. Buffett didn’t find these people at Harvard Business School. When he made Jacques CEO of Borsheim’s, she was a 34 year old immigrant with no college degree. But he saw that she had the ambition, the passion, and the integrity, and he was smart enough to realize that is what matters.
This deeply rooted commercial DNA is an enormous competitive advantage for Berkshire Hathaway in each of its businesses. I would guarantee that those businesses outperform their competitors financially by a large margin. As Buffett has mentioned before, asking his managers about making money or controlling costs is like asking them about breathing; it’s not something for which they come up with a strategic plan, it’s a completely reflexive act. Nebraska Furniture Mart has 3 executives, 15 vice presidents, and 3,000 employees. Bureaucracy is non-existent. When asked about how they charge buyers for capital employed, Batt replied, “We know the business, so we don’t need to employ cost accounting systems. Plus, that would mean hiring cost accountants, and we don’t have the time or energy for that.”
It is Buffett’s peculiar genius that he is able to make the game sound so straightforward. Want to make money investing in businesses? Remember three things: Mr. Market, Margin of Safety, and make sure the business has a moat. The moat either comes from a low-cost position or from pricing power, the latter of which usually results from a strong brand. If you’re going in with a partner, make sure that they are a passionate and ambitious fanatic who has devoted their life to the business, and that they don’t lie, cheat, or steal. That’s about it. As Buffett puts it, you don’t need an eleventh commandment; it’s all spelled out in the first ten.
At the end of our lunch, I witnessed Joel Greenblatt meet Buffett. Greenblatt is in many ways the heir to Ben Graham’s legacy at Columbia, and it was fascinating seeing these two great investors, a generation apart, meet for the first time. Buffett told the surrounding students how lucky they were to have professors like Greenblatt and Greenwald at Columbia. Then he congratulated Greenblatt on his best-selling recent book, The Little Book That Beats The Market. “Terrific book,”, Buffett said. “Buying great businesses at cheap prices. Doesn’t it seem so simple?”
Q&A
Buffett opened with the story of Rose Blumkin, one of his idols. Blumkin was a Russian Jewish immigrant who came to the US in 1919 speaking no English. She worked for 18 years saving money to bring the rest of her family over and accumulating the $500 she needed to start the Nebraska Furniture Mart in 1937. That was the entire sum of outside invested capital in the company. When she passed away at age 103 in the 1990’s, having never learned to read or write English, she was worth tens of millions of dollars and she presided over a business empire. Her heirs have carried on running the family business, and the Nebraska Furniture Mart had sales of roughly $700m in 2005.
Question 1: How do you determine your circle of competence?
He tries to buy businesses where he can see the future – where he has a very good idea of what the business will look like in 10 to 20 years. The business needs to have a wide and deep moat, and it needs to be selling for a reasonable price. You need to be prepared to move quickly when you find a good business, as the opportunities to buy them can be very fleeting.
Buffett told the story of Craig Ponzio, owner of Larson-Juhl, a picture-frame distributor. Ponzio started the business in 1982 and increased sales from $3m to $300m over an eighteen year period. Ponzio gave Buffett a phone call in 2000 to see about selling him the business. Buffett had never even considered the business before, but knew after about ten minutes of talking with Ponzio that it was a cinch.
Larson-Juhl has over relationships with over 18,000 framing outlets, and has distribution centers throughout the country. It fulfills 95% of its orders the next day. It would make no sense to try and compete with it – the investment would never pay off. Even if you did have hundreds of millions of dollars, it would be almost impossible to get the framing outlets to switch distributors. The business has an enormous moat.
Buffett also relayed the story of his recent BusinessWire purchase. The CEO read the November 2005 WSJ cover article on Buffett, called him upon, and they soon struck a deal. Business Wire and PRWire are essentially a duopoly in their business, and a price war wouldn’t make any sense and is unlikely.
Question 2: GEICO is one of Berkshire’s crown jewels. You know the auto insurance industry cold, and you have been extolling the virtues of the GEICO and Progressive business models for decades. Why haven’t you ever taken a stake in Progressive?
Essentially, "thumb-sucking". That is what his partner Charlie Munger calls it when they identify opportunities in their circle of competence and fail to pull the trigger. Buying one didn’t preclude buying the other. He immensely admires Peter Lewis, the longtime CEO of Progressive. He asks the question of CEO’s – if you had a silver bullet and could kill one of your competitors, who would it be? For GEICO, Buffett would his silver bullet, and all the rest of his ammo, shooting Progressive. Years ago [presumably in the early 1980’s], they were briefly looking at putting the two companies together. He joked that each CEO, Jack Byrne of GEICO and Peter Lewis, would each come to him and report that negotiations were moving along, only that each was under the impression that he was gong to be the CEO of the combined company.
Buffett told the story of his initial involvement with GEICO as a Columbia student. It was obvious to him in 1951 that GEICO would do very well for a very long time. Everyone hates buying car insurance, but they are forced to, and a good chunk of them will go with the low-cost provider.
Buffett mentioned that GEICO now has a slightly better position than Progressive [due to a lower cost structure, I believe], but that the two of them will be duking it out and both will gain share for a long time. When the internet hit, Progressive actually had an edge for awhile. Because they had no direct distribution up to that point, they were quicker to seize on the internet as their direct distribution channel. GEICO had been so successful with its direct mail and phone strategy that those institutional forces vested in the old systems prevented it from shifting to the internet nearly as quickly as it should have. Buffett eventually had to lock them in a room and tell them they couldn’t come out until they had a viable internet strategy.
Question 3: What do you read?
Everything. Annual reports, 10-K’s, 10-Q’s, biographies, history. When he’s in airplanes, he’ll read the instructions on the seat backs. Two books he recommended specifically are Poor Charlie’s Almanack and Personal History, Kate Graham’s bio. He rarely ever reads fiction, feels like it would be taking up time he could be reading about business. He reads five newspapers a day, and plays bridge twelve hours a week.
Playing bridge significantly improves his quality of life, and he noted that those twelve hours he spends on it come directly out of his reading time. He pays $120/year to play online and would easily pay a million dollars, but they can’t figure out how to get more money out of him. He finds that fascinating. When he goes out to speak at the Microsoft Summitt, he challenges all of those brilliant technical people with that – he loves bridge and would easily pay millions, yet they can’t get it out of him. He bets them he will come back the next year and the situation will not have changed. His bridge name is ‘tbone’ and Bill Gates’ is ‘chalengr’ [not sure if the spelling on that is correct, but the point was that Gates’ name was a misspelling of “challenger”. I did not catch the name of the online service he plays on, but presumably it is the largest one.]
Reading has made him rich over time. He told the story of going through 12,000 pages of Moody’s manuals in 1951. “It was absolutely a question of turning pages”. On page 1433, he found Western Insurance Securities. Its earnings per share were as follows: 1949 - $21.66, 1950 - $29.09. In 1951, the low-high share price was $3 - $13. He went to a broker and read the Best’s Insurance manuals, and talked to agents – it was a perfectly fine company with nothing wrong.
Ten pages later, on page 1443, he found National American Fire Insurance (“This book really got hot towards the end!”) NAFI was controlled by an Omaha guy, one of the richest men in the country, who owned many of the best run insurance companies in the country. He stashed the crown jewels of his insurance holdings in NAFI. In 1950, it earned $29.02. The share price was $27. Book value was $135.
Buffett found it fascinating that this company was located several blocks from the broker where he worked. His fellow brokers were bright, rational people whose job it was to buy cheap securities, and they refused to buy NAFI, instead investing in “blue chips”.
He then took out a copy of the 2005 Korean Stock Market guide. It was more of an almanac than a brokerage report. It was sent to him for free by a broker. “If it had been $10, I wouldn’t have paid for it.” Based on the recommendation of a friend who thought South Korean stocks were cheap, Buffett spent 5-6 hours leafing through the pages and put together a $100m portfolio of 20 or so companies. Daehan Flour sold 25% of the flour in South Korea, which had a large and stable economy. It’s earnings over the last few years: 12,870 won, 18,000 won, 22,830 won. It had over 100,000 won in securities. The stock price was 38,000 won. “You have to make money buying stocks like this at 2x earnings. Brokers aren’t going to tell you about Daehan Flour.” Reading is key. Poor Charlie’s Almanack is great – that book has all you really need to know about investing. The Intelligent Investor is still the best book on investing. It has the only three ideas you really need.
1) Chapter 8 – The Mister Market analogy. Make the stock market serve you. The C section of the WSJ is his business broker – it quotes him prices every day that you can take or leave, and there are no called strikes.
2) A stock is a piece of a business. Never forget that you are buying a business which has an underlying value based on how much cash goes in and out.
3) Chapter 20 – Margin of Safety. Make sure that you are buying a business for way less than you think it is conservatively worth.
Buffett told the story of how he ended up going to Columbia. It was August of 1950, he had graduated from University of Nebraska and was in the library in Omaha looking at different grad schools. He had applied to Harvard Business School that spring and been rejected. He had read the Intelligent Investor in college, and was surprised to find Ben Graham and David Dodd listed as Columbia professors. “I figured they were long since dead.” He wrote a letter to David Dodd and received back a wonderful acceptance letter from Dodd.
Question 4: Please share your thoughts on your position in Remy International and the auto parts industry in general.
“Boy, I thought airlines were tough." They took the position in Remy three years ago.
When your big customers are teetering on the brink of bankruptcy, it’s tough to get price increases. You can’t survive as a high-cost producer in this industry. You can’t pass through costs like you could in the old times. He is very sympathetic to Rick Wagoner and Bill Ford. It is fascinating to see how these companies ended up in this position. Back in the 1950’s and 1960’s, GM’s only worry was that it would have anti-trust problems for having over 50% share of the U.S. auto market. Workers wanted a piece, and it was easy for the executives to give pension and health care benefits, as those benefits did not show up on the income statement [as opposed to, say, wage increases, which flowed directly through the income statement.]
Accounting drove the decisions. If you were a 63 year old executive at GM who was retiring in two years, it made absolute sense to give in on those benefits, because there were no accounting consequences. You know his incentive. It was really nuts. They fight the idea of unrecorded costs all the time at Berkshire Hathaway. In insurance, it’s easy; people do it by not reserving properly.
He talked about his position as a board member at USAir. Their seat costs were 12 cents/mile, compared to 8 cents/mile at Southwest. USAir had a huge percentage of the routes at several main hubs, like Philadelphia (something like 70-80%), and charged high prices. You knew that those profits weren’t going to last, but it was several years out in the future and the board of USAir didn’t want to face reality.
Question 5: What investment lessons have you learned?
He keeps making mistakes. Predicting the future is hard, and it will keep being hard. As long as his mistakes are in his analysis, that’s okay. When you buy a stock, you need to be able to get out a yellow legal pad and write down, in one page why it is cheap. For example, “I am buying the Coca Cola company for $14b for x, y, and z reasons and I think it is worth far, far more than that.”
He bought Dexter [shoe company] in 1993 and paid in Berkshire stock “which was ungodly dumb”. It was earning $40m pretax at the time, but that didn’t last as it got hammered from lower-cost foreign competitors.
Petrochina had a $35b market cap when he purchased it. He could say for sure that he thought it was worth appreciably more. It had a similar profile to Exxon, with the advantage that it was committed to paying out 45% of its earnings to shareholders in cash. “You could tell by the way they wrote about it in the annual report that it was a serious commitment. They quoted the dividend payouts out to twelve decimal points.” Petrochina made $16b in 2005 and paid out $7b in dividends, and Buffett bought his stake in the whole thing at a $35b valuation. The reason that he bought internationally with Petrochina and in Korea was because they were so cheap.
This all assumes that things sometimes trade at the wrong price. The framework is simple. Mistakes come from misassessing an industry, sometimes getting management wrong. You are going to make mistakes when you are looking at the over 50 businesses [that he has bought]. Mistakes are okay when you have a margin of safety.
Question 6: If you graduated from business school now and wanted to do what you are doing now, what would be your approach?
He would do the same thing. While there is more competition now, there are more opportunities. He wouldn’t waste any time. He bought his first stock when he was eleven years old, and if anything, would start earlier. He had read every book on investing in the Omaha public library by age nine.
It’s terrifically important to understand history. The Long Term Capital Management blowup in 1998 was a repeat of Northern Pacific in 1903.
These kinds of opportunities keep coming up not because humans are dumb, but because humans are human.
Working with your own money is more fun. He told the story of trying to sell GEICO to his clients when he was a broker in the early 1950’s. People wouldn’t touch it, so he’d try and scrimp up extra money to buy an extra five shares whenever he could.
He finds the game fun and always has. If you like it, keep practicing. It’s hugely important to buy stocks on your own. By doing that, you learn in a way that you can’t from reading books. Temperament and emotions are hugely important, and you need to experience that first-hand.
You want to go work around smart people who you admire. Make sure that you are doing what you want to do with interesting people. He told the story of the HBS student who picked him up at the airport in Boston for a talk years ago. The guy was 30 years old. Buffett asked him what he was doing after school, and the guy replied that he was taking a consulting job “because it would make his resume look good”. At a certain point, you need to jump in the pool. “It’s like saving sex up for old age.”
Question 7: What current business leaders do you admire?
Graham is up there. There are lots. In terms of one person, Tom Murphy is the guy he would go with, in terms of blending business talents, people skills, and qualities as a human being. Here is a great interview transcript with Murphy from a few years back. Murphy was the longtime CEO of Capitol Cities, which bought ABC in the 1980s.]
Murphy is now 80 years old, but if Buffett had a business to run and could convince him to run it, Murphy would hit it out of the park.
Question 8: Comment on your change in investment style and recent dabbling in silver, currencies, etc.
He does what he understands. He has been buying junk bonds for 50 years, doing arbitrage since he was a teenager. The currency bet originally had a positive carry, although that is not true anymore. If he had to make a bet about the dollar declining over the next ten years, he would say the odds are pretty high.
Silver has an interesting history. [My notes are fuzzy here]. The government was involved for a long period of time. In the 1930’s, the government bought up large stocks at a fixed price. After World War II, there was a big demand increase, and a large imbalance built. There was a huge amount above ground, over 1 billion ounces. You could see the imbalances in the government’s published numbers. 400-500m ounces is mined each year. Production is largely a byproduct of other metals (copper, etc), so supply is relatively inelastic. When prices get high, larger amounts come on from reclamation (melting down existing silver items), but normally reclamation is a small percentage.
In the late fall of 2002, buying junk bonds was like shooting fish in a barrel. His friend Howard Marks of Oaktree Capital was buying many of the same positions (telecom and energy) at the same time. Marks had a chart showing a list of the bonds and their price in the fall of 2002 and then 12-18 months later. The YTM on the bonds went from 30-50% to under 7% in 12-18 months. [Buffett showed a copy of this slide at last year’s annual meeting. That kind of jump in YTM implies a 4-7x jump in price.] You don’t need to do that many times in your life to get rich.
It’s crazy what happens in markets occasionally. In 1998, after the LTCM blowup, the spreads in on-the-run and off-the run treasuries were 30 bps.
Another example is the Resolution Trust Corporation in the early 1990s. All of the Savings & Loans went broke. Hundreds of billions of dollars in real estate were dumped on the government. The government officials in charge had no incentive to keep the properties and/or maximize the value they received in return. In fact, every time they got rid of a property, their lives got easier. All of the commercial developers were broke, so their was no buying competition. Buffett went in on a deal for the Woolworth building in downtown Manhattan near NYU. The lease was at $4/square foot and the building was clearly worth a lot. The building would surely release at over $20/square foot. It was a bet on foot traffic around NYU. They put in $8m. They later took out a non-recourse $26m mortgage. “You couldn’t miss”. Buffett half-mentioned a commercial building in Phoenix. The building had a $100m mortgage – two years earlier you could have easily sold it for $100m. When things blew up, no one would touch it.
“You will see a half dozen fish-in-a-barrel opportunities in your investing lifetime, with the water drained and fish not flopping anymore. The key is to make sure you are ready to act quickly when they happen”. In 1998, he got the call about LTCM on a Sunday. “You can make lots of money when people call you at home on Sunday.”
Question 9: What are your thoughts on the newspaper industry?
The Buffalo News is going downhill. Buffett won’t sell it because he has promised not to sell any of his businesses unless a) they will permanently lose money, b) there are labor issues, or c) the manager lies or steals. He started writing 15 years ago about how the economics of newspapers were no longer bulletproof. Forty years ago, newspapers and network television stations were the best businesses around; that’s not as true today. He told the story of the newspaper in Council Bluffs, Iowa. Back then, the newspaper owned the only megaphone in town that it made sense for local businesses to advertise through. Now, there are alternatives with cable and the internet.
The Las Vegas Review Journal – the area has seen explosive growth in population in recent years and it has seen a 15% decline in circulation.
Buffett told the story of World Book (which Berkshire bought through Scott-Fetzer in 1983). In 1985, the World Book encyclopedia cost $600 and sold 300,000 copies. It weighed over a hundred pounds and took up over thirty books. Now, that’s freely available over the internet.
“You can argue that my decision not to sell businesses is not economically rational, and I would agree with you. It’s just how I prefer to do it. But maybe it is economically rational. Craig Ponzio (Larson-Juhl) wouldn’t have called if he knew I might sell his business. We bought five businesses last year, none at auction, (because of this policy).”
Question 10: Why do companies sell to Berkshire instead of remain as standalone companies?
Businesses sell to him because he is solving a problem for them. In family businesses, when you get a few generations out, the ownership splits many ways, and families want a way to monetize the asset without losing control of the business. He gave the example of his purchase in Ben Bridge Jewelers.
When he is selling Berkshire as a buyer, he gives the following none-too-subtle pitch. “You have been working your whole life building up your business. It is your masterpiece. Selling to Berkshire is like putting that museum in the Metropolitan Museum. You know it will stay exactly as you left it, and won’t be touched it all. Or you can sell it to a Private Equity shop, which is the equivalent to a porn shop. Thhey will gussy it up, put in on display, maybe retouch the breasts, likely flip it to another porn shop in a year. Metropolitan Museum or porn shop, the choice is yours.”
Question 11: Would you invest in a hedge fund?
Yes, if a 30 year old Charlie Munger or Sandy Gottesman or Bill Ruane was running it, and they had all their money and their families’ money in it and were sharing in the downside. He has no complaint with incentive pay for hedge funds, he just wants to make sure the person running it is as committed as his partners. When he came back to Omaha in 1956, seven people wanted him to run money. He started with $105,000. He would setup the Partnership with the same fee structure today. [He kept 25% of gains over a 6% hurdle rate. Buffett mentioned offhand something about Charlie Munger recently turning his money over to someone to manage, although I am not sure if I heard correctly.]
You can occasionally find small groups of bright people who can do well over time. These people will be distinguished much more by temperament than IQ. You want to make sure that these people treat your money like it is their’s.
Question 12: What would you pay for a solid company that is growing earnings at 8-10%/year?
Not many companies will do that. You see a lot of garbage about EBITDA. Depreciation is the worst kind of expense in that it is prepaid. He looks at EBIT/EV. He’ll generally pay 7x for a decent business. For insurance companies, he looks at float and the cost of float.
He was CEO of Salomon Brother “for nine months and four days, and if you think I wasn’t counting, you’re crazy.” He found it fascinating that these bankers would run around creating pitchbooks for companies they had never heard of three weeks prior which contained projections going out years. When he asked them how much Salomon would earn next week, they couldn’t answer.
“It’s a joke.” Projections and how the numbers are dressed are ridiculous. He told the story of buying Scott-Fetzer. First Boston had been trying to sell the thing for some time and had put together several pitchbooks. Buffett ended up contacting the CEO directly and negotiating the deal with him. At the closing, the First Boston guy came in and collected his $2m fee. The banker went up to Charlie Munger with a copy of the pitchbook and tried to push it on him. Munger replied, “I’ll pay you $2m not to have to read it.”
Question 13: What would you do about the trade deficit?
Buffett rehashed what he wrote in his 2003 Fortune article, Why I’m not buying the U.S. Dollar.
The more trade, the better. Exports are 10% of GDP. Ricardo’s assumptions hold, but they didn’t consider IOU’s. He proposes a market-based “trade certificate” system; when U.S. companies export goods, they receive a matching nominal value of “trade certificates” that they can then sell to anyone who wants to import.
When foreigners want to cash in their dollars by buying U.S. assets, like the recent CNOOC case (large oil company whose assets are mostly overseas), Congress goes ape. This is not a good policy. It is hypocritical, and not good for stable politics over time. Other thean WMD’s, this will be the big political and economic issue in not too many years. [Buffett seemed to be emphasizing the political issue over the economic issue.]
Agenda
8:30 – 10am - Visit Nebraska Furniture Mart w/Bob Batt, grandson of founder Rose Blumkin and senior executive
10am – 12pm - Q&A with Warren Buffett at Berkshire Hathway headquarters
12 – 2pm - Lunch at Gorat’s steakhouse w/Buffett
2 – 4pm - Visit Borsheim’s (jewelry store) w/ Susan Jacques, CEO
Intro
I recently had the good fortune of visiting Warren Buffett in Omaha with a group of roughly 130 Columbia MBA students and several professors. Most of the students were taking a Value Investing seminar with Bruce Greenwald, a professor in the Value Investing Program at Columbia. Joel Greenblatt and Eddie Ramsden, adjunct professors in the program, also came along. Special Thanks to Erin Bellissimo and Liz Koe from the Heilbrun Center for Graham and Dodd Investing for helping set up the trip.
Buffett has hosted a number of similar such visits over the past few years and will host several dozen this year. Many of the notes from other visits can be found online with a little digging. The visit was fantastic. Everyone we encountered from Berkshire was a class act.
Below are my general observations and my notes from the Q&A. This is not meant to be a complete transcript of what happened. In cases where Buffett covered a story that he has previously told, I tried to link to it. I tried more to capture the gist of what was said than the exact quote. What is below is taken from my scribblings and memory, and any factual errors or misrepresentations are my own.
General observations
Eddie Lampert, the hedge fund manager and current chairman of Sears Holdings, is a long time Buffett admirer. In his recent letters to his shareholders, Lampert has used the adjective commercial numerous times to describe the type of employee he is looking for. It’s a peculiar adjective, one that you don’t hear very often, and it well signals Buffett’s impact on Lampert.
The word “commercial” perfectly describes Warren Buffett and the soul of what he has built at Berkshire Hathaway. Buffett is shamelessly and unabashedly commercial. The man has spent most of the waking hours of his 75 year life obsessively reading about, learning about, and engaging in the game of business. During our visit, when he was not telling us about an off-the-wall deal from his past (like trying to buy a town in Ohio as a 21 year old in 1951) or some commercial genius he idolizes (Rose Blumkin), he was trying to sell us jewelry and mattresses, or mugging for the camera with his capitalist groupies. He clearly enjoyed every minute of it. Buffett is an exemplar and cheerleader of the capitalist ethic, and in this circle, at least, he is virtually a rock star. He is both the dean and the Elvis of American Business.
Buffett's commercial spirit extends to the entire Berkshire Hathaway family. Bob Batt, one of three executive officers at Nebraska Furniture Mart, and Susan Jacques, CEO of Borsheim’s, each took a few hours to show us around their respective stores. They both clearly knew their businesses cold, and they are obsessed with pleasing the boss. Bob Batt understands the furniture business better than almost anyone else on earth, from the design of the showroom floor to the export competitiveness of fifteen different developing countries. Susan Jacques could break down the competitive characteristics and financial details of her jewelry competitors to the nth degree. She chatted with me for fifteen minutes on the threat of the internet distribution players in the jewelry business, and was keenly aware of the threats she faced ten years out. Buffett didn’t find these people at Harvard Business School. When he made Jacques CEO of Borsheim’s, she was a 34 year old immigrant with no college degree. But he saw that she had the ambition, the passion, and the integrity, and he was smart enough to realize that is what matters.
This deeply rooted commercial DNA is an enormous competitive advantage for Berkshire Hathaway in each of its businesses. I would guarantee that those businesses outperform their competitors financially by a large margin. As Buffett has mentioned before, asking his managers about making money or controlling costs is like asking them about breathing; it’s not something for which they come up with a strategic plan, it’s a completely reflexive act. Nebraska Furniture Mart has 3 executives, 15 vice presidents, and 3,000 employees. Bureaucracy is non-existent. When asked about how they charge buyers for capital employed, Batt replied, “We know the business, so we don’t need to employ cost accounting systems. Plus, that would mean hiring cost accountants, and we don’t have the time or energy for that.”
It is Buffett’s peculiar genius that he is able to make the game sound so straightforward. Want to make money investing in businesses? Remember three things: Mr. Market, Margin of Safety, and make sure the business has a moat. The moat either comes from a low-cost position or from pricing power, the latter of which usually results from a strong brand. If you’re going in with a partner, make sure that they are a passionate and ambitious fanatic who has devoted their life to the business, and that they don’t lie, cheat, or steal. That’s about it. As Buffett puts it, you don’t need an eleventh commandment; it’s all spelled out in the first ten.
At the end of our lunch, I witnessed Joel Greenblatt meet Buffett. Greenblatt is in many ways the heir to Ben Graham’s legacy at Columbia, and it was fascinating seeing these two great investors, a generation apart, meet for the first time. Buffett told the surrounding students how lucky they were to have professors like Greenblatt and Greenwald at Columbia. Then he congratulated Greenblatt on his best-selling recent book, The Little Book That Beats The Market. “Terrific book,”, Buffett said. “Buying great businesses at cheap prices. Doesn’t it seem so simple?”
Q&A
Buffett opened with the story of Rose Blumkin, one of his idols. Blumkin was a Russian Jewish immigrant who came to the US in 1919 speaking no English. She worked for 18 years saving money to bring the rest of her family over and accumulating the $500 she needed to start the Nebraska Furniture Mart in 1937. That was the entire sum of outside invested capital in the company. When she passed away at age 103 in the 1990’s, having never learned to read or write English, she was worth tens of millions of dollars and she presided over a business empire. Her heirs have carried on running the family business, and the Nebraska Furniture Mart had sales of roughly $700m in 2005.
Question 1: How do you determine your circle of competence?
He tries to buy businesses where he can see the future – where he has a very good idea of what the business will look like in 10 to 20 years. The business needs to have a wide and deep moat, and it needs to be selling for a reasonable price. You need to be prepared to move quickly when you find a good business, as the opportunities to buy them can be very fleeting.
Buffett told the story of Craig Ponzio, owner of Larson-Juhl, a picture-frame distributor. Ponzio started the business in 1982 and increased sales from $3m to $300m over an eighteen year period. Ponzio gave Buffett a phone call in 2000 to see about selling him the business. Buffett had never even considered the business before, but knew after about ten minutes of talking with Ponzio that it was a cinch.
Larson-Juhl has over relationships with over 18,000 framing outlets, and has distribution centers throughout the country. It fulfills 95% of its orders the next day. It would make no sense to try and compete with it – the investment would never pay off. Even if you did have hundreds of millions of dollars, it would be almost impossible to get the framing outlets to switch distributors. The business has an enormous moat.
Buffett also relayed the story of his recent BusinessWire purchase. The CEO read the November 2005 WSJ cover article on Buffett, called him upon, and they soon struck a deal. Business Wire and PRWire are essentially a duopoly in their business, and a price war wouldn’t make any sense and is unlikely.
Question 2: GEICO is one of Berkshire’s crown jewels. You know the auto insurance industry cold, and you have been extolling the virtues of the GEICO and Progressive business models for decades. Why haven’t you ever taken a stake in Progressive?
Essentially, "thumb-sucking". That is what his partner Charlie Munger calls it when they identify opportunities in their circle of competence and fail to pull the trigger. Buying one didn’t preclude buying the other. He immensely admires Peter Lewis, the longtime CEO of Progressive. He asks the question of CEO’s – if you had a silver bullet and could kill one of your competitors, who would it be? For GEICO, Buffett would his silver bullet, and all the rest of his ammo, shooting Progressive. Years ago [presumably in the early 1980’s], they were briefly looking at putting the two companies together. He joked that each CEO, Jack Byrne of GEICO and Peter Lewis, would each come to him and report that negotiations were moving along, only that each was under the impression that he was gong to be the CEO of the combined company.
Buffett told the story of his initial involvement with GEICO as a Columbia student. It was obvious to him in 1951 that GEICO would do very well for a very long time. Everyone hates buying car insurance, but they are forced to, and a good chunk of them will go with the low-cost provider.
Buffett mentioned that GEICO now has a slightly better position than Progressive [due to a lower cost structure, I believe], but that the two of them will be duking it out and both will gain share for a long time. When the internet hit, Progressive actually had an edge for awhile. Because they had no direct distribution up to that point, they were quicker to seize on the internet as their direct distribution channel. GEICO had been so successful with its direct mail and phone strategy that those institutional forces vested in the old systems prevented it from shifting to the internet nearly as quickly as it should have. Buffett eventually had to lock them in a room and tell them they couldn’t come out until they had a viable internet strategy.
Question 3: What do you read?
Everything. Annual reports, 10-K’s, 10-Q’s, biographies, history. When he’s in airplanes, he’ll read the instructions on the seat backs. Two books he recommended specifically are Poor Charlie’s Almanack and Personal History, Kate Graham’s bio. He rarely ever reads fiction, feels like it would be taking up time he could be reading about business. He reads five newspapers a day, and plays bridge twelve hours a week.
Playing bridge significantly improves his quality of life, and he noted that those twelve hours he spends on it come directly out of his reading time. He pays $120/year to play online and would easily pay a million dollars, but they can’t figure out how to get more money out of him. He finds that fascinating. When he goes out to speak at the Microsoft Summitt, he challenges all of those brilliant technical people with that – he loves bridge and would easily pay millions, yet they can’t get it out of him. He bets them he will come back the next year and the situation will not have changed. His bridge name is ‘tbone’ and Bill Gates’ is ‘chalengr’ [not sure if the spelling on that is correct, but the point was that Gates’ name was a misspelling of “challenger”. I did not catch the name of the online service he plays on, but presumably it is the largest one.]
Reading has made him rich over time. He told the story of going through 12,000 pages of Moody’s manuals in 1951. “It was absolutely a question of turning pages”. On page 1433, he found Western Insurance Securities. Its earnings per share were as follows: 1949 - $21.66, 1950 - $29.09. In 1951, the low-high share price was $3 - $13. He went to a broker and read the Best’s Insurance manuals, and talked to agents – it was a perfectly fine company with nothing wrong.
Ten pages later, on page 1443, he found National American Fire Insurance (“This book really got hot towards the end!”) NAFI was controlled by an Omaha guy, one of the richest men in the country, who owned many of the best run insurance companies in the country. He stashed the crown jewels of his insurance holdings in NAFI. In 1950, it earned $29.02. The share price was $27. Book value was $135.
Buffett found it fascinating that this company was located several blocks from the broker where he worked. His fellow brokers were bright, rational people whose job it was to buy cheap securities, and they refused to buy NAFI, instead investing in “blue chips”.
He then took out a copy of the 2005 Korean Stock Market guide. It was more of an almanac than a brokerage report. It was sent to him for free by a broker. “If it had been $10, I wouldn’t have paid for it.” Based on the recommendation of a friend who thought South Korean stocks were cheap, Buffett spent 5-6 hours leafing through the pages and put together a $100m portfolio of 20 or so companies. Daehan Flour sold 25% of the flour in South Korea, which had a large and stable economy. It’s earnings over the last few years: 12,870 won, 18,000 won, 22,830 won. It had over 100,000 won in securities. The stock price was 38,000 won. “You have to make money buying stocks like this at 2x earnings. Brokers aren’t going to tell you about Daehan Flour.” Reading is key. Poor Charlie’s Almanack is great – that book has all you really need to know about investing. The Intelligent Investor is still the best book on investing. It has the only three ideas you really need.
1) Chapter 8 – The Mister Market analogy. Make the stock market serve you. The C section of the WSJ is his business broker – it quotes him prices every day that you can take or leave, and there are no called strikes.
2) A stock is a piece of a business. Never forget that you are buying a business which has an underlying value based on how much cash goes in and out.
3) Chapter 20 – Margin of Safety. Make sure that you are buying a business for way less than you think it is conservatively worth.
Buffett told the story of how he ended up going to Columbia. It was August of 1950, he had graduated from University of Nebraska and was in the library in Omaha looking at different grad schools. He had applied to Harvard Business School that spring and been rejected. He had read the Intelligent Investor in college, and was surprised to find Ben Graham and David Dodd listed as Columbia professors. “I figured they were long since dead.” He wrote a letter to David Dodd and received back a wonderful acceptance letter from Dodd.
Question 4: Please share your thoughts on your position in Remy International and the auto parts industry in general.
“Boy, I thought airlines were tough." They took the position in Remy three years ago.
When your big customers are teetering on the brink of bankruptcy, it’s tough to get price increases. You can’t survive as a high-cost producer in this industry. You can’t pass through costs like you could in the old times. He is very sympathetic to Rick Wagoner and Bill Ford. It is fascinating to see how these companies ended up in this position. Back in the 1950’s and 1960’s, GM’s only worry was that it would have anti-trust problems for having over 50% share of the U.S. auto market. Workers wanted a piece, and it was easy for the executives to give pension and health care benefits, as those benefits did not show up on the income statement [as opposed to, say, wage increases, which flowed directly through the income statement.]
Accounting drove the decisions. If you were a 63 year old executive at GM who was retiring in two years, it made absolute sense to give in on those benefits, because there were no accounting consequences. You know his incentive. It was really nuts. They fight the idea of unrecorded costs all the time at Berkshire Hathaway. In insurance, it’s easy; people do it by not reserving properly.
He talked about his position as a board member at USAir. Their seat costs were 12 cents/mile, compared to 8 cents/mile at Southwest. USAir had a huge percentage of the routes at several main hubs, like Philadelphia (something like 70-80%), and charged high prices. You knew that those profits weren’t going to last, but it was several years out in the future and the board of USAir didn’t want to face reality.
Question 5: What investment lessons have you learned?
He keeps making mistakes. Predicting the future is hard, and it will keep being hard. As long as his mistakes are in his analysis, that’s okay. When you buy a stock, you need to be able to get out a yellow legal pad and write down, in one page why it is cheap. For example, “I am buying the Coca Cola company for $14b for x, y, and z reasons and I think it is worth far, far more than that.”
He bought Dexter [shoe company] in 1993 and paid in Berkshire stock “which was ungodly dumb”. It was earning $40m pretax at the time, but that didn’t last as it got hammered from lower-cost foreign competitors.
Petrochina had a $35b market cap when he purchased it. He could say for sure that he thought it was worth appreciably more. It had a similar profile to Exxon, with the advantage that it was committed to paying out 45% of its earnings to shareholders in cash. “You could tell by the way they wrote about it in the annual report that it was a serious commitment. They quoted the dividend payouts out to twelve decimal points.” Petrochina made $16b in 2005 and paid out $7b in dividends, and Buffett bought his stake in the whole thing at a $35b valuation. The reason that he bought internationally with Petrochina and in Korea was because they were so cheap.
This all assumes that things sometimes trade at the wrong price. The framework is simple. Mistakes come from misassessing an industry, sometimes getting management wrong. You are going to make mistakes when you are looking at the over 50 businesses [that he has bought]. Mistakes are okay when you have a margin of safety.
Question 6: If you graduated from business school now and wanted to do what you are doing now, what would be your approach?
He would do the same thing. While there is more competition now, there are more opportunities. He wouldn’t waste any time. He bought his first stock when he was eleven years old, and if anything, would start earlier. He had read every book on investing in the Omaha public library by age nine.
It’s terrifically important to understand history. The Long Term Capital Management blowup in 1998 was a repeat of Northern Pacific in 1903.
These kinds of opportunities keep coming up not because humans are dumb, but because humans are human.
Working with your own money is more fun. He told the story of trying to sell GEICO to his clients when he was a broker in the early 1950’s. People wouldn’t touch it, so he’d try and scrimp up extra money to buy an extra five shares whenever he could.
He finds the game fun and always has. If you like it, keep practicing. It’s hugely important to buy stocks on your own. By doing that, you learn in a way that you can’t from reading books. Temperament and emotions are hugely important, and you need to experience that first-hand.
You want to go work around smart people who you admire. Make sure that you are doing what you want to do with interesting people. He told the story of the HBS student who picked him up at the airport in Boston for a talk years ago. The guy was 30 years old. Buffett asked him what he was doing after school, and the guy replied that he was taking a consulting job “because it would make his resume look good”. At a certain point, you need to jump in the pool. “It’s like saving sex up for old age.”
Question 7: What current business leaders do you admire?
Graham is up there. There are lots. In terms of one person, Tom Murphy is the guy he would go with, in terms of blending business talents, people skills, and qualities as a human being. Here is a great interview transcript with Murphy from a few years back. Murphy was the longtime CEO of Capitol Cities, which bought ABC in the 1980s.]
Murphy is now 80 years old, but if Buffett had a business to run and could convince him to run it, Murphy would hit it out of the park.
Question 8: Comment on your change in investment style and recent dabbling in silver, currencies, etc.
He does what he understands. He has been buying junk bonds for 50 years, doing arbitrage since he was a teenager. The currency bet originally had a positive carry, although that is not true anymore. If he had to make a bet about the dollar declining over the next ten years, he would say the odds are pretty high.
Silver has an interesting history. [My notes are fuzzy here]. The government was involved for a long period of time. In the 1930’s, the government bought up large stocks at a fixed price. After World War II, there was a big demand increase, and a large imbalance built. There was a huge amount above ground, over 1 billion ounces. You could see the imbalances in the government’s published numbers. 400-500m ounces is mined each year. Production is largely a byproduct of other metals (copper, etc), so supply is relatively inelastic. When prices get high, larger amounts come on from reclamation (melting down existing silver items), but normally reclamation is a small percentage.
In the late fall of 2002, buying junk bonds was like shooting fish in a barrel. His friend Howard Marks of Oaktree Capital was buying many of the same positions (telecom and energy) at the same time. Marks had a chart showing a list of the bonds and their price in the fall of 2002 and then 12-18 months later. The YTM on the bonds went from 30-50% to under 7% in 12-18 months. [Buffett showed a copy of this slide at last year’s annual meeting. That kind of jump in YTM implies a 4-7x jump in price.] You don’t need to do that many times in your life to get rich.
It’s crazy what happens in markets occasionally. In 1998, after the LTCM blowup, the spreads in on-the-run and off-the run treasuries were 30 bps.
Another example is the Resolution Trust Corporation in the early 1990s. All of the Savings & Loans went broke. Hundreds of billions of dollars in real estate were dumped on the government. The government officials in charge had no incentive to keep the properties and/or maximize the value they received in return. In fact, every time they got rid of a property, their lives got easier. All of the commercial developers were broke, so their was no buying competition. Buffett went in on a deal for the Woolworth building in downtown Manhattan near NYU. The lease was at $4/square foot and the building was clearly worth a lot. The building would surely release at over $20/square foot. It was a bet on foot traffic around NYU. They put in $8m. They later took out a non-recourse $26m mortgage. “You couldn’t miss”. Buffett half-mentioned a commercial building in Phoenix. The building had a $100m mortgage – two years earlier you could have easily sold it for $100m. When things blew up, no one would touch it.
“You will see a half dozen fish-in-a-barrel opportunities in your investing lifetime, with the water drained and fish not flopping anymore. The key is to make sure you are ready to act quickly when they happen”. In 1998, he got the call about LTCM on a Sunday. “You can make lots of money when people call you at home on Sunday.”
Question 9: What are your thoughts on the newspaper industry?
The Buffalo News is going downhill. Buffett won’t sell it because he has promised not to sell any of his businesses unless a) they will permanently lose money, b) there are labor issues, or c) the manager lies or steals. He started writing 15 years ago about how the economics of newspapers were no longer bulletproof. Forty years ago, newspapers and network television stations were the best businesses around; that’s not as true today. He told the story of the newspaper in Council Bluffs, Iowa. Back then, the newspaper owned the only megaphone in town that it made sense for local businesses to advertise through. Now, there are alternatives with cable and the internet.
The Las Vegas Review Journal – the area has seen explosive growth in population in recent years and it has seen a 15% decline in circulation.
Buffett told the story of World Book (which Berkshire bought through Scott-Fetzer in 1983). In 1985, the World Book encyclopedia cost $600 and sold 300,000 copies. It weighed over a hundred pounds and took up over thirty books. Now, that’s freely available over the internet.
“You can argue that my decision not to sell businesses is not economically rational, and I would agree with you. It’s just how I prefer to do it. But maybe it is economically rational. Craig Ponzio (Larson-Juhl) wouldn’t have called if he knew I might sell his business. We bought five businesses last year, none at auction, (because of this policy).”
Question 10: Why do companies sell to Berkshire instead of remain as standalone companies?
Businesses sell to him because he is solving a problem for them. In family businesses, when you get a few generations out, the ownership splits many ways, and families want a way to monetize the asset without losing control of the business. He gave the example of his purchase in Ben Bridge Jewelers.
When he is selling Berkshire as a buyer, he gives the following none-too-subtle pitch. “You have been working your whole life building up your business. It is your masterpiece. Selling to Berkshire is like putting that museum in the Metropolitan Museum. You know it will stay exactly as you left it, and won’t be touched it all. Or you can sell it to a Private Equity shop, which is the equivalent to a porn shop. Thhey will gussy it up, put in on display, maybe retouch the breasts, likely flip it to another porn shop in a year. Metropolitan Museum or porn shop, the choice is yours.”
Question 11: Would you invest in a hedge fund?
Yes, if a 30 year old Charlie Munger or Sandy Gottesman or Bill Ruane was running it, and they had all their money and their families’ money in it and were sharing in the downside. He has no complaint with incentive pay for hedge funds, he just wants to make sure the person running it is as committed as his partners. When he came back to Omaha in 1956, seven people wanted him to run money. He started with $105,000. He would setup the Partnership with the same fee structure today. [He kept 25% of gains over a 6% hurdle rate. Buffett mentioned offhand something about Charlie Munger recently turning his money over to someone to manage, although I am not sure if I heard correctly.]
You can occasionally find small groups of bright people who can do well over time. These people will be distinguished much more by temperament than IQ. You want to make sure that these people treat your money like it is their’s.
Question 12: What would you pay for a solid company that is growing earnings at 8-10%/year?
Not many companies will do that. You see a lot of garbage about EBITDA. Depreciation is the worst kind of expense in that it is prepaid. He looks at EBIT/EV. He’ll generally pay 7x for a decent business. For insurance companies, he looks at float and the cost of float.
He was CEO of Salomon Brother “for nine months and four days, and if you think I wasn’t counting, you’re crazy.” He found it fascinating that these bankers would run around creating pitchbooks for companies they had never heard of three weeks prior which contained projections going out years. When he asked them how much Salomon would earn next week, they couldn’t answer.
“It’s a joke.” Projections and how the numbers are dressed are ridiculous. He told the story of buying Scott-Fetzer. First Boston had been trying to sell the thing for some time and had put together several pitchbooks. Buffett ended up contacting the CEO directly and negotiating the deal with him. At the closing, the First Boston guy came in and collected his $2m fee. The banker went up to Charlie Munger with a copy of the pitchbook and tried to push it on him. Munger replied, “I’ll pay you $2m not to have to read it.”
Question 13: What would you do about the trade deficit?
Buffett rehashed what he wrote in his 2003 Fortune article, Why I’m not buying the U.S. Dollar.
The more trade, the better. Exports are 10% of GDP. Ricardo’s assumptions hold, but they didn’t consider IOU’s. He proposes a market-based “trade certificate” system; when U.S. companies export goods, they receive a matching nominal value of “trade certificates” that they can then sell to anyone who wants to import.
When foreigners want to cash in their dollars by buying U.S. assets, like the recent CNOOC case (large oil company whose assets are mostly overseas), Congress goes ape. This is not a good policy. It is hypocritical, and not good for stable politics over time. Other thean WMD’s, this will be the big political and economic issue in not too many years. [Buffett seemed to be emphasizing the political issue over the economic issue.]
posted by Ben at 8:14 PM
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