Rick Casterline made his annual trek to Omaha for theBerkshire Hathaway
Part 1covered the annual opening film and preamble comments from Warren Buffett regarding Berkshire's newest purchase, Israeli cutting-tool manufacturer Iscar. Part 2 and Part 3 showed Buffett and Charlie Munger taking questions from the crowd. Today, the Q&A session continues, post-lunch break.
Question: What do you think of immigration reform? How will it affect business?
Warren Buffett: In Nebraska, there are plenty of illegal aliens, and they work in the meat-packing business in particular. I was at the airport and saw 100 people all shackled together. They were illegals in the process of being deported. I think illegal immigration is a problem, and it should be addressed quickly. I can't see shipping the 11 million people who are here illegally back to their home countries. I also think we should enforce the rules more aggressively and perhaps liberalize them some. A reduction in the number of illegal aliens in the work force might cause prices to rise somewhat, but it wouldn't likely have a big effect on the economy overall, or on specific industries. Who's to say, if Charlie and I were born elsewhere, that we wouldn't try to get in? So I'm sympathetic.
Charlie Munger: My advice is: If you don't like the results, get used to it. We have never had the will to enforce the immigration laws. What you see is what you'll continue to get.
Question: Which is the best school for finance?
WB: I spoke to students from around 40 business schools over the course of the year. Now we're doubling up, so that we put two groups together for visits.
The teaching of finance has improved over the past 20 years, but from a very low base. The flat-Earth orthodoxy of 20 years ago, of modern portfolio theory and the efficient market hypothesis, is breaking down. [The universities] of Kansas, Missouri, Florida, Columbia, and Stanford, among others, have good programs. Twenty-five years ago, you couldn't get a job or advance if you didn't go along with the EMH [Efficient Market Hypothesis] and MPT [Modern Portfolio Theory] orthodoxy.
Nowadays, students all think they'll get rich doing what Charlie and I do. The amount of brainpower going into money management is somewhat distressing, but it's a great time to be 20 or 25 years old and be getting out of school. A lot of students who come to visit say that they want to go into private equity or hedge funds. I'm not sure what the economy is going to do for basics like food and clothes. The Kansas students put on skits and try to sell me companies. Students at all of these schools are looking for companies I might buy.
CM: Half of the business school graduates at the elite Eastern schools say that they want to go into private equity or hedge funds. Their goal seems to be to keep up with their cohorts at Goldman Sachs (NYSE: GS ) . This can't possibly end well.
Question: Do people sell to Buffett or to Berkshire? Should you become chairman so the new CEO can get experience?
WB: When we pass, nothing will change, but my successor will probably be put on probation by the media for a while, maybe a year or so. The phone might not ring for a while. Bankers will try the new guy out to see if he'll bite on their deals, but soon it will become clear that the culture has not changed. Yardsticks won't change. The board won't change. There will be a hiatus of sorts, but it won't last long because the people the board has selected to run Berkshire are phenomenal, and Berkshire will remain one of a kind.
CM: I don't think it would work well to have a half-and-half management. We don't need an operating guy; we have people running the businesses, and the main thing is not to destroy or damage the spirit they have.
WB: There will be stories a year after I die headlined "Berkshire: One Year Later," but that will fade out, and my successor will put his own particular stamp on the place. Even after I'm gone, Berkshire will have the reputation of being a one-of-a-kind place for a business owner who cares about the future of his business but has to sell for some tax or family reason.
CM: Speaking for the Munger heirs, I hope they continue to wring the last drop of good out of Warren.
WB: At low pay. Once it happened, the arrival of my successor could be a positive, since it would demonstrate that the Berkshire culture is institutionalized and doesn't depend on one individual. I'm not in the same league as Sam Walton, but when he died, people saw that the business didn't depend on just one man.
Question: How should we give to charities?
WB: You have to pick the things that are most important to you. For many people, it's their church or their school, generally. To some extent, you should give to causes that give you personal satisfaction. I like to think of things that are important but don't have natural funding constituencies, but for most people, there's nothing wrong with giving to things that give them satisfaction.
You don't have to be as objective about that as you are when picking securities. I often go where my gut leads me. If I'm looking at giving larger amounts, I feel I have an obligation to focus on big societal problems that wouldn't get a lot of attention otherwise.
Question: When you invested in electric utilities, did you think of using those utilities for other things like carrying data over them?
WB: No. We're going to earn an attractive return on capital employed whether we transmit it the old way or whether some new way emerges. We strive to do a good job in keeping our costs down and our customers happy. We follow the rules and regulations of the states we do business in. When choosing which generating sources we use, we follow the will of the people in the states we serve. If they want to pick a more expensive way to generate for some reason, that is OK with us. We don't expect any big changes in the economics of what we're doing. We're not invested in the electric utility business on the expectation of deriving revenues from other activities.
Question: Are media companies less profitable today because of technology?
WB: People will always want to be entertained and informed, but people just have two eyeballs, and there are only 24 hours in a day. Fifty or 60 years ago, "media" for most people consisted of the local movie theater, the radio, and the local newspaper. Now people have a variety of ways of being informed, faster, and they have more entertainment options, but we still have only two eyeballs and 24 hours per day. No one has figured out a way to increase the time available to watch entertainment. And any time there's more competition, the economics of that business tends to deteriorate. Newspapers are still highly profitable, especially compared with tangible capital employed, but the outlook isn't nearly as rosy as it was 20 or 30 years ago.
At one time, network TV had a license from the government that was essentially the right to a royalty stream. There were basically only three highways to the eyeballs of hundreds of millions of people for advertisers like GM (NYSE: GM ) , Ford (NYSE: F ) , and Gillette to choose from, and they would pay a significant amount of money to get on those highways and advertise to a mass audience. But as the ways to get in front of people's eyeballs increases, the value of those highways decreases.
Few businesses get better with more competitors. The thing to do was to buy the NFL when it was first organized. There are now more ways than ever to transmit events, and value can be extracted from them in different ways.
We still own World Book. World Book used to sell 300,000 [encyclopedia] sets per year in the mid 1980s for $600 each. Then the Internet came along. The problem is that you could get a good bit of the same information without cutting down trees, delivering the books, etc. The problem wasn't that the product wasn't worth the money; it's that people have other alternatives. I don't see anything that will change this.
CM: It's a rare business that doesn't have a way worse future than it has a past.
Question: Talking about the trade deficit: We are addicted to foreign goods. Should we try to break this cycle? How will this affect foreign currencies?
WB: My views on the dollar are as strong as ever, perhaps a bit stronger. We are doing less in currency futures because as interest rates have changed, the carrying costs have gone from negative to positive. There are better ways for us to invest in foreign currencies. We like the idea of owning earnings power in other currencies -- that's one reason we're enthusiastic about Iscar.
[Reading a passage on large current account deficits:] "Countries that have gone down this path inevitably run into trouble." That was Alan Greenspan. When he said that in 2002, the current account deficit was unsustainably large, and now four years later, it's twice that big.
In my view, the problem is going to be significant. People talk about a soft landing, but no one has explained to me how this will happen. I think you will see significant consequences at some point.
CM: Generally speaking, it isn't good to have a large deficit and current account deficit. A great civilization may be able to withstand something like this for longer than you may have thought, but you'd think at the end there'd be a comeuppance, and you'd have to adjust, and it would be painful. Do you agree, Warren?
WB: Yes. I don't see how people say it's sustainable. The longer it goes on, the more chance that at some point, probably brought on by some extraneous affair, there are some big adjustments taking place. As for knowing when or exactly how, it's impossible to know that sort of thing.
CM: I have no special capacity to predict whether the euro is priced right. The fact that half of Berkshire's cash was held in non-dollar currencies at one point was an absolute non-event. It's been a very profitable non-event, but it's still a non-event.
Years ago, portfolio insurance was popular. People were selling it as a highly sophisticated way for large institutions to manage money and mitigate risk, and they earned a lot selling it. Then on Oct. 19, 1987, a relatively small amount of money that had been invested in portfolio insurance led to a one-day 22% drop. Each of the individuals who invested in portfolio insurance was intelligent, but in aggregate, they created a doomsday machine. I think the odds of something like this are magnified today compared to the 1980s. I don't know who will yell "fire," but when it happens, I'm sure the currency markets will play a role in the race for the door.
Question: Do you believe the CPI [Consumer Price Index] is a good measure of inflation?
WB: Bill Gross has written about this. If you go out to the Nebraska Furniture Mart and construct a price index, it hasn't moved very much, and in some areas, like DVD players, prices are down 75%, so there's been deflation. But I do think the CPI is not a particularly good index. I always get a kick out of it when [observers] say "core inflation . which excludes food and energy." Food and energy always struck me as something core. I mean, what could be more core than food or energy?
[Editor's note: Berkshire owns Nebraska Furniture Mart.]
Also, the CPI no longer includes housing prices because people said they rise faster than other prices, so now it includes imputed rent instead. But the rental factor has significantly lagged the rise in housing.
I do think the CPI has understated inflation, but everyone has their own way of living. If you sit around drinking Cokes all day, you don't face much inflation, but for someone buying a new house versus six to eight years ago and driving 30 to 40 miles to work, CPI has gone up a lot more than the numbers would indicate.
CM: I see it a lot at Costco (Nasdaq: COST ) -- there has been almost no inflation, but elsewhere there has been. I'm not going to feel sorry, though, for someone who's paid $27 million for an 8,000-square-foot condo in Manhattan.
WB: If you look at Wal-Mart's (NYSE: WMT ) annual report, its LIFO adjustment is peanuts. Here's a company with $200 billion in sales in the U.S., but its LIFO adjustment is not worth a dime, yet some of our businesses have seen substantial LIFO adjustment -- our jewelry stores, and our steel inventories at MiTek. Input costs in the carpet business went nowhere for 20 years, but now the adjustments are big, since oil is the main component, and we have $100 million or so in LIFO adjustments.
Question: Can you tell us about the acquisitions you've done over the past year?
WB:Russell (NYSE: RML ) is still in process; it'll probably be a couple of months before completion. . We bought [medical professional liability insurer] Medical Protective on the suggestion of [General Electric (NYSE: GE ) CEO] Jeff Immelt. I knew Immelt wanted to shed some insurance assets, and I suggested we'd be interested in that part of it, so we talked and made a deal. We also bought [utility provider] PacifiCorp.
One thing we haven't done is participate in any auctions. We get pitch books occasionally, but the projections are just plain silly. Maybe that's why no one actually signs the books. I'd love to talk to the people who wrote the books and bet them whether their projections will turn out to be right.
The owners of Iscar are keeping 20% [of their company]. They think Berkshire is the best place for their business and their people, and where they'll have the most opportunity to grow.
I don't know how many stories you read about a $4 billion deal, where there was no investment banker on either side.
CM: The interesting thing about it to me is the mindset. A lot of these new helpers don't have our mindset; they run around talking about doing deals. We talk about welcoming partners. The guy doing deals wants to do a deal and then unwind it in the near future. It's totally opposite for us. I think our system will work better in the long term than flipping deals. I think there are so many of them that they'll get in each other's way. I don't think they'll make enough money to meet their expectations by flipping, flipping, flipping.
WB: By charging fees, fees, fees.
CM: I asked a friend who just left a large investment bank, "How does your firm make money?" He said, "Off the top, off the bottom, on the sides, and in the middle."
Question: How would derivatives melt down progress?
WB: It's hard to tell who will yell "fire," or how many people would rush to the exits. LTCM [Long-Term Capital Management] affected the financial world in a big way. There were some pretty strange things happening during that period.
Look at what happened in the junk bond market in 2002 -- it closed for awhile, almost. It was chaos. In 1991, when we were in Salomon, in the middle of August, and on a Sunday, we were within about half an hour from seeking a federal judge to hand over the keys and go to bankruptcy. The law firm was drawing up the papers. Fortunately, the Treasury reversed itself. The Dow opened down a couple hundred points the next day.
CM: It could have been absolute chaos.
WB: There's a very interesting story, with an interesting moral. Nick Brady was Treasury secretary at the time. He was a Berkshire shareholder because of his long relationship with the Chaces.
[Editor's note: The Chace family founded Berkshire Fine Spinning, a textile mill that merged with Hathaway Manufacturing in the 1950s. Malcolm Chace III is a director at Berkshire Hathaway.]
CM: He knew about us and was following the story. He trusted you, Warren, and I think that mattered.
WB: The size of the exposure was nothing then compared to what it would be now. It's true that derivatives positions are more collateralized now. It's not an experiment that you would want to voluntarily conduct -- let's put it that way.
Question: What would you use for the margin of safety if investing in a newspaper?
WB: What multiple should you pay for a business earning $100 million pre-tax whose earnings are going to go down 5% per year? Newspaper multiples are uncomfortably high if you believe profits are going to decline. They're taking newspaper readers to the cemetery, but they aren't gaining new ones when they graduate out of college. The virtuous cycle isn't true anymore, but prices don't reflect this. We love them as products, and thought they were the greatest of companies with bulletproof franchises. We were wrong.
CM: I once thought GM was a bulletproof franchise. Now we put them both in the "too hard" pile. If something is too hard to do, we look for something that isn't too hard. What could be more obvious?
WB: It may be that no one has followed the newspaper business as closely as we have for as long as we have -- 50 years or more.
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