Rick Casterline made his annual trek to Omaha for theBerkshire Hathaway
Part 1 covered the annual opening film and preamble comments from Warren Buffett regarding Berkshire's newest purchase, Israeli cutting-tool manufacturer Iscar. Part 2, Part 3, andPart 4showed Buffett and Charlie Munger taking questions from the crowd. Today, the Q&A session wraps up.
Question: Who are some present-day mentors young people should look to?
Warren Buffett: You don't need to look to present-day people. If you learn the lessons of Tom Murphy, you don't need any others in business. The lessons are timeless. There's going to be a Harvard Business School case study on Cap Cities. If you learn certain lessons from the right people, that knowledge won't change.
[Editor's note: Thomas Murphy was CEO of Capital Cities/ABC until Disney (NYSE: DIS ) bought the company in 1996.]
Charlie Munger: We're not following the examples of any 40-year-old investors.
WB: I didn't know there were any 40-year-olds; I thought they were all 25. [Laughter]
Investing is not complicated; you work to find pockets of value. You didn't need a high IQ to buy junk bonds in 2002 -- you needed to have the courage of your convictions when everyone else was terrified, and it was the same in 1974. People were paralyzed. You need to learn to follow logic rather than emotion, and that's easier for some people to do than others.
CM: We had less competition when we were young, though. There weren't too many smart people in the investment business back then. Now, all kinds of bright people want to be in investment management. But in those days, we'd often be the only buyers.
WB: But Charlie, in 2002, there was lots of money and there were lots of smart people, and it was still easy to make a lot of money in junk bonds.
CM: Yes, but you get a lot of weird behavior during a convulsion like that. If you can be wise when everyone else is terrified, you'll do well.
WB: Two years ago, a lot of great companies in Korea were trading at three times earnings.
CM: That was a result of the Asian meltdown in the late 1990s.
WB: Yes, it took a big convulsion for Korean valuations to get so low. But there were plenty of smart people around, and all of the relevant information was freely available to them.
CM: Then name 20 more like that.
WB: If I had 20 more, I wouldn't name them.
Question: If you were starting today with $1,000,000, with a goal of 20% average growth for 40 years, what would be your strategy in the first five years?
WB: I formed my first partnership 50 years ago Tuesday with $105,000. You don't need to have a lot of great ideas. If Charlie and I were starting again, Charlie would say we shouldn't be doing this . but we'd be doing something very similar. Charlie would say we couldn't find 20 [investment ideas], but we don't need 20. We only need a few that can pay off very big. I'd follow the same strategy we follow now, although we'd be able to look at smaller stocks than we look at now. We'd have a tough time if trying to buy businesses. We'd have no reputation; we'd be too small of a player.
Charlie started out in real estate development because it took very little capital, and you can magnify brain power and energy in real estate, but, the basic principle wouldn't be different. If I were running a small partnership a couple of years ago, it would be 100% in Korea. We'd look for something that was mispriced and underowned.
CM: Finding a single investment that will return 20% per year for 40 years tends to happen only in dreamland. In the real world, you uncover an opportunity, and then you compare other opportunities with that. And you only invest in the most attractive opportunities. That's your opportunity cost. That's what you learn in freshman economics. The game hasn't changed at all. That's why Modern Portfolio Theory is so asinine.
WB: It really is, folks.
CM: If Warren were starting today, he'd put together a concentrated portfolio. Your one or two best ideas are way better than the rest. So when you act, you're thinking about how the alternatives compare with your best idea. But you don't want to own your 10th-best idea when you can use that cash to invest in your best idea.
Question: What do you think of Jeremy Siegel?
CM: Is that the fellow who likes common stocks over long periods of time?
CM: I would say he's demented. [Huge laughter]
WB: Well, he's a very nice guy.
CM: He may well be a very nice guy, but he's comparing apples against elephants in trying to make accurate projections about the future.
Question: How have your underwriting standards changed since weather patterns have become more severe?
WB: It will be hard to increase float by eight or nine billion [dollars] in the future. We are getting close to 10% of property casualty insurance. The earthquake experience of the past 100 to 200 years has more validity than the hurricane experience. What will the hurricane experience be over the coming 10 years? I don't know that for sure, but I think about it every day.
CM: We'd be out of our minds if we wrote weather-related insurance on the theory that global warming will have no effect. The laws of thermodynamics are such that as oceans get warmer -- and I think they are getting warmer -- storms will have more energy.
WB: When things go up 1% or 2%, costs can go up 100%. That's the game we're playing, but if we don't like the prices we're being offered, and we haven't in many areas, we don't play, and we're happy to have someone take our place.
Question: What about investing in health care?
CM: Too hard of a pile.
Question: Chapter 11 bankruptcy -- I know you've been active in the past. What are your thoughts on possible reforms?
CM: You have competition there, where courts themselves have gone into bidding contests to get bankruptcy business attracted. They have found that if they develop a culture where they overpay a lot of people egregiously, they can attract more business -- lawyers, consultants. I find this so unpleasant to watch, I don't pay attention as much as I probably should.
WB: We bought certain bonds [Ospreys] of Enron. A complicated bankruptcy can be opportunity for profit, but there are so many people looking at them, there is not as much promise right now, but more in the past. Fruit of the Loom, for example, Any time there is something that big and complicated, there is a good chance for mispricing. Big retailers are becoming brands of their own, and the struggle between retailers and manufactures will go on and on and be more intensified. Gillette and Procter & Gamble (NYSE: PG ) are better as a combined enterprise because of the strengths of the Wal-Marts (NYSE: WMT ) .
Question: What is the outlook for P&G's pharma business?
WB: I don't know a thing about the pharma business.
CM: That makes two of us.
Question: Back to the current [U.S.] account deficit. If you add up the current account deficit, you get about $4.5 trillion. Thus, net indebtedness to foreign investors is $4.5 trillion -- but it isn't; it is $2.5 trillion. So $2 trillion of our current account deficit is financed by capital gains. Does this mitigate your concern about deficits?
WB: We've earned more on American-owned assets in foreign countries than they own in American assets. Part of that is because if they own Treasury bonds they get 1%, but if we own theirs we get, say, 4%. This means a favorable net balance in interest income. That is turning somewhat -- our rates are increasing, and our direct investment abroad was made in earlier times, [thus giving] higher returns. But over time, it's going against us. The net debt is now more than $3 trillion, and that varies with what the dollar is doing. When the dollar is weakened, that brings down our net-debtor position. So inflation becomes an attractive position to politicians in the future.
CM: I haven't spent as much time on it as Warren has, but I share his pessimism. It's amazing how much ruinous behavior you can get by with if you're a successful government because of the reputation the U.S. has.
Question: Isn't insurance like gambling, and made for the house? Is insurance for the fiscally challenged?
WB: Gambling involves creating risks that don't need to be created, [such as] betting on where a little ball falls on a wheel that's spinning. If you own a home, the risk is there. You can watch a football game without taking on risk, but you can't live in a house without taking on risk.
CM: The whole concept of house advantage is a very interesting one. In a lot of investment management operations, the proprietors of the funds are taking a rake like the croupiers of Monte Carlo, only bigger.
Question: What do you think about naked short selling?
WB: As you know, we have a friend who's been outspoken on naked shorting. I don't have a great problem with it. If anyone wants to do that with Berkshire, more power to 'em.
[Editor's note: The friend in question is Overstock.com (Nasdaq: OSTK ) CEO Patrick Byrne, formerly CEO of Berkshire subsidiary Fechheimer Brothers.]
Companies with a large short interest very often have been revealed as frauds or semi-frauds -- not the one my friend runs. If someone is running something semi-fraudulent, they're probably pretty good at it. It's a very tough game and tough emotionally. If you buy, it can go down 20 points or up indefinitely.
CM: It would be one of the most irritating experiences in the world to find something crooked, and to short it, at X, and watch it go to 3X, and to watch them happily sloshing around in your money while you're meeting margin calls. Why would you want to go within hailing distance of that?
END OF Q&A SESSION
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