A full transcript follows the video.
This video was recorded on May 8, 2017.
Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You're listening to the Financials edition, taped today on Monday, May 8, 2017. My name is Gaby Lapera, and joining me in the studio is Michael Douglass, analyst, colleague, somewhat benevolent overlord. [laughs]
Michael Douglass: Well, when you put it that way ...
Lapera: Michael Douglass, how's it going?
Douglass: It's great. I'm a little bit sleep deprived after the Berkshire Hathaway meeting, but that's kind of par for course.
Lapera: Oh, you, hinting at what we're going to talk about! What a subtle transition!
Douglass: Yeah, look at me not burying the lead at all.
Lapera: So yeah, listeners, as you might have guessed, we're going to talk about the biggest thing in financials that happens every year, which is the Berkshire Hathaway conference.
Douglass: Woodstock for capitalists.
Lapera: I'm also really excited to have someone in the studio with me, no offense to John and Jordan and all those cool kids. It's really nice to actually see someone's facial expression as I talk to them.
Douglass: Yes.
Lapera: To know that my jokes have landed. I just assume that they have with Maxfield.
Douglass: Or not, as the case may be. We all swing and miss.
Lapera: That's true. Since I can't see them, I just assume they're laughing. [laughs] But, yeah, Berkshire Hathaway. Let's talk. You know what we should do, we should start by talking about, how is Berkshire Hathaway doing? What did Warren Buffett have to say about his company?
Douglass: Sure. Let's start one step further back: What is Berkshire Hathaway?
Lapera: Fair enough.
Douglass: At its core, Berkshire Hathaway is an insurance business. The way insurers make their money, there's two ways. They write a policy, you pay a premium, they pay out if you get into an accident. A lot of insurers lose a bit of money on the policies, but they make it back with investments. Berkshire Hathaway actually makes money on the policies and then makes more on investments. So it takes the float -- that's money that they received in premium income that they haven't paid out yet in damages -- and they invest that. Berkshire invests in two ways -- either in the stock market, and then also in wholly owned businesses. Berkshire owns a lot of brands you don't really associate with insurance, things like Brooks Running, things like Fruit of the Loom, things like BNSF railroad, Business Wire --
Lapera: All sorts of things. He's got a finger in so many pies, you don't even know about the pies.
Douglass: Legitimately. And I'm a Berkshire Hathaway shareholder. I've been reading the annual letters for a few years; I've gone twice. When I walked around the exhibition hall on Friday, I was like, I didn't realize they owned those guys, too. So it's sort of a constant thing. If you're dealing with Buffett and Berkshire, there's always something more than you're expecting.
Lapera: Definitely. Listeners who are interested in learning more about how insurance companies work, we're actually going to do a show on insurers in late May or early June, so get excited about that. I can already think of so many wonderful questions that people might have to ask. In fact, if you have a question about insurance companies, please email us at [email protected], and we'll see if we can answer it on that episode. Anyway, now that I'm done pitching myself ... [laughs]
Douglass: So, to circle back to your actual question --
Lapera: Berkshire Hathaway, in general, doing pretty well. For listeners who don't know, the Berkshire Hathaway insurance businesses include Geico, General Re, which is a reinsurance business -- anything else that I'm forgetting? I think those other big two insurance businesses.
Douglass: Those are the big two. They just acquired another one, but those are the big guns in that arsenal.
Lapera: Yeah. In general, it sounds like they're doing pretty well. But one of the things that I know Warren Buffett mentioned is they have a lot of money right now, and they're not 100% sure how to invest the float. What's going on?
Douglass: One of the problems, when you get to the size of Berkshire Hathaway, which has a market cap somewhere around $400 billion, and you are writing so much insurance business and you have a lot of float and a lot of cash just sitting there, it becomes difficult to make acquisitions that are actually going to move the needle. If you think about it, if you have a $1 million business, if you find a $100,000-a-year business, that's a 10% gain. If you're a $100 billion business, $100,000 does not matter. That's been their issue -- they really need to do big, transformative acquisitions, and it's difficult for them to find them, particularly at a good value. You look at the stock market; it's been on a bull run for a long time. I think one of their struggles, probably, is that they're not able to get necessarily good businesses at a good price, or a fair price, because prices are so inflated. So, what they basically said is, "We're going to try to invest this money. If we're not able to, we'll consider raising the floor for share buybacks and start buying back Berkshire shares if that's the best use of the money," and they even hinted at possibly instituting a dividend at some point.
Lapera: Maybe.
Douglass: Don't read too much into that.
Lapera: Historically, Warren Buffett has been really against dividends. He's been like, "I'm going to keep your money."
Douglass: "And I'm going to spend it making you more money, as opposed to just paying it back to you and doing nothing accretive to the business."
Lapera: Exactly right. And you mentioned also, they might increase the threshold for when they'll do share buybacks. Historically, I think he said it was below one and a half?
Douglass: 1.25.
Lapera: 1.25 book, then it was worth him buying back shares of Berkshire Hathaway. But they might raise the floor a little bit, so maybe it will be one and a half or 1.75 for them to start buying back shares, because they just can't think of anything else to do with their huge amount of money. It's kind of a nice problem to have, I guess.
Douglass: Yes, as those problems go.
Lapera: Yeah. But, one of the things that you talked about a little bit is they have to go for these really big, transformative businesses, so one of the things that they don't really do is buy into start-ups.
Douglass: Yeah. I think there are probably two reasons for that. One is, a start-up often takes a while to start moving the needle. Not everything becomes a Facebook overnight. Almost nothing becomes a Facebook overnight, Facebook didn't become a Facebook overnight. Then, the other thing is, Buffett, for better or for worse, his stance has always been a more value investor way of looking at things. So he's looking for proven businesses. Start-ups, by definition, are not proven businesses. In fact, they're often trying to disrupt proven businesses. So I think that's probably another of the hiccups for him, is that he's tending to look for stuff where he can look at the cash flow and be like, "Yeah, that's a good value for us," as opposed to something small and speculative.
Lapera: And I think another little bit of it is that he only likes to invest in businesses that he understands, and by their nature, start-ups are hard to understand frequently, like, what they will actually do.
Douglass: And that's why he's been shy about tech, generally speaking. It's not necessarily because he's opposed to tech or thinks tech isn't important. It's just that he and [Charlie] Munger don't think they have any advantage in evaluating tech. If they have other businesses where they can understand them better than anybody else can, they're going to go ahead and try to take advantage of market inefficiencies there, as opposed to in a tech space, where they're throwing darts at a dartboard as much as anybody else.
Lapera: Yeah. That's why it was kind of a big deal when he invested in IBM. People were like, "Oooh!" I think you said something about him talking about Amazon and Google at Berkshire Hathaway.
Douglass: Yeah. It's interesting. They've basically admitted mea culpa on IBM and have sold a third of their share. He's long been a fan of Jeff Bezos. Last year he brought him up, and probably in past years as well. He's basically said, on both Amazon and Alphabet, "We missed the boat, we should have invested sooner, but we can't identify everything." Berkshire also owns Apple shares, although they view it more as a consumer-goods brand play than as a tech company. With the iPhone and all the brand strength there, fair enough.
Lapera: Yeah, definitely. A couple things that I always like to mention whenever we talk about Berkshire Hathaway. One, most importantly, you shouldn't buy things just because Warren Buffett buys things. A, you don't know exactly what he owns. B, you don't know exactly why he owns things. Sometimes he talks about it, but like, for example, when he bought ExxonMobil, everyone was like, "Huh?" And it turns out that he just thought it was a better investment than having his cash sit around in cash. He was like, "This does marginally better than a savings account, so I'm going to buy ExxonMobil." That's not a great reason to buy a business if you're an individual investor. The other thing is, Warren Buffett is really big on index funds.
Douglass: Yeah. Actually, the 2016 shareholder letter, which was released a couple months ago, there was a whole section devoted to just Jack Bogle. And Jack Bogle actually came in and attended the annual meeting.
Lapera: Can you tell listeners who Jack Bogle is?
Douglass: Jack Bogle is the founder of Vanguard.
Lapera: Who we all have a huge crush on. [laughs]
Douglass: Yes. He pioneered the low-cost index fund. Buffett argues, I think correctly, that's he's basically done more for investors than anybody else alive, because he's been able to help investors cut out tens of billions of dollars in fees by moving to index funds.
Lapera: Low-cost index funds.
Douglass: Precisely. So Bogle was there, and Buffett got a question about why he's advised his wife, after he passes, to buy index funds. And he said, basically, for 90% or so of investors who aren't interested in doing the kind of work and due diligence and spending the time to really understand businesses, index funds give you broad diversification, A, and B, you don't have to be stressed about a specific business, because it's an index fund of the entire market. The implication was sort of, "If you're not really that engaged, don't buy Berkshire; buy index funds."
Lapera: Yeah. Although some people would argue that you're better off buying Berkshire than your average single stock, like a Google or an Apple, just because Berkshire is very diversified as a single stock, because they own all these brands that you mentioned earlier that are in all sorts of different spaces.
Douglass: Yeah, I think that's a fair enough argument. I would say, on the flip side, people who put their entire portfolio in one stock, it's generally not a good idea. I would cede to Buffett on this one and say, if it's one stock or an index fund, buy the index fund.
Lapera: Absolutely.
Douglass: If it's multiple stocks, and you're willing to do the time and due diligence and research and take your lumps when you miss, then I think -- I'm an individual stock investor, you are, too -- it's kind of what we do here at The Motley Fool.
Lapera: Yes, I am now an individual stock investor, as of January or February of this year. Thank you for helping me make that choice. I'm so pleased to own [Gilead Sciences]. [laughs]
Douglass: Can't win 'em all in the short term. If we have a long-term mindset, I am confident in that business long-term.
Lapera: Me, too, which is why I chose to buy it.
Douglass: Despite the pain.
Lapera: Yes. Anyway. The other thing he talked a little bit about during the conference was big trends he had noticed, and one in particular that could be a threat to Berkshire Hathaway, which is driverless cars, which you might not initially think of as a threat to Berkshire, but if you think about it, they make a ton of money off of Geico. That's where they get their float to invest things. If you have driverless cars, people need less insurance.
Douglass: Yes. If they -- driverless cars -- make the world safer, it's going to be a very good thing. But it won't be a good thing for auto insurers like Geico. That's definitely a threat. Of course, on the flip side -- and he highlighted another threat, actually, to Berkshire's business, BNSF, the freight railroad, that, basically, coal is on a long-term decline. People talk about bringing coal back, but economically speaking, it appears that it's just not going to happen over the long term. Freight railways like BNSF are going to suffer as a result, and they are looking for other things to carry instead of coal. So that's going to be an issue too. On the flip side, there were some positives. One thing he highlighted was AI [artificial intelligence]. He said he sees a lot of real opportunity in AI. Does that mean Warren Buffett is going to invest in AI? I don't know, you don't know, nobody knows. Warren Buffett probably doesn't know right now. But you can think about a lot of really good implications there for insurance. Imagine if your actuarial tables are built out by a computer that is able to find a little bit more efficiency than the average human being. There's a lot of opportunity if used correctly. He was definitely very bullish on it as a concept in the coming decades.
Lapera: Definitely. Actually, just to get back to the coal thing really quick, even though he's not very bullish on coal, he is pretty bullish on renewable energy, right? And they're making some investments in that space.
Douglass: Incredibly. It's Berkshire Hathaway Energy; they are a big wind and solar provider. Or a big wind provider.
Lapera: There's a lot of wind in Nebraska. So much wind. No one told me. I lived in Nebraska, for background. I lived there for two years. And everyone was like, "Oh, it's going to be so cold, you're going to be so miserable." No one told me about the wind! No one.
Douglass: It's a lot of wind.
Lapera: So much wind. It makes it so much worse. And I had to buy shorts to put underneath all my dresses, just in case, to make it all PG-cool while I was in Lincoln, Neb. A little embarrassing. I'm so sorry I told you that, listeners, but you can share in my shame now. [laughs]
Douglass: And when it comes down to it, Berkshire Hathaway Energy has been able to deliver energy cheaper than in connected states, and from competitors. So there's a real opportunity for them to dig out a moat for themselves in renewable, and that's something they're pushing pretty hard.
Lapera: Yeah. And the other thing, talking about transportation and coal and using energy, is the airline industry.
Douglass: Yes. Buffett was asked questions about the airline industry. Especially given the United incident, that's not surprising.
Lapera: Just for background, Berkshire owns --
Douglass: Four of the major airlines.
Lapera: Yeah, parts of the Big Four.
Douglass: Essentially, he and Munger -- it was funny; it's one of those things where two-thirds of their answers to questions about the airlines were saying it's not a great business. And then one-third was like, "Well, but here's why we decided to invest." It seems to me like they don't feel airlines are necessarily a home run or a grand slam, but they see it is a single-double kind of opportunity where you have -- passenger miles will increase over time, in the coming five to 10 years is their guess. If that's the case --
Lapera: Because of increasing globalization and people working all over the world.
Douglass: Yeah. If so, airlines should benefit, because they carry those people. Therefore, they bought the Big Four. And they bought the Big Four not because they thought they were necessarily the best positioned. They just wanted raw diversification and hadn't identified a single company that really seemed likely to disproportionately win.
Lapera: That's fair. Hedging your bets. Everyone does it.
Douglass: Yeah, including Warren Buffett.
Lapera: Including Warren Buffett. Listeners, in case you were curious about how Warren Buffett decides to purchase a company, to actually acquire a company, we have a couple articles that talk about it. Just hit me up at [email protected], and I will definitely send them to you. I think that pretty much covers everything. But -- this is fun, because we're at the Fool -- two questions for you. What was the funniest thing that happened while you were there?
Douglass: I've got to say, one shareholder got up and she said, "My question is, do you know any eligible bachelors?" [laughs] And she was like, "No, but really," and she really had a question about Bank of America warrants, which was a very good and thoughtful question, but it was a nice little moment, where Buffett and Munger both looked like, "Uh, I mean, we're sure you're wonderful, uh, uh," because what do you say to that? In an arena of 20,000-30,000 people?
Lapera: And it's also great to me because I love Nebraskans, but sometimes they're a little bit more bashful than us East Coasters. So I can just imagine the looks on their faces, like, "Oh. Oh, no." [laughs]
Douglass: They handled it very well. It was funny; it was a good conversation.
Lapera: OK. How about, what was a really cool thing you did while you were in Omaha? A fun thing.
Douglass: Reading a 10-K in my spare time is my idea of fun, so I'm not sure what "really cool" qualifies as. It was really nice to go to Gorat's, which is the steakhouse that Buffett recommends in his annual letter to shareholders. He's been recommending it every year since '95. And I had what he specifically recommended, which is the 22-ounce T-bone and the hash browns. It was very good. My colleague, Ana, and I went together. We took a four-hour walk afterwards to settle everything. But it was a really cool experience. We got to meet the owner, a really nice guy. I want to say a school classmate of Buffett's. That was really fun, and to think through, gosh, what things have probably happened in this restaurant, that Buffett had this idea, or bought Precision Castparts, or Apple, or whoever. So that was a lot of fun.
Lapera: Yeah, that's really cool. Warren Buffett is a super-interesting guy. For listeners who aren't very familiar with him, he actually lives in the same house he bought back in the '60s in this neighborhood in Omaha. It's just a nice little house. I've walked past it before. This is making me really miss Nebraska, Michael. [laughs]
Douglass: Well, sorry, and also I'm not sure how to react to that.
Lapera: I'm just getting feelings of nostalgia. Hello to everyone at Captain Jack's. I don't think you listen to my podcast, but you employed me while I was in grad school. Thanks for the tips and thanks for the beers. [laughs] Anyway, thank you so much for coming and talking to us about Berkshire Hathaway. I really appreciate it. Listeners, if you have any questions for us, like I said, I think I've pitched our email about a million times this episode, but I'm just so excited to hear from you guys.
Douglass: And one more time, that's [email protected].
Lapera: That's good, with a good baritone.
Douglass: I was trying for a smooth jazz radio voice.
Lapera: It's hilarious, because Kristine Harjes, who does the Healthcare podcast, she doesn't actually sound like that in real life. I'm her roommate, so I would know. She definitely does this [breathy voice] "Hello, my name is Kristine Harjes, and this is Industry Focus: Healthcare." And she just sounds like she's on NPR. She just sounds goofier in real life. Like, in a beautiful way -- don't get me wrong, but not like that. And I love it, it's like she turns into a different person as soon as she gets behind the mic. I think I sound about as goofy on the mic as I do in real life. [laughs] Anyway. As usual, people on the program may have interests in the stocks they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear. Thank you very much to Anne Henry, today's producer. I hear that you ran quite a bit recently.
Anne Henry: I did. I ran almost 23 miles in a weekend.
Lapera: Oh my gosh, that's many miles.
Douglass: I was about to say, that's about 18 miles more than I walked this past weekend.
Lapera: Yeah. Anyway, thank you both to Michael and Anne. For listeners who are curious about the puzzle, I wanted to thank you guys for submitting stuff. That was really awesome of you. We've actually been kind of overwhelmed by the amount of email that we've gotten from you. We're going to keep looking for other fun things to do in the future. We've actually already notified the 10 winners that they've gotten their answers in first. It happened maybe within five minutes of the Tech episode publishing, so we know you didn't listen to that whole episode. You should go back and listen to it, because I'm sure it's great. Anyone who is looking for the answers can go to the Motley Fool Podcast group, because we're going to post them in there this Friday. You have to ask for permission to join the group, but an admin will let you in sometime soon. It's Chris Hill. Chris Hill will let you in sometime soon, and if he doesn't, you can go ahead and email him and complain to him about it. Just don't email us about it. [laughs] You're welcome, Chris! So, thank you everyone very much for joining us. I hope everyone has a great week!
