Rick Casterline made his annual trek to Omaha for the
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 showed Buffett and Charlie Munger taking questions from the crowd. Today, the Q&A session continues.
Question: Are we in a commodities bubble?
Warren Buffett: I don't think there's a bubble in agricultural commodities like wheat, corn, and soybeans, but if you get into metals, there has been terrific move. . At the beginning, [prices are] driven by fundamentals, and at some point, speculation drives [them]. With copper, there was a little shortage, and then people got worried. It's that old story: What the wise man does in the beginning, the fool does in the end. Any asset class that has a big move that is based initially on fundamentals is going to attract speculation. The famous case always is tulip bulbs. Tulip bulbs may have been more attractive than daffodils. How far it goes, you never know. The eyes of the world never looked at silver when it was $1.60 in the '60s. My guess today is that copper is responding more to speculative pressures than fundamentals.
Charlie Munger: I think we've demonstrated all we know about commodities by our skillful trade in silver. [Laughter]
WB: I bought it very early and sold it very early. It's like Cinderella at the ball. At the start of the party, the punch is flowing and everything's going well, but you know that at midnight, everything's going to turn back to pumpkins and mice. But you look around and say, "One more dance," and so does everyone else. Everyone thinks they'll get out at midnight. Adam Smith [suggested] several years ago that the problem for that particular dance with Cinderella is that there are no clocks on the wall. The party does get more fun -- dance partners get prettier . one more glass of champagne.
This is what's happening with copper today, Internet stocks in 1999, and uranium stocks in the 1950s. The party does get to be more fun, and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice.
Question: Russia is doing better thanks to commodities. What needs to happen in Russia for you to invest there?
WB: I had breakfast three years ago with [Mikhail] Khodorkovsky [and] a translator. He was thinking about listing Yukos on the NYSE, but it would require registering [with the] SEC. I think it's hard to develop confidence that the world has changed there in terms of attitude toward capital. [Citigroup's] Walter Wriston once said that sovereign governments don't default. We found out in 1998 that they do. We inherited some energy-related assets in Russia, via Salomon a number of years ago. The authorities were happy to let us invest when we were using our money to drill, but when the time came to take the oil out, they weren't so crazy about us being investors. It might be a while before we invest there again.
It's hard to develop confidence that Russia has changed much in its view of capitalism and outside capitalists. At one point, we were concerned about the lives of our people there. When we went to pull the equipment out of the country, we got word that if we tried to pull the equipment out, not only would we not get the equipment out, but we wouldn't get the people out, either.
Question: What are your thoughts on the residential real estate market in the U.S.? Where is it headed? How is California different?
WB: We managed one time to develop a great piece of property in California for over 20 years.
CM: I think we got our money out, plus interest. [Laughter]
WB: That's not an exaggeration. We nurtured the land value, and we cashed out for 5 or 6 million dollars. We finished at the wrong time. What do you think it would be worth now, Charlie?
CM: Maybe $100 million. [Gasps from crowd].
WB: Everything is wonderful about it -- terrific climate, wonderful location, on the water. But from time to time, even in great localities -- you've seen it happen in New York a couple of times -- the swing in values has just been huge. What we're seeing in our residential brokerage business is a slowdown everyplace, most dramatically in the hottest markets. The market where you see the greatest falloff tends to be the high end, where people have bought for investment rather than use. People will pay $300,000 and mortgage $270,000 for the house, and if it goes to $250,000, they won't sell it or move if they have a job. But when you have investment or speculation-type holdings, when you've had day traders of the Internet move into the day trading of condos, then you get a market that can move in a big way.
Real estate is different from stocks. If you own real estate, there is a great tendency to look at the one that sold down the street a few months ago. In Dade and Broward counties [in Florida], for example, where the average condo was $500,000, if you go back to 2004, there were fewer than 9,000 condos for sale, and around 2,900 would sell per month, so turnover was less than four months. Now, there are 30,000 condos for sale, or $15 billion in property, and turnover is less than 2,000 per month. We have had a bubble in residential real estate to some degree. I think there will be downward pressure in prices, especially on higher-end properties. In Omaha, prices will be OK.
CM: Bubbles came in Manhattan and California. In Omaha, housing is quite reasonable, so the [rural] country is not all the same at all.
WB: I just got word that attendance [at the meeting] is 24,000 this year. Even better, at Nebraska Furniture Mart, which had 1997 sales of $5.5 million, sales last year were $27 million, and we're likely to do over $30 million this weekend, which is equal to normal monthly sales.
[Editor's note: Berkshire owns Nebraska Furniture Mart.]
Question: Dividends? I throw out clothes after I haven't used them in two years; with $40 billion in cash, should Berkshire do the same?
WB: Well, it won't go to Goodwill, I promise you that. We consider the normal level of cash at Berkshire as being $10 billion. It won't go below that. We need to keep some liquidity because of the [catastrophe insurance] business. We do not need $40 billion. We had $37 billion at end of March. We spent $4 billion on Iscar. We'd be happy to just have $10 billion in cash and to put the rest to work. I'm looking at one idea now that's low-probability that could take $15 billion. Whether it comes to fruition, who knows?
We don't like having excess cash around, but we like even less doing dumb deals, because if we do a dumb deal, we do it forever. It's likely, but far from certain, that three years from now we will have significantly less cash and more earning power. You're right to keep jabbing us, though. Neither of us likes cash. People come to us because they know we're so liquid, but we don't need to be this liquid. We will get more chances like PacifiCorp in the future.
CM: If you go back to the annual report of Berkshire 10 years ago and compare it to the last one, despite great difficulties of deploying cash, we've put an awful lot of wonderful stuff in Berkshire over the past 10 years. We're not gloomy about the process.
Question: It has been some time since there was a comment from Coca-Cola
WB: Coke is a fabulous company. It will sell more than 21 billion cases of various products, and that goes up every year. The stock in 1998 sold for over $80 per share when earnings were $1.50, and earnings weren't as good quality then as they are now, when they are $2.17. Every year, [Coke accounts] for a greater share of the liquids consumed by people in the world. They make a fabulous ROIC. Coke has 5 or 6 billion dollars of tangible assets and makes a similar amount on a pretax return. The stock got to a ridiculous level, but you can't hold present management responsible for that. Volume grows by 5, year in and year out, while the global population grows at just 2%. You can fault me for not selling any. We'll own Coke years from now.
[Chokes on peanut brittle]
WB: Peanut brittle gets caught occasionally, but it's worth it.
Question: How much has insurance hardened? Are people looking more at quality?
WB: When you say insurance, I assume you're talking about reinsurance. Other lines, like auto, have been softening. In auto insurance, our policies are up more than premium volume, so the average premium is down a little bit. In reinsurance, in which we are a big player, there are great variances. For marine platforms on the Gulf Coast, prices are up dramatically, and they should be. In the past two years in the Gulf, reinsurers have taken in $2.5 billion and have endured $15 billion in losses. In the past few years, we've been the largest biggest mega-[catastrophe] carrier in the word, and I'm sure we will be this year, but our mix has changed. Prices are up a lot, but we don't know if our exposure has gone up even more.
We don't know if the experience of the past two years is to be relied upon more than the past 100 years. We do know that it would be silly to assume that the past two years are outliers. Atmospheric conditions and water temperatures have changed. We don't know all the variables and causes that go into hurricane frequency and severity. If the past two years are the most reliable indicator, we're not getting paid enough. If the past 100-year record is more reliable, we'll be making a lot of money.
The scary possibility is that the changes haven't stopped yet and that the past two years are not as bad as things get. When you start getting down to chaos theory, where seemingly insignificant changes can lead to huge effects, you can dream up some very scary scenarios. We will write in certain areas and certain coverages. We are willing to risk a lot of money, if we think we're getting paid adequately, but it's not like flipping a coin or rolling dice -- there are many changing variables. We have a lot of exposure to wind, heading into the third quarter, though not as much as we had a couple of years ago. Prices have hardened in that particular area. If we think pricing becomes overdone, we'll take down more risk.
We don't believe in modeling. The modelers don't know a thing. It's silly. We get paid for making guesses on it. Over a lifetime, we'll know if we were right. Even if there are low losses this year, we won't know if we were right.
It's still a business we like. If we have a super-super catastrophe, say $250 billion, or four times Katrina, which can happen, we would pay maybe $10 billion. We can pay, and comfortably pay, but many others in the industry would be in trouble.
CM: If you look at the record of past and if you average it out, it has been quite respectable, and why shouldn't we use our capital strength to get into stuff that makes other people frightened?
Question: What's your exposure to silver?
WB: We had a lot of silver at one time, but we don't have it now. The original decision was that the production and reclamation of silver was 100 million ounces less than annual consumption. Now a lot of consumption has gone down, for example in photography, but that's where there is a lot of reclamation as well, so it balances out.
Silver was out of balance, but there's now a lot above ground, and a huge amount could be removed from other uses, which could increase supply, which is what happened when the Hunt brothers tried to corner the market in the early 1980s. There are few pure silver mines; most silver is produced as a byproduct from other mining, so it's not easy to bring on added production. I thought silver would get tight. I was early and sold early.
You're right that a commodity doesn't earn anything, so unlike a company, in which earnings are accumulating every year, you have to sit with a commodity and hope for a shift in the supply and demand. It's a big drawback.
CM: We didn't get where we are by owning non-interest-bearing commodities. It's a good habit to trumpet your failures and be quiet about your successes.
WB: Well, we have a lot to trumpet, then.
Question: Is it a good strategy to invest in regions with high resources per capita?
[Editor's note: The questioner was hinting at Canada.]
WB: That's a little too macro for us. We prefer to worry about whether or not people will keep eating candy, and if they will pay more for it each year. We don't play big trends like demographic trends. There's too much money to be made year to year than worry about trends that take 10 years to play out.
CM: You'll note we recently failed to profit from one of the biggest commodity booms in history. We will probably continue to fail in the same way.
WB: Well, we'll think of new ways to fail.
Question: How should we address the risk of nuclear terrorism in the U.S. as investors?
WB: It would depend on the severity of the event. If you're looking for a way to profit from such an event, I'm sure there's some bank somewhere that will sell you a mortality derivative. State-sponsored usage of WMDs will happen some day. We've always had evil people. Thousands of years ago, if you were psychotic, you picked up a rock and threw it at someone. Later, they would use swords, and then they shot each other. But since 1945, man has had the capacity to use nuclear weapons. Some people say that the global elimination of poverty will end the nuclear risk, but the U.S. used nuclear weapons in 1945 when it was the richest nation on Earth. People will justify their use. What holds it in check is the lack of knowledge, and the degree to which materials are controlled, and deliverability. We are losing on all of those fronts.
As for how our company and stock will do, Berkshire is better set to survive than anyone else, but it won't make much difference.
CM: The chance of no nuclear device being used in the next 60 years on purpose is pretty close to zero. There's not much we can do about it, except take the consequences as they come.
WB: You can elect leaders who are very aware of the problem and devote efforts to mitigate it, but you can't eliminate it -- the genie is out of the bottle. In 2004, both [major presidential] candidates said it's the major problem of our time, but it is hard to address.
Question: Repurchasing question. Why does Berkshire buy Wal-Mart
WB: Most of the time, we would not be able to buy a material amount [of our stock] in terms of increasing the value of remaining shares. Trading volume is low. The act of writing about the buyback eliminated opportunity, much like the Heisenberg Uncertainty Principle. If the price is sufficiently suppressed, we will announce that we intend to do it and then see if we get a chance.
CM: A lot of share-buying, not bargain-seeking, is designed to prop stock prices up. Thirty to 40 years ago, it was very profitable to look at companies that were aggressively buying their own shares. They were motivated simply to buy below what it was worth.
Berkshire has the lowest turnover of any major company in the U.S. The Walton family owns more of Wal-Mart than Buffett owns of Berkshire, so it isn't because of large holdings. It's because we have a really unusual shareholder body that thinks of itself as owners and not holders of little pieces of paper.
Question: What do you think of business schools, and what advice would you give the new generation of "helpers" who want to follow in Buffett's footsteps?
CM: There are certainly a lot more helpers. What should you do to be like Warren Buffett? The best thing you can do . is reduce your expectations. [Laughter]
WB: If your wife is going to have a baby, it is better to call an obstetrician than [delivering] it yourself. If your pipes are clogged, it is better to call a plumber. Most professionals have value added to them over what the laymen can do themselves. In investments, you do not have that in aggregate, despite $140 billion in total annual compensation, and it does the same thing that one person could do if he spent 10 minutes per year thinking about his investments. It's hard to think of another business like that. Can you, Charlie?
CM: I can't think of any.
WB: And it has become a bigger and bigger business. And it is unique in that the more you charge, the more money you bring in. It is useful to be in a business like that. When I speak to students, I ask them to name a business like that. One great answer is running a business school, because the amount you charge is a sign of prestige. No one wants to go to the business school that charges $20,000 in tuition, but if the school charges $40,000, more do.
In the investment field, you now have large portions of investment managers who charge fees that, in aggregate, cannot work out for investors. Obviously, some do, but you . pay the manager 20% of the profits if they make money, and if they don't, they just close up and reopen later. If you charge this in an economy that's only growing a few percent a year, the math doesn't work. The question for you is how to pick out the exceptions, but everyone who calls on you says they are the exception. I will bet you that if you name any 10 partnerships with more than $500 million in assets and put them up against the S&P 500, they will trail the S&P, after fees, over time. Then again, I've identified good managers before the fact.
In 1969, when I closed my partnership, I recommended my investors go with [Sequoia Fund's] Bill Ruane and [First Manhattan's] Sandy Gottesman. If you know enough about the person and how they've done in the past, you can occasionally find someone. But if you're running a big pension fund, with everyone calling on you, you will likely invest in the best salespeople.
CM: I think it ought to be a crime to entertain a state pension fund manager, and it should be a crime for that person to accept [one]. Watching these managers go after the business is not a pretty site. The whole concept of the house advantage is an interesting one in modern money management. The terms of the managers of the private partnerships look a lot like the take of the croupier at Monte Carlo, only greater.
WB: Is there anyone we've forgotten to offend?
BREAK FOR LUNCH
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