Recently, I had the pleasure of talking with Lawrence Cunningham, esteemed professor of law at George Washington University. Professor Cunningham has written numerous books about investing and business, including one of my all-time favorites, The Essays of Warren Buffett: Lessons for Corporate America. His latest work, a collaboration with former AIG CEO Maurice Greenberg, is titled The AIG Story.
Cunningham's classic on Buffett is a seminal text here at The Motley Fool, so that was the main focus of our discussion. Here's the full transcript of our chat:
Buck Hartzell: You're a prolific writer, in addition to all your teaching duties. We're here today to talk about the third edition of The Essays of Warren Buffett: Lessons for Corporate America. Thanks for joining us, Lawrence.
Lawrence Cunningham: It's a pleasure, Buck. Thanks for having me.
Hartzell: This is one book that the Fool uses to train all of its managers. It's required reading, and we think anybody that's a student of business, or certainly an investor or a manager anywhere should definitely read this book. We use it as a textbook for how we go about things in our business.
Cunningham: Yes, we use it, too, as a textbook. We teach a couple of different courses at GW. George Washington University is where I teach. We teach a little bit in the business school on corporate governance, and they use it in the Applied Portfolio Management course to train students in value investing.
Hartzell: As you reflect back on the first book, and now through the third version, is there a lesson or two that really resonates with you as an investor or a student of business?
Cunningham: Oh, yes. I guess probably the favorite (there are a dozen and they appear in different ways on different readings) and it applies in investing, business and life, is what I call the "son-in-law's test." This is his principle about only going into business to work with people that you would be happy to have your daughter marry.
Hartzell: OK...
Cunningham: He avoids working with people unless he likes them, admires them, and trusts them. That resonates with me, so I try to avoid working with people that I wouldn't want to have my daughter marry and avoid getting into businesses relationships with them. I think it's a wonderful test and a great principle to apply.
Hartzell: Absolutely.
Cunningham: I think the second thing was once you have that principle in place, it will take you a long way. A great example of that concerns the original publication of this book. When I first compiled it, he and I talked about publishing arrangements. He discouraged me from going with the big publishing houses who are these big, anonymous institutions that have their own set of interests and so on, and encouraged me, instead, to think about publishing it myself, which I did.
And then I went and teamed up with some friends of mine who run a small academic publishing house who helped me on the distribution end and things like that. Because I liked, trusted and admired those guys, we were able to make this arrangement without even any formal agreement or anything like that. It was just a handshake. Those are the kinds of things you get from thinking like Warren Buffett and reading through these letters. They've certainly meant a lot to me.
Hartzell: That is such a great lesson. You think of the quality of the people that exist at Berkshire Hathaway (NYSE: BRK-B). I think they've always said you can't do a good deal with a bad person, and certainly he's avoided that. Perhaps there's a book somewhere in the future that says, "All the Deals that Warren Buffett Did Not Do." I'd love to read that book...
Cunningham: [Laughing]. That'd be very interesting...
Hartzell: ...because he's had opportunities to do deals with bad people and he's passed on them, and those don't make the headlines.
Cunningham: Exactly, and I agree with you, Buck. One result of his application of that "son-in-law test" to his acquisitions is that the population of senior executives across Berkshire is -- I've met a lot of them, over the years, and they're the kind of people you like, trust and admire.
I mean, there are exceptions. A big organization like this that now has hundreds of thousands of people in it (including a very large number of senior executives) can make a mistake, or people can change; but for an organization of its size, it's extraordinary how delightful, how talented, and how capable that management group is.
Hartzell: Absolutely, and I think that's a great lesson for anyone to take away. This letter that Buffett puts out every year to his shareholders is required reading for anybody that's an investor or certainly a manager out there. One of the things that he highlights is that communication should come from the person who's running the business -- that the shareholders pay him to do it.
It seems that so many of these letters we read are form letters written by PR people. My question is when you pick up an annual report these days, how many CEOs do you think actually write their letters? Obviously we know Buffett does, and Carol Loomis helps him edit it. What percentage do you think actually write their own letters?
Cunningham: I'll bet it's very small. It's obviously hard to tell. No CEO is going to admit to this. But they're busy leaders. They're surrounded by handlers who advise them on everything related to PR, and no doubt take a lot of the job of writing these things away from them.
And one reason is that I think in order to get a CEO to personally undertake this task the way that Buffett does -- there's got to be something distinctive about the company. There's got to be something special about it that would lead a CEO to want to reach out so directly and personally, and put his own personality into it. Obviously, there are a few things that are special about Berkshire that have led Buffett to do this over all these years.
The first thing is that he conceives of the organization as if it were a partnership, rather than a large public company, so he sees himself as the managing partner and thinks that he owes it to his fellow partners to explain to them the kinds of things he's thinking about that he would like to hear from his other partners if they were making the disclosure.
That mind-set is reflected, too, in the fact that most Berkshire shareholders on January 1 end up being the same group of shareholders on December 31. There's very little turnover in the shareholder group. People are happy to hear the missive, every year. One year's report can build on the prior year's report.
The other thing that's kind of special about the Berkshire shareholder demographic is that a very large number of Berkshire holders still have a large part of their net worth in Berkshire stock. They tend not to be widely diversified (as many shareholders are) so it's worth their time to read an annual report -- a lengthy, thoughtful one. All of these things make Berkshire a little special.
A final thing is Buffett really is on both sides; that is, he is the manager reporting to his shareholders, and then he's got all these operating companies, all these subsidiary managers who report to him as a stockholder. So, he sees it both ways. He wants to hear from his managers the unvarnished truth -- warts and all -- directly from their mouths; not a polished bit of prose from the PR group. So, there are these very distinctive and special things about Berkshire that just don't distinguish the vast run of the Fortune 500 or the Russell 2000.
But I've looked through letters of other CEOs or chairmen, and there are only a handful that look like the personality that wrote them, and there's always something special about them. I'm thinking, as some examples, of Robert Walton at Wal-Mart, who has sort of a family vision for the company. People like Jeff Bezos at Amazon or Larry Page at Google -- they're the founding fathers of their company and so you really do get a sense that you're hearing from them. Rupert Murdoch, I think, also writes his own letters. They sound like him, anyway, and he's got sort of a journalist sensibility, writing for a media company. But unless there's something like that -- something peculiar and distinctive about the company -- I don't see the CEOs making the kind of investment that Buffett has.
Hartzell: Yes. And certainly we see with those people that you just mentioned, as well, that a lot of their identity, and certainly the bulk of their net worth, are tied up in those businesses, just like Buffett. I think like 99% of his net worth...
Cunningham: Yes. That may be like the unifying theme. It's all about eating your own cooking and being the owner/manager -- I know the themes that are important at The Motley Fool. That might be the thing to look for...
Hartzell: Right...
Cunningham: ...in quality communication.
Hartzell: Absolutely. Well, here at The Motley Fool we love owner/operators. We love people who are successful enough to do whatever they want to do in life, and have chosen to remain there and run those businesses. That's what they love, and we think you get good rewards as shareholders if you align yourself with those types of people.
When you look at the last 10 or 12 years that you've updated here in the 3rd edition, is there a message or a hidden theme in there? Is Warren trying to do anything special to prepare Berkshire, the business managers or shareholders, for life without Warren and Charlie? Is there anything that sticks out to you?
Cunningham: Yes, there are a couple of things. He's talked about succession planning for a long time, but you are right. That subject has been much more on his mind, and in the media's mind, in the last 12 years or so, just as a matter of aging and so on. The epilogue to this edition of the essays has a couple of explicit pages where he talks directly about what sort of specific technical planning has been going on in the last 12 years.
Especially since 2005, they've talked very clearly about defining functions -- splitting his job into an executive officer job, an investment officer job -- and then thinking about particular people who might go into those, not that they've been publicly disclosed. He explains that the board has discussed three people who could take over the CEO job, and recently hired at least two people who could handle the CIO job. He's much more direct and conscious and clear about that.
But to your point about the hidden message, I do think that there has been a commitment -- I think it goes back decades -- but it's been intensified in the last 10 or 15 years, which is that Berkshire Hathaway needs to be bigger than any human being. It needs to be bigger than Warren Buffett. There used to be a genuine concern 20 years ago. He always joked about what would happen if Warren Buffett got hit by a truck.
And there was a credible sense that, that company would become very different -- that it would be very hard to sustain his imprimatur. His personality was so attached to it that it might revolutionize in some ways. And I think a big part of what's been happening, substantively, in the last 15 years has been a cementing of Berkshire's institutional force. It's like a fortress. It's a machine. We now have this terrific base of insurance companies that generate reliable amounts of float -- these tremendous operating companies managed by terrific people with moats around them, with strength in their markets, run by terrific people that spin off substantial amounts of excess cash.
The business model is so instantiated, it's so in place that it would be hard for anybody to mess it up; certainly in a very short period of time. I think that's a little bit of what's been going on in the last 15 years substantively at the company, and it comes through in a lot of the discussion of the operational and strategic activities that have been going on at the company.
Hartzell: Right. Of those three possible candidates to take over the role of CEO, who do you think the most likely folks are for that position?
Cunningham: I think it's too hard to tell. I don't like to wager on that, because he explains that this is a moving target. Warren is fit as a fiddle and dancing into work every day. His life expectancy may now be closer to five years on an actuarial basis, but even that's a long time and you can defy those odds. Obviously, he mentions various people. "Tony" Nicely is always mentioned...
Hartzell: Right. Of Geico. CEO of Geico, yes.
Cunningham: ...and there are quite a few. There are quite a few people who could probably make a lot of the managerial decisions better than Warren could. I wouldn't want to gamble on the actual person. I know some of these fellows, and they are really just terrific people and I think, as he says, any one of them would do an excellent job.
Hartzell: Yes. They certainly have a plethora of "deep bench" right there who could fill in...
Cunningham: Yes, deep bench...
Hartzell: ...and do a great job. One of my favorite parts of the book is on the "institutional imperative" and I guess Charlie Munger calls that "monkey see or monkey do." You see a lot of corporations that whatever their competitors do, then they've got to go do it right away. Do you have a favorite lesson that Warren has imparted on you over the years that's benefited maybe your decision making?
Cunningham: Yes, that's a great question. I like the institutional imperative, too. It's a very interesting force in organizations about mimicking your peers, and also just the difficulty of changing an institution's course and the way that there's just a tendency in associations and enterprises to absorb all the resources available. I think that's a really powerful one.
My list of favorites might be revealed in the last page of the book, page 305. I call it a "concept glossary," and I list 10 concepts that have always stood out to me, and institutional imperative is on there. The thing I think is so powerful about this list is that they're concepts that Warren Buffett developed in the context of management and investing, but they're so powerful, they seem to be adaptable to nearly every other aspect of life.
Just to look down the list -- the "circle of competence" to start near the top. It's about sticking with your knitting. He's thinking about limiting his investment universe to businesses that he can understand because of his experience and background. It's such a basic, common-sense principle, but it's pretty useful to think about it in terms of the professional decisions you make, civic responsibilities you might undertake, or even parenting decisions about what you or your spouse might be better at in terms of certain supervision and things like that. So, I love that one.
I think the other really profound one is the "margin of safety." Warren says these are the three most important words in investing, and he attributes that notion to Ben Graham, his teacher. I think investing is about making sure that the price you pay is vastly less than the value you get -- that there's some big margin of safety in the price-value difference. Again, I think it's a great psychological outlook to carry around with you through all the decisions that we make -- that there's always a downside, and that ideally you've thought that through and tried to make a decision that gives you the best chance of a good result.
I'll take one more. The "dividend test" is a great one that comes out of corporate finance that says that a board is justified in retaining a dollar of earnings only if doing so increases market value by a dollar per share. This is a great commonsensical test, but it can be applied in a lot of other settings. I always tell my wife whenever we do home renovations that I'll only spend a dollar on the kitchen if it increases the market value of the house by a dollar. It's a "principle of prudence." And I love your institutional imperative example, but I think all 10 of my favorites are listed there in the concept glossary.
Hartzell: That's a great summary of certainly the big concepts, and I love that we can apply those to parenting, as well. I think there's value there. Going to the news recently. There's been some issues with the whale trades going on with JPMorgan (JPM 1.28%). It's interesting as you're reading through some of the testimony in front of Congress and all this kind of stuff -- it just seems that there's a lack of accountability to some degree, where nobody seems to be taking responsibility for losing $6 billion on a big trade -- not the person who ran the division nor the CEO of the company.
One of the things that has always stuck out to me for Buffett is that he always says, "I'm chief risk officer. I'm not just CEO and I don't outsource the role of chief risk officer." The question for you is -- and you come at this from a legal angle as well, being part of the law school there at George Washington -- why do think so many companies try to hide the truth from what's going on; not just from their shareholders but from other bodies? Why can't they just lead with the truth and then go from there?
Cunningham: Oh no, I think this is a very serious problem. The case of JP -- and it's not limited to it -- is it's not uncommon for people in corporations to point the blame at their colleagues, or in any event, just deny that they had anything to do with it. That kind of blame deflection does occur even at the highest levels.
You see them on boards of directors and with CEOs. I think that one reason it occurs is because -- I'll just come right out with it. Buffett is very clear about this. Especially at a financial institution like JPMorgan (but really at any large organization) the chief executive officer needs to be the chief risk officer -- that managing risk can't be delegated.
The thought is that boards of directors need to make it very clear to the CEO that she or he is responsible for risk, and when things blow up, her head is going to roll, and not somebody else's, because it's not going to be possible to blame this on a chief risk officer or subsidiary president or something like that.
And in fact, that lesson, that essay appears for the first time here in the 3rd edition. It's just from a couple of years ago. It's on page 77. He's so emphatic about it, and he's saying it's because this is the most important job, and it's the most consequential in terms of financial risk. Boards just need to say that a CEO is responsible, period, and it stops there. That's a big problem and it needs correcting.
I think another general problem that you see in corporate America is when people shade the truth or hide the truth a little bit -- the case of the whale trades as the first sets of disclosure (this wasn't really that big of a deal and it's not being understood properly). It's a lot of denial and obfuscation.
I think one of the big problems, here, that you don't see at Berkshire (another lesson I like from the book) is that one reason you get that kind of problem is that managers, up and down the chain, can overpromise and then find it hard to deliver and start to do things they shouldn't; either take trading positions they shouldn't, or make statements that they shouldn't. One of the culprits here, in my view (and it's pretty clear from the essays too) is that it's about our obsession with predictions. Analysts are very interested in what managerial projections are, what the earnings forecasts are, what the results are going to be next quarter and next year.
That's a very dangerous thing to do. No one knows, and no one really should be forced to predict, because as you predict, managers tend to be optimistic by nature. The projections tend to be a little more aggressive than they should be. You come up short. It's tempting to either deny that you come up short or hope that things are going to turn around, and you get into this cycle of cruel BS.
One thing that Buffett does -- Buffett's very clear that they never make predictions or projections at Berkshire. You read through these letters for 30 or 40 years -- they're never saying that they believe earnings per share are going to be anything in the future. It's just never done. That's a plight or a problem that you never have to encounter. It's a psychological condition you don't have to be in. But, good luck. I doubt that the Street is going to forget about projections.
Hartzell: I love when you read the letters. Usually Mr. Buffett leads with some kind of failure or poor result to start off a letter. It's usually like, "I messed up this year. Here's where we did badly." You never see that in other letters, and I think it builds trust and credibility in the rest, and it makes you want to read the rest of that letter, because you [think], I believe this person. He just told me where he messed up. Now I want to read the rest...
Cunningham: Exactly.
Hartzell: ...but nobody seems to want to follow that.
Cunningham: It's such a great point, Buck. I did a word search on the letters in the raw form and how they show up in the essays, and I did a little word cloud on it, too. The word "mistake" is one of the most common words used in the reports...
Hartzell: Oh, nice...
Cunningham: ...he's saying he made the mistakes all the time. I'm going to try and do an essay of my own writing about this -- about Warren Buffett on mistakes -- and try to analyze when does he admit them, what are they about, what do you get from them, lessons learned and stuff. And there's a great study capsule or study module in the question of mistakes at Berkshire. It's a very important thing, I think, for a manager to be able to say "I made a mistake..."
Hartzell: Absolutely. You think of all the learning...
Cunningham: ...but it's not an easy thing.
Hartzell: ...all the learning that's just been passed onto the next generation of leaders when you come out and admit that in public. It's hugely valuable. You mentioned corporate boards and that leads me into another question.
Certainly through 2008 and 2009 and the financial crisis we saw, I'd say, ineffectiveness is probably the kind way to put it when we describe the performance of corporate boards of directors. We saw bailouts. We saw multimillion-dollar bonuses coming in the next year because "we need to retain these people." How do we get boards to actually represent the interests of shareholders? It just seems like it's a broken institution. It doesn't seem to be working.
Cunningham: Well, I'll just start off with an observation about this that he makes in one of the letters that I excerpted in the essays about how old this problem is. It's one of the most vexing challenges in corporate governance and it goes back, as he puts it, at least 2,000 years to Jesus Christ...
Hartzell: [Laughing]...
Cunningham: ...he quotes from Luke about a certain rich man who told his manager, "... give an account of thy stewardship; for thou mayest be no longer steward." Directors have been thrown out, found wanting for two millennia or more, probably. So yes, it's a very hard problem that you mentioned. It's a serious problem, but it's a hard problem.
What Buffett constantly says is, "What I need to find in my directors are people who have just three sorts of qualities: they've got to be business savvy, they've got to be interested, and they've got to be shareholder oriented." That's your big point. Those are three big criteria. That's what he looks for. That's what he's looked for over the years, both in Berkshire, but more importantly his operating companies and at the investees.
But what you've got in corporate governance over the last 20 years -- none of those three things really show up...
Hartzell: Right...
Cunningham: ...there's been this extreme obsession, I suppose, with independence. The mantra has been you need to have people who don't have any other relationship with the CEO. Well, that doesn't deliver you any of these three things. It might get you some detachment. People might think that it gave a director a spine. That he's able to say no.
But it turns out that's not even true. The social structure of a board of directors makes it very difficult -- even for a person otherwise independent and otherwise meeting those tests -- to tell the CEO no, you can't make that acquisition, or no, that payment is too high. No, that executive compensation package is too high. We've put all of our eggs in the independence basket, and not enough in this basket of shareholder orientation, interestedness, and business savvy.
My own vote and what I'd really like to see (and I've written elsewhere about this kind of thing) is a return to a focus on expertise. This person is on this board because they understand what it takes to open a market, or what it takes to patent this technology, and how to turn that into value for stockholders. She understands how to think about value propositions and acquisitions and will be able to persuade people that they ought to oppose this one or support that one.
I share your concern, and I like the standard, the characteristics that Buffett lays out as the kind of directors we ought to be looking for, but I am afraid that the corporate governance machinery has been so focused on independence that we've lost sight of expertise. Maybe the pendulum will swing back because of episodes like those you mentioned.
And there's enough conversations. We're heading in that direction of people being more willing to say maybe it is more important to think about whether this person understands insurance or accounting or international affairs rather than whether they have no relationship with the company. I do hope we head in that direction.
Hartzell: Certainly when we talk about boards, I think one of the things that most of us (and I'm a shareholder in Berkshire Hathaway, as well) signed up for is that the board is eating their own cooking. They've got a personal stake in how things turn out at Berkshire Hathaway, and we could care less about the independence. If somebody has a big chunk of their own worth tied up in the company, we think they're going to act in our behalf, on the shareholders' behalf.
A question for you. It seems like there's recently been new board members introduced for Berkshire Hathaway. The newer board members certainly are straying, a little bit, from the eating of your own cooking, there. Obviously they haven't been around, as long, so they don't have as big of a stake.
But some of them have just really insignificant stakes in Berkshire Hathaway stock. I think Susan Decker is one of those. She has two shares, probably around $300,000 worth of Berkshire, which is insignificant to her worth. Do you think Berkshire is straying a little bit with some of their newer board members and caving in to the independence crowd by appointing some of those folks?
Cunningham: I'm concerned about that. I'd like to see her raise her stake. Four million used to be the standard at Berkshire. She is the exception. Everyone else has at least $4 million. Most still do. Charlie and Warren obviously have billions and the old guard -- certainly "Sandy" Gottesman has about $10 billion or something like that. It's really hard to know for sure. Tom Murphy. Even Ron Olson may not be billions, but it's a vast percentage of his own net worth -- $50 million to $60 million or probably something like that.
So, the old guard certainly had "eat our own cooking" in their bones. And you worry about whether we still have that. We certainly have Howard Buffett. Bill Gates, especially through the Gates Foundation, has a big chunk. But you're right. With Ms. Decker and the other newer people, Meryl Witmer, Steve Burke and Charlotte Guyman -- they have some, maybe $10 million or $15 million. It's something, but maybe not the kind of stakes we used to see.
And you do look at this board. It's a very different group than the traditional group. They're all much younger. They're in their fifties. The funny thing about Berkshire is that quite a few of the guys are octogenarians -- more than half. I mean Charlie, Warren, Tom Murphy, Sandy, Don Keough, Walter Scott are all in their eighties. Ron Olson is 71.
What's striking to me about that is that's one governance platform that Berkshire managed to repudiate -- the age limits for directors. I think in the late 1990s-early 2000s, the governance crowd advocated for age limits of 70 or 65, and a very large number of the S&P 500 adopted them. I was against that. It led to Jack Bogle being thrown out of Vanguard. I'm still against it, and I've written about this. It excludes talent from your reach. I would hate to see these six people thrown off the board because they're 80. And so, Berkshire defied that one.
But some of these others, the rule on independence -- so they had to add various people outside it. Charlie doesn't count as independent. Warren doesn't. I don't think Howard does. You've added these people, and I'm sure they're terrific, but it's a little different complexion and driven by governance rules.
The other notable thing about this is three of the four younger people are women, which had never happened before. That's probably a good thing, overall, but it's definitely a sign of the times. It's about the world that Berkshire lives in now is different from the world in which it grew up in the 1970s, 1980s and even in the 1990s. I think it's good question. Andrew Ross Sorkin might want to ask a version of that one at the meeting.
Hartzell: Right. I think that would be a good one, and particularly, as you noted, those people are the younger people on the board, so after Warren and Charlie and the great leadership rolls over, it could be that those are the people calling the shots, and certainly we would like for them to have skin in the game as shareholders.
One new thing that happened this past year was Buffett announced that he would buy back shares. That's kind of a big thing. He doesn't do that very frequently. It got a little, nice tick in the stock, and he said he'd do it at 1.1 times book value of the business. Shortly afterwards he changed his mind and upped it to 1.2 because he got an offer to buy back some shares, and he bought back a nice block of shares.
The question for you is we love this. We love when a company lays out a threshold of when they'll buy back shares, because let's face it. Most companies are awful at share buybacks. They either do it just for dilution, or they do it when they have leftover cash and they tend to buy a lot more shares when the stock or their price is richer, and they don't buy it back when it gets cheap. So, we love this threshold. Are you aware of any other companies that have that discipline that Berkshire announced? To lay out their buyback threshold and make it public?
Cunningham: Buck, I agree with all the preparatory comments you just made; and no, I'm not aware of it. I didn't do any thorough research on it, but from just general observations and conversations with the professional managers about Berkshire when they did this leads me to conclude that it's a rare thing for management to identify, certainly, a price. A breakpoint of 110% or 120% of book value is a very interesting metric, and very clear.
The thing that bothered me a little bit about that episode -- I think even leading institutions like the Wall Street Journal who questioned that buyback made misleading statements about it, like it was on sweetheart terms...
Hartzell: Right, yes!
Cunningham: ...and that really bothered me. First it was not sweetheart terms. It was at market according to disclosed parameters, and it's from a longtime shareholder. That's the kind of thing that's done in a partnership. It just defied everything that Berkshire had stood for to say that it was a sweetheart deal, or that it wasn't accurately disclosed.
I don't know of any other company who says they'll be buying up to 110% or 120% of book value. Obviously, anytime you do that; anytime you buy at the price that's lower than value, you're making good use of shareholder money. In this new edition, there's a really nice, new essay on how to think about a buyback. I think people will come to understand better the appeal of what he's done and how unusual it is.
Hartzell: And certainly we've seen Warren be a big fan of investing in companies that are buying back their own shares -- most recently IBM (IBM +0.90%), who he put about a $10 billion stake in, and they've been aggressively buying back their shares. And he has a pretty simple rule. You mentioned that essay. You have to have excess capital, and your stock has to be trading at a level that's significantly below its intrinsic value. It seems like it's only two steps. It shouldn't be that difficult, but yet CEOs across the landscape continually get it wrong on buybacks. Why do you think that is?
Cunningham: The benign reason would be that CEOs always think their stock is underappreciated, underpriced, and that they're actually getting a great deal. That's sort of the benign reason. The more pernicious one is the point that you were making -- that it's to offset the dilution that arises from issuing stock options and that sort of thing -- and just an indifference, in a way, to shareholder value. That they're actually using money that would be better deployed elsewhere.
And even Buffett, just to complete the point on what he says, has mixed feelings when he goes back into the marketplace and buys shares that are lower than their value. It's helping the continuing shareholders, but it's hurting most people. And the way he reconciles that mixed emotion is to say he is going to be very clear about what his assessment of the value is, and when they're going to buy, and at what prices; and then people can make their own decision about whether they want to separate at least part of their shares at that price or not.
Hartzell: Right. We have Berkshire Hathaway. We have these great lessons that Buffett has written and put in this nice book, and we have at least one company that's been successful at saying, "We can learn something from that Berkshire Hathaway model. We're going to actually copy it." That's Markel from down in Richmond, Virginia near Fool Global Headquarters here, and they've had a lot of success. Do you know of any other companies who have copied the Berkshire model? It seems that throughout corporate America, very few of them have taken any of these lessons to heart. Are you aware of other companies that are trying to enact the Berkshire Hathaway playbook?
Cunningham: I think that there have been particular lessons. I know senior managers have read The Essays of Warren Buffett. They get that there are important takeaways -- and I think on particular line items. You look down the table of contents. There are things that people have learned about governance, or investing, or common stock and so on. I think people get the importance of full and fair disclosure. They think more clearly about trying to attract business-savvy directors. They're careful about charitable contributions and executive pay. I think people take away individual lessons here and there.
I think it would be very difficult to replicate the entire organization, and all of its governance attributes, and even managerial philosophy because (I think it's the case, at least) Warren Buffett is and was a sui generis. He's a one-of-a-kind, kind of guy in that he had this vision back in the 1960s and had a group of people around him who all shared this.
It was very contrarian at the time and still, today, on how to value businesses, how to think about stock market prices; even how to manage an insurance company and how to turn the float into investment capital, and then to nurture it along this partnership sensibility, but into a large public corporation that just generates enormous float from the insurance side and tremendous excess cash from the operational side.
Then to have this one fellow able to make the managerial leadership decisions and also make the investment capital allocation decisions. It would be very difficult for me to imagine another Berkshire Hathaway. Applying, wholesale, all of the features to an existing or to a new company would be a long shot.
But to the extent the Markels, or others, have done it or have substantially done it or have the aspiration to -- a larger group of managers and people think there are some lessons in here that will work for them and that will apply in their company. I think that, that has happened and will continue to happen is probably very good.
Hartzell: Absolutely. And if you find a benevolent capitalist dictator, hang onto them as an investment, right? If you can find another one of those...
Cunningham: [Laughing] Exactly...
Hartzell: ...hang onto them, because you could have a long run.
Cunningham: Exactly.
Hartzell: Okay, great. Lawrence, we're going to do a thing we call Buy, Sell or Hold now. I'm going to ask you just a few quick questions, and you can tell me whether you're a buy, a sell, or a hold on those ideas, OK?
Cunningham: Gotcha.
Hartzell: Buy, sell or hold that Berkshire Hathaway will make large repurchases of its shares in the next year, which would mean that the stock, at some point, will probably have to trade below 1.2 times book value?
Cunningham: Actually, I'm going to hold on that one, because we've got the rule, right? We know what the rule is because of disclosure, so it's solely a question of market volatility. I'm going to hold on that, because I never am very good at predicting it.
Hartzell: Okay, good. Buy, sell, or hold Berkshire Hathaway will find another "whale" of an acquisition. That means that they're going to buy a company that's over $15 billion in value in the next year.
Cunningham: I'm going to hold again, because they don't come along very often. We had Heinz, already, this year. We didn't have anything in 2012. His criteria for acquisitions are fairly strict, and if [market prices] deviate from values overall, they're a little elevated rather than depressed right now. I'd hold on that one.
Hartzell: Okay. So, Warren will have to put his elephant gun away for the next year or so, perhaps.
Cunningham: [Laughing] Keep it out, but maybe not be able to pull the trigger.
Hartzell: Right, yes. This is an either/or. You have to be a buy on one of these. Are you a stronger buy on See's Butterscotch Lollipops or on See's Peanut Brittle?
Cunningham: I'm a very strong buy on the Peanut Brittle.
Hartzell: Okay, all right. You're along with the Hartzell children on that one...
Cunningham: Very good...
Hartzell: ...you're right along with it. Buy, sell or hold Berkshire Hathaway—the stock will beat the S&P 500 over the next five years. He famously said in the letter this year that they may actually lose for the first time over a five-year period to the S&P 500. I'm talking about the next five going forward.
Cunningham: Well, I'm going to buy on that one. I'll be out on a limb, a little bit. I find that track record difficult to fight with. That goes back to 1965-1969 that they've never lost that one, so I'm willing to go out on a limb on that.
Hartzell: And our last one. Buy, sell or hold that a personal investor would be better off buying the investment picks of Todd Combs and Ted Weschler than buying Berkshire Hathaway stock. Those two, who are in line to be the next co-CIOs of Berkshire Hathaway, reportedly beat the S&P 500 by double digits in 2012. Should you invest in their picks or buy Berkshire stock?
Cunningham: I'm with Berkshire on that. I'm going to sell on the proposition. What I said in the beginning to one of your first questions -- my sense is that Berkshire Hathaway has become bigger than Warren Buffett, and I think that it's bigger than any individual, even two rock star investors like those guys. So, I'm long on the company.
Hartzell: Okay. Well, they're certainly off to a great start, those whippersnappers, but let's hope that Berkshire, as a whole, can outperform their performance over the next year. Once again, Lawrence Cunningham, thanks for joining us here at The Motley Fool. The author of The Essays of Warren Buffett and a professor at George Washington Law School. We appreciate you joining us. Have a great semester up in New York City and hopefully you'll come visit us when you get back in the D.C. area.
Cunningham: Thanks, Buck. It's always a pleasure.
