In this episode of Industry Focus: Financials, Gaby Lapera talks with Michael Douglass about what he got to see this weekend, when he sat in on the Berkshire Hathaway (BRK.A -0.78%) (BRK.B -0.81%) annual meeting.
Find out what Warren Buffett and Charlie Munger had to say about how the company does due diligence on their investments; how their vast size is making investing harder for them; why certain investments of theirs aren't doing so well, and what they can or can't do about it; and some of the most entertaining questions from shareholders.
A full transcript follows the video.
This podcast was recorded on May 2, 2016.
Gaby Lapera: Buffett buffet. A look into the annual Berkshire Hathaway meeting.
Hello everyone! Welcome to Industry Focus, financials edition. Today is May 2nd, 2016. For our new listeners, Industry Focus is an investment-centered show that deep dives into a different sector every day of the week, and it's Monday so it's financials day. Listen tomorrow for consumer goods, Wednesday for healthcare, energy Thursdays, and tech on Fridays. Welcome to the studio. My name is Gaby Lapera and joining me today is Michael Douglass, our Financials Bureau Chief and analyst extraordinaire. I'm going to hop right into it. He got to go to Berkshire Hathaway.
Michael Douglass: Jealous? Are you jealous?
Lapera: I'm so jealous.
Douglass: A little bit?
Lapera: I hear it's the Woodstock of capitalism.
Douglass: That is a phrase many people use for it.
Lapera: Yeah. I'm really excited to have you here. This is kind of our sneak peek into what you saw in Omaha. I've actually already been to Omaha so don't describe the city. Just describe the meeting.
Douglass: Very mid-western. It was really the short answer for Omaha. Right? Sort of, kind of spread out.
Lapera: It's so spread out.
Douglass: And not very tall.
Lapera: Except for right in the center.
Lapera: Anyway. Berkshire Hathaway. Let's start with this. If you're a new listener or a new investor, maybe you don't get what the big deal is about Berkshire Hathaway and Warren Buffett and Charlie Munger, so if you could give a little explanation as to that. I'm going to lower my chair because I think Chris Hill sat here last and I can't reach the ground.
Douglass: That wouldn't be so great. By the way, thanks for having me. This is fun. Those who have been here for a long time and remember from back in the day and I -- I would say -- did a much less good job of hosting Industry Focus Financials and Healthcare. It's fun to be back and see just how much things have changed since the cowboy days.
Berkshire Hathaway. It's an insurance conglomerate and before you fall asleep, it actually does a lot of other stuff too. Essentially, this company owns a lot of brands that you know about but that you've never thought were all own by the same parent company. Essentially the way it does this is, Berkshire is really focused on insurance, particularly with Geico which you may have heard of, as the low-cost operator in auto insurance. It takes the money that's thrown off by this and some other businesses to sort of purchase new businesses and also to purchase investments in other businesses from time to time. Berkshire owns brands that you may have heard of: Dairy Queen, Fruit of the Loom, See's Candy, BNSF which is the ...
Lapera: Railroad company.
Douglass: Big railroad company. Berkshire Hathaway Energy, and just a number of different companies and that it wholly owns. Most recently Precision Castparts was a stock it picked up. Then it also ... Buffett also invests the float from insurance so that sort of ... The money that's been paid in and not yet been paid out. That's been paid in premiums and not yet been paid out in actual insurance costs to invest in a number of stocks. Buffett owns American Express, Coca-Cola, and IBM.
Lapera: Wells Fargo.
Douglass: Wells Fargo.
Lapera: You have to mention a bank on the financials show.
Douglass: Of course. Of course. The financial ... We must mention Wells Fargo. Sort of significant percentage of some of these really big companies. I think Berkshire owns over 9% of Coca-Cola. Really, really big stocks. Buffett and his Vice Chairman, Charlie Munger, are known for pithy commentary and just this sort of like long-term focus in investing. They're really value investors.
Lapera: They're also very mid-western.
Douglass: Yes. In what way?
Lapera: They are very mid-western in that they are plain folk.
Douglass: Oh yes. Very.
Lapera: Who have a wily intelligence hidden behind a folksy demeanor.
Douglass: I would say those are all very accurate. If you want to see a really well thought out investing philosophy, read Warren Buffett's annual letter to Berkshire shareholders. It's available on the Berkshire Hathaway website.
Lapera: They actually have compilations of it on Amazon that you can find for cheap. It's a really good resource if you're just starting out investing. A lot of his philosophy mirrors The Motley Fool's or perhaps we mirror his. I'm not really sure.
Douglass: He came sure so yeah, we mirror his.
Lapera: This is not a chicken and the egg debate. The chicken definitely came first.
Douglass: Buffett has been chairman of Berkshire Hathaway since 1965, or CEO since 1965, so he's been around in this business for a long time. One of the fascinating things about Berkshire Hathaway is that so within investing, people often talk about how difficult it is to pick stocks, how difficult it is to grow things faster than the market, unless you're day trading, and what Warren Buffett has done with Berkshire Hathaway is he's grown the book value of the company by over 19% a year. It's just been this tremendous ...
Lapera: Which is incredible. Again, if you're a new investor, the average growth for a company is not around 20%.
Douglass: Right. The S&P grows by 7 to 10% annually, historically, on average. It's just been this tremendous growth story and he's really showed that picking great businesses and picking great stocks, you can deliver out-sized returns if you invest for the long-term. He has just, sort of ... He was described by one shareholder as Dumbledore in a shareholder question. There were a few groans in the room, but it's very true that he is the dean of long-term investors these days, originally trained by, influenced heavily by Ben Graham who's kind of the father of modern value investing. He's changed over a little bit to not just become sort of a strict value investor but to also think about really good management and to be willing to even pay up a little bit for good management, like he did with Precision Castparts, which was the most recent major Berkshire Hathaway purchase.
Lapera: Thank you. I think this was a really good description of Warren Buffett, Berkshire Hathaway, kind of Charlie Munger.
Douglass: Yeah. Maybe a little long. Sorry about that. I can't help myself.
Lapera: You ramble. That's OK.
Lapera: I knew that coming into this. I just need to take a brief break from the show to mention to our listeners that we have a pretty rad 401(k) site that went live this morning. If you have any questions or need some help planning your 401(k), it's a really pretty great resource, so head on over to 401k.fool.com to check it out.
Transitioning into the second part of our show ...
Lapera: Which I don't think I'm supposed to say out loud. I think it's just supposed to be in the notes but just so you know, we're transitioning into the second part of our show.
Douglass: It's OK. In church sometimes I just read the bulletin, so that works.
Lapera: What do you think was the most important thing Buffett said, that individual investors should know about investing?
Douglass: It's really ... I appreciate you asking that, because it's the easiest question for me to answer and that's because Warren Buffett said, "The most important investing lesson you can learn right now ..." He very much telegraphed what exactly that was. He has this sort of long standing, famous bet with Protégé Partners, which he made back in 2006 and it's essentially -- which was over a decade predicting whether the cumulative returns of 5 hedge-funds picked or the S&P 500 Vanguard Index would win. Essentially Buffett's on the one side saying, "Listen, passive, low-cost indexing wins against this sort of fee-heavy, hyperactive, hyper-reactive management style that hedge-funds do." So far, it's not quite finished, but so far he's winning 3 to 1. We're talking 60-some percent gains versus 20-some percent gains. I want to say it was 21.9% return so far as the end of 2015, versus 65.7% on the S&P 500, showing that passive investing works. Really it's not reacting to the day-to-day. It's not freaking out about what one quarter earnings means or another quarter means, but really just sitting, watching, and letting it ride.
Lapera: Yeah, and that's cool that you mentioned Vanguard. Vanguard is a very, very low-cost way to invest. Their fees are so much lower than competitors. I think a lot of other funds, their fees run around 1% which when you're investing is huge. Vanguard is like 0.05, I believe, for their S&P.
Douglass: Yeah. It's a tremendously low-cost fund. The point that Buffett really made here was, for many investors, even for most investors, passive low-cost indexing is simply the way to go because if you don't have the time to do Charlie Munger and Warren Buffett style due diligence on a company, the answer really is something simple. Just not reacting and letting the growth compound over time.
Lapera: Let's talk about that real quick though, because Warren Buffett and Charlie Munger talked about how they do their due diligence when they go to purchase a company.
Douglass: Right. It was kind of funny, because the question was sort of implying that they were doing something wrong. "You don't hire the lawyers and consultants and look through the reams of paper and maybe how should that change?" Buffett and Munger were pretty upfront. They essentially said, "Listen, we don't sweat the small stuff. We've made investment mistakes. The investing mistakes we've made would not have been found. We would not have been able to prevent those mistakes by looking through another 5,000 sheets of paper and looking at the lease exit clauses on a bunch of stores." The problem was more a predicting where the company could be in a few years, predicting how management would react in a few years, and that's the sort of thing that you don't really get from written sources.
Lapera: They talked a lot about the things that they look for when they're looking for a company. They're looking for good management. They're looking for a good business model, and those aren't really things that you can see on paper. Of course, I'm sure they checked the fundamentals but ...
Douglass: Well, think about this from financials, you can look at your charge offer ratio, and that can be a useful proxy for a conservative credit lending culture, right? It can be a useful proxy. There are things you can find, but they don't require this sort of in-depth, like I'm going to read every email ever, by this company in my due diligence. I'm setting up a bit of straw man here but I think the point still is that all too often -- and this another point they made -- all too often in negotiations, people sweat the small stuff and then egos get involved and then the deal falls apart. Whereas for them, it's really key that they get a good price for the company that they are buying, and have a good company, and that's really about it. It's not about all these little minutia. It's really about getting the deal done at a price that they think they can make good money off of. It's hard to argue with 50 years of success.
Lapera: That's totally fair. That actually also brings up another question, talking about buying businesses. Warren Buffett has talked in the past or spoken about in the past the difficulties of Berkshire Hathaway becoming so large. He says that it's becoming increasingly difficult to find businesses that he can purchase or invest in that will move the needle in a dramatic fashion for Berkshire.
Douglass: Right. It's interesting because if you read online about Buffett and Buffettisms, and people talking about Warren Buffett and his wisdom, you'll often hear a lot about how Warren Buffett prefers non-capital intensive businesses. Things like See's Candy where essentially they're going to throw off a lot of cash pretty quickly, not require a lot of intensive investment, and just go ahead and just make money for you.
I think it was Munger, actually, who said it in response to a question about why does that change. He said, "Well, times changed and reluctantly our minds did too." As Berkshire's gotten bigger, they had to go for these sort of big capital-intensive businesses, because that's the only thing that's big enough to actually move that needle anymore. That's why you're seeing things like Precision Castparts, BNSF, the railway, entering the Buffett portfolio, and both of those are acquisitions in the last 6 years. Precision Castparts, in fact, closed earlier this year.
That's just the only way that they can really get the returns. Buffett actually sort of sign posted if they're unable to get future acquisitions like that, if they start finding that more and more difficult, they may raise the floor for their share repurchase. Right now, the rule at Berkshire Hathaway is, we would probably, they never say guaranteed, they would probably start purchasing stock at 1.2 times book value, because they believe the intrinsic value of the business is much more than that 1.2x. If they're unable to deploy capital more effectively elsewhere, they might end up raising that threshold to I don't know, I'm making up a number here. 1.3x, 1.4x. Who knows? I think that would be a sign that growth is really going to slow, sort of more permanently, and so I hope that they don't do that. I hope they're able to still take out their elephant guns and finding companies like Precision Castparts, and they said they'd love to find three or four more businesses like that.
Lapera: Yeah. This is something that Warren Buffett has talked about in the past that this is an advantage that individual investors have over at Berkshire Hathaway. That they can invest in things and it'll make a huge difference, as opposed to Berkshire Hathaway which ...
Douglass: Right. You got a 300 and ... I don't know what the price is today but it's roughly a $360 billion market cap company. If you buy out a $150 million market cap company, how much is that really going to move the needle? If you invest half a billion dollars in another stock, how much is that going to move the needle? Really they have to kind of look for these really big stocks or big companies to go after. Buffett has also been upfront about the fact that he killed the S&P back in the sixties and seventies. It's just been a lot tougher since then.
Lapera: I have a question. Did anyone ask any questions about some of the more, I don't know, some of the businesses that Berkshire's invested in that maybe aren't doing so hot right now, like American Express or railroad companies in general aren't doing great?
Douglass: Yeah, so there were a fair number of questions about incoming competitive threats and railroads, Buffett was upfront that coal is in a decline and that is going to affect all of our railroads, including BNSF, and so no matter how well BNSF manages ...
Lapera: Sorry. Just a break for our listeners. Railroads transports a lot of coal. That's where they get a majority of their income from.
Douglass: Yeah. I want to say it's ... I think I read a stat that it was something like 40% of freight volume in 2014. It's big, and that BNSF is going to report probably lower revenue through the rest of this year, compared to last year. That's probably a trend that will continue.
He also did talk a little bit about American Express. The general feeling I got was that they're very much in wait and see mode over the various companies that people see threats in, and they're pretty confident that those companies are going to do just fine moving forward given the overall secular sector trends. I think it's one of those things that we'll just have to wait and see. Again, I don't tend to be that deferential to management, because I think all too often management sort of has their own reason for wanting to present things a certain way. With Buffett, I'm really not so concerned about that. He's got a estimated $60 billion net worth and he's in his 80s and he pretty much does what he wants.
Lapera: Yeah. He's a final term president, essentially.
Douglass: Right. I don't think he's too ... I don't know. I don't think he feels much need to spend. I'm inclined to be pretty deferential and just say, "If it's good enough for Buffett, as a Berkshire shareholder personally, it's good enough for me."
Lapera: That's a resounding endorsement.
Lapera: Just to close the episode, I would like you to pick the best quote that you heard from the meeting.
Douglass: Sure. I'm not going to be able to quote it perfectly, but there was a shareholder who was a cattle rancher who ... I'll pick two because why not. The first one was there was a shareholder who was a cattle rancher who was basically like, "So, what do you think of cattle as an investment?" Charlie Munger said, "I'll take this one." He said something like, "I can't think of a worse business." He just laid it down. The thing is, Munger ... Buffett talks around things a lot, sort of like I do. Munger is the master of the one-liner. When he says something, it's just like, Boom. That. That right there. That's the quote.
There was another thing. It wasn't for the response itself but I think I mentioned earlier a shareholder was talking a lot about how Warren Buffett is Dumbledore and Berkshire Hathaway is Hogwarts, and this sort of long extended metaphor about long-term investing and magic. Once he finished his question, Warren Buffett said, "I haven't read Harry Potter but I'll take it as a compliment." It was just sort of like him being, "Sure. That's fine. I'll answer your question now."
It was a really good time. It was great to see so much energy. People had been lining up since the wee hours of the morning. It's really cool to see 20, 30,000 people at 7-7:30AM wide awake and excited and really happy. That is something that I never saw pretty much ever. It was a really cool thing to see and to experience that first-hand.
Lapera: I bet it must have been wild seeing the CenturyLink completely filled.
Douglass: Yeah. Not completely. There were definitely some bare patches but they were still pretty darn small. They streamed it online, in part to help reduce congestion.
Lapera: This is the first year that they streamed it.
Lapera: Which is very exciting. I know that we, The Motley Fool personally, decided to send less people as a result of the streaming. When I say less people, I mean 19 less people.
Douglass: Right. It was ... I always wanted ... It was rainy and kind of cold, so I'm wondering if a lot of the drop-off was also people saying getting out of bed and looking outside and saying, "Not today." Certainly that was one of the rumors going around. It was really a fantastic get together. Really cool to see all these CEOs of Berkshire companies just available and answering questions. I got to meet the CEO of Dairy Queen. I got to see a ton of people in R&D and in management positions, just talking to normal folks. That was really kind of an unique experience.
Lapera: This would be like a 12 year old girl meeting Britney Spears back in the 90s. This is the sense that I'm getting from Michael Douglass.
Douglass: Am I fanboying that hard?
Lapera: A little bit. It's OK though. I think a question that comes up every year -- I don't know if anyone has been brave enough to ask Warren Buffett directly yet -- is he's getting older. Charlie Munger is older than he is. How do they see that playing out for the future of the company?
Douglass: There was sort of a question about it. It was essentially so Ajit Jain is taking over more and more of the insurance part of Berkshire, and so the implication there was kind of ... The question was a little wandering but the implication there was, "Hey, what does this tell us about succession?" Buffett essentially said, "The fact that Ajit Jain is taking over more insurance is a sign that Ajit Jain is very good at insurance and you should read nothing into Berkshire's succession plans from it."
Lapera: Fair enough. That sounds like a Warren Buffett response to that question.
Douglass: "I'm doing what I want. Deal with it. Respectfully." Yes.
Lapera: That is all we have time for today. Thank you so much for coming on to the show. I really appreciate it. For our listeners, the mailbag episode is coming up. Send me your questions. I'll answer anything you might have questions about, but especially related to financial matters or personal finance. I guess I could also answer questions about baking and osteology if you really want to know my opinions on those things. I have them. I have so many opinions. I have opinions on everything. Not everything. That's not true.
Douglass: I have opinions on bad pop music, so have to talk about that any time.
Lapera: Fair enough. If you have any bad questions about bad pop music. Sorry. If you have any questions ...
Douglass: Any great questions about bad pop music.
Lapera: There's no bad questions. I have to say that. I used to teach. There's no bad questions. Unless the answer is in the syllabus then it's a bad question. Sorry. I got a lot of student emails that could've been easily answered by just reading the syllabus. Anyway. Thank you guys so much for joining us today!
As usual, people on the program may have an interest in the stocks they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell based solely on what you hear. Contact us at firstname.lastname@example.org or by tweeting us @MFIndustryFocus. Especially with those questions that I know you want to send me. Let us know if you have any questions about Berkshire Hathaway, and we'll try to answer them. Everyone, have a great week!